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Managing construction risks in Asia-Pacific
Indonesia
Insight

Managing construction risks in Asia-Pacific: Indonesia

The construction industry in Indonesia has long been considered the backbone of the country's economic and social development, and regulations are being continuously amended to ease complexity and expedite processes for businesses and foreign investors.

Indonesia represents approximately 40 percent of the ASEAN economy and population, and investors are particularly attracted to its strong economic growth and resilience.

The construction industry has largely been considered the backbone of Indonesia's economic and social development. In 2019, the construction industry registered an annual growth rate of 5.8 percent,5 and is expected to continue to grow throughout 2021 – 2024.

40%

Indonesia represents approximately 40% of the ASEAN economy and population

 

Are there any restrictions on foreign investment?

Foreign investment in Indonesia was first recognized in the Foreign Investment Law of 1967, which was amended and consolidated into the new Investment Law in 2007. Regulations are being continuously amended by the government of Indonesia, with the aim of easing complexity and expediting processes for businesses and foreign investors. However, there are some restrictions on foreign investment. These restrictions are contained in the Negative Investment List, which specifies industries for which foreign investment is closed, or open only up to a certain percentage of its capitalization.6 For example, a construction services business is open for up to 67 percent foreign investment (70 percent if the foreign investor is from an ASEAN nation).7 Before conducting business, approval must be obtained from the Indonesian government and any other relevant agency for the business sector.

An important requirement under Indonesian law is the use of the Indonesian language in a memorandum, agreement or contract involving an Indonesian party

 

Is your contract enforceable under Indonesian law?

Generally, Indonesian law recognizes and upholds the freedom to contract,8 subject to mandatory provisions of law.9 Indonesian law does not require the use of a particular standard form of contract. However, Law No. 2 of 2017 on Construction Service (Construction Law) requires a construction agreement to contain certain provisions including, for example:

  • A clause detailing work formulation, which contains the scope of work, including a clear description of the value of work, unit prices, lump sum and time limits
  • A clause for the period of work and maintenance to be covered by the contractor
  • A clause detailing the method of payment, including the employer's obligation to complete payments for the construction services, along with payment guarantees
  • Event of default provisions
  • A clause for termination upon a party's non-compliance with its obligations
  • A force majeure clause and
  • A dispute resolution clause

On April 21, 2020, the Indonesian government issued an implementing regulation under the Construction Law (GR 22/2020). The regulation provides clarity on, among other things: (i) the construction resources supply chain; (ii) direct appointment provisions (i.e., no public tender/selection process); (iii) aspects of public interest; and (iv) construction services agreements. For example, the Construction Law gives state companies the opportunity to directly appoint service providers under "certain conditions." GR No. 22/2020 sets out those conditions.

a. Penalty or liquidated damages clauses

Although the general principle of Indonesian law is that the parties are free to determine the terms of the agreement between them,10 it also provides that the terms of that agreement should not violate principles of fairness or a sense of justice.11 There is therefore a degree of uncertainty around the enforceability of liquidated damages clauses.

b. Exclusion and limitations of liability clauses

The principle of the freedom to contract allows contracting parties to limit liabilities, including for indirect or consequential damages. However, the enforceability of such restrictions is subject to principles of fairness (keadilan), customary practice (kebiasaan), and laws and regulations, as provided under Article 1339 of the Indonesian Civil Code.12 Limitations of liability for damages resulting from gross negligence or willful misconduct may be considered contrary to public policy.

c. Language and currency requirements

An important requirement under Indonesian law is for the Indonesian language to be used in a memorandum, agreement or contract involving an Indonesian party.13 This requirement applies regardless of the contract's governing law. If the agreement involves a non-Indonesian party, the contract must also be drafted in the foreign party's national language or English.14

Generally, the Presidential Regulation No. 63 of 2019 provides that parties may agree on the governing language of the contract in case of a difference in interpretation between the Indonesian and non-Indonesian versions. However, in the case of construction work contracts involving foreign parties, the Construction Law specifically states that contracts must be in both English and Indonesian, with Indonesian as the prevailing language in the case of dispute.15

Contracting parties must also be mindful that Indonesian law16 provides that the Indonesian Rupiah (IDR) must be used in all commercial transactions effected in Indonesia. Non-compliance with this law will result in one-year imprisonment, a fine of IDR 200 million, or both, unless a contracting party can satisfy one of the following exceptions:17

  • It is a transaction related to state revenue or expenditure
  • The revenue or awarding grant will come from abroad or go abroad
  • International commerce transactions
  • Bank deposits in a foreign currency or
  • International finance transactions

d. Conditional payment clauses

Under Indonesian contract law, freedom of contract permits parties to establish pay-when-paid clauses, which are not addressed by specific Indonesian laws or regulations. Such clauses allow contractors to make payments to their subcontractors only upon payment by the employer.

5.8%

Annual growth rate of the construction industry in Indonesia in 2019

 

How does a contractor secure adequate cash flow in Indonesia?

Indonesian law allows parties to a construction contract to freely negotiate the payment terms. Payment methods may include progress payments and milestone payments; parties may also agree to retain certain amounts in advance, only to be payable upon completion of the works.

Project delays often affect contractors' cash flow. The Construction Law does not generally address suspension or termination of project works. However, construction contracts often give the contractor the right to suspend its work while retaining title and rights over the goods and supplies used in the works. Indonesian law permits contractors to claim that title, the right to remove goods and materials supplied from the site that will remain with the contractor until it has been paid. Article 1459 of the Indonesian Civil Code also provides that ownership of goods will not be transferred as long as there is no handover from the seller (i.e., the contractor) to the buyer (i.e., the employer) for goods or supplies that are not fixed to the land. This means that the contractor may hold back the formal handover of goods until it has been paid.

 

When does a right to terminate arise from a breach of contract under Indonesian law?

The Construction Law requires contracts to contain a clause specifying the conditions for termination arising from a party's non-compliance of its obligations.

Otherwise, the Construction Law is silent on the grounds on which a contract can be terminated. Typically, parties will include provisions for an employer's right to terminate for a default or bankruptcy of the contractor. Similarly, the contractor is often entitled to do so if the employer goes bankrupt, or it fails to pay within a specific period.

 

When might the parties' obligations be amended, or performance excused, due to unforeseen circumstances?

The concept of force majeure is found in Articles 1244 and 1245 of the Indonesian Civil Code. To qualify as a force majeure event:

  • The event must have been unforeseeable when the parties signed the contract, and have caused the non-performance or late performance of one parties' obligations
  • The event must not be attributable to the affected party, and not within its control (the affected party must perform its obligations to the extent possible) and
  • The affected party must act in good faith

The burden of proof for demonstrating a force majeure event is on the non-performing party.

Under the Construction Law, construction contracts must contain a force majeure clause. Contractors must be mindful that while the concept of force majeure is recognized in the Indonesian Civil Code, it is relatively unspecific, and a party seeking to relieve itself from performing its contractual obligation may find it difficult to prove the necessary elements. As a result, parties are advised to include a clear force majeure clause in their contract. Ideally the clause should strike a balance between being broad (to take into account appropriate circumstances) and specific (so it is clear when it can be relied on).

 

How can disputes under construction contracts be resolved?

Under the Construction Law, construction contracts must contain a dispute resolution clause. Various methods of dispute resolution can be used:

  • Litigation: Construction disputes are categorized as general civil disputes. No separate court specifically handles construction disputes. Disputes will be heard by the District Court, and may be appealed to the High Court
  • Arbitration: This is the preferred alternative to litigation in Indonesia.18 The Indonesian National Board of Arbitration (BANI) and Indonesian Construction Arbitration and Alternative Dispute Resolution Board (BADAPSKI) are arbitration organizations that are commonly referred to in Indonesia. For international projects or large construction contracts, arbitration also commonly occurs under the ICC or SIAC Rules. Arbitration is governed by Law No. 30 of 1999 Concerning Arbitration and Alternative Dispute Resolution (Arbitration Law). Article 60 of the Arbitration Law provides that an arbitration award shall be final and binding upon parties to the dispute. The Arbitration Law also provides that the existence of a valid arbitration agreement precludes the parties from submitting the dispute to the Indonesian District Court.19 As a party to the New York Convention, Indonesia also recognizes and enforces arbitration awards made in other contracting states. Article 66 of the Arbitration Law sets out the requirements for the enforcement of foreign awards in Indonesia, including: The award must be rendered by an arbitrator or arbitral tribunal in a country which, together with Indonesia, is a party to a bilateral or multilateral treaty on the recognition and enforcement of international arbitration awards (e.g., the New York Convention)
    • The award may only be enforced in Indonesia if the award falls within the scope of commercial law, and is consistent with the public order
    • An award may be enforced in Indonesia only after obtaining an order of Exequatur from the Chief Judge of the Central Jakarta District Court and
    • If one of the disputing parties is the Republic of Indonesia, the award may only be enforced after obtaining an order of Exequatur from the Supreme Court of the Republic of Indonesia that will be delegated to the Central Jakarta District Court for execution

 

1 World Bank, https://data.worldbank.org/indicator/SP.POP.TOTL?locations=ID.
2 World Bank, https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=ID.
3 World Bank, '4.2 World Development Indicators: Structure of Output' (2019) available at: http://wdi.worldbank.org/table/4.2.
4 Cekindo Business International, Overview of Building and Construction Sector in Indonesia, available at: https://www.cekindo.com/sectors/building#:~:text=Indonesia's%20construction%20sector%20is%20growing%20at%207%2D8%25%20per%20year.&text=Between%202017%20and%202022%2C%20Indonesia's,USD%2021%20billion)%20in%202018.
5 Global Data, Construction in Vietnam - Key Trends and Opportunities to 2023, 30 January 2019, available at: https://www.giiresearch.com/report/time270545-construction-indonesia-key-trends-opportunities.html.
6 Negative Investment List 2016, available at: https://www.indonesia-investments.com/upload/documents/Negative-Investment-List-May-2016-Indonesia-Investments.pdf.
7 Negative Investment List 2016, available at: https://www.indonesia-investments.com/upload/documents/Negative-Investment-List-May-2016-Indonesia-Investments.pdf, at page 54, item no. 174.
8 Indonesian Civil Code, Article 1338.
9 Indonesian Civil Code, Article 1320.
10 Indonesian Civil Code, Article 1338.
11Indonesian Civil Code, Article 1339.
12 Indonesian Civil code, Article 1339.
13 Law No. 24 of 2009 on the National Flag, Language, Emblem and Anthem, Article 31.
14 Law No. 24 of 2009 on the National Flag, Language, Emblem and Anthem, Article 31.
15 Construction Law, Article 50 (3).
16 Law No. 7 of 2011 on Currencies, Article 21(1).
17 Law No. 7 of 2011 on Currencies, Article 21(2).
18 Karen Mills, International Bar Association, 'Arbitration Guide: Indonesia' (Report: January 2018) p 3.
19 Law No. 30 of 1999 Contracting Arbitration and Alternative Dispute Resolution, Article 3.

 

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