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Managing construction risks in Asia-Pacific
Philippines
Insight

Managing construction risks in Asia-Pacific: Philippines

The Philippines construction industry is expected to grow with the introduction of the "Build, Build, Build" initiative and the amendment of a number of laws that would loosen restrictions on foreign investment.

The Philippines is becoming an increasingly attractive place for investment as a result of its sustained economic growth, active labor market and favorable business conditions.

 According to a recent World Bank report, the Philippine economy carried its strong growth momentum from the second half of 2019 into early 2020. While growth in the Philippines decelerated in 2020 due to the impact of COVID-19, economic growth is expected to rebound in 2021 – 2022.4 Such economic growth, particularly as it relates to investments, is largely due to the government's ambitious "Build, Build, Build" infrastructure program. This program focuses on high-impact projects that are intended to increase the economy's productivity, create jobs, generate higher incomes and strengthen the investment climate to foster sustained growth. More specifically, the "Build, Build, Build" initiative is aimed at raising infrastructure investments to 7.4 percent of the country's gross domestic product (GDP) by 2022, as compared to the 5.1 percent figure in 2016.5

7.4%

The Philippines’ Build, Build, Build initiative is aimed at raising infrastructure investments to 7.4% of the country’s GDP by 2022

 

Are there any restrictions on foreign investment?

Foreign investment in the Philippines is regulated by the Foreign Investments Act of 1991 (Republic Act No. 7042, as amended). While it is the policy of the Philippines to attract, promote and welcome foreign investments, the Foreign Investments Act, and other special laws, place restrictions on foreign ownership in certain sectors. These restrictions are summarized in the 11th Foreign Investment Negative List (11th FINL) issued by the president through Executive Order No. 65 series of 2018.6 The restrictions most relevant to investment in the construction industry include:

  • A 40 percent limit on foreign ownership in respect of contracts for the construction and repair of locally funded public works (subject to certain exceptions under the Build-Operate-Transfer Law (Republic Act No. 7718, as amended)) and
  • A 40 percent limit on foreign ownership in the exploration, development and utilization of natural resources, except under a financial or technical assistance agreement entered into with the president for large-scale exploration, development, and utilization of minerals, petroleum and other mineral oils7

The 11th FINL does not provide an exclusive list of restrictions or exceptions to such restrictions. For example, the president may agree to waive or modify the application of nationality restrictions or preferences in the procurement of contractors for projects financed through official development assistance under Republic Act No. 8182, as amended.

The Philippine Congress is due to vote on legislation amending a number of laws, including the Foreign Investments Act.8 It is understood that these amendments would serve to loosen the restrictions on foreign ownership and foreign investment.

40%

Limit on foreign ownership in respect of contracts for the construction and repair of locally-funded public works

 

Is your contract enforceable under Philippine law?

The Civil Code of the Philippines (Republic Act No. 386, as amended) will apply to a construction contract that is both governed by the law of the Philippines and relates to a project to be constructed in the Philippines. Otherwise, the applicability of the Civil Code to a construction contract will depend on a number of factors including the governing law of the construction contract, place of performance of the contract and the nationalities of the contracting parties. For example, a contract for execution of a project in the Philippines that is not governed by Philippine law but where one of the parties is Filipino is likely to be sufficiently connected to Philippine law such that the Civil Code will apply to it.

The Civil Code defines a contract as "a meeting of minds between two persons whereby one binds himself, with respect to the other, to give something or to render some service."9 For a valid contract to exist, three requirements must be satisfied: consent, object and cause.10 A construction contract that is freely entered into and signed (signifying consent) for the construction of a specific scope of works (the "object" of the contract) in return for payment of a contract price (the "cause") is likely to satisfy these three requirements.

Generally, Philippine law recognizes and upholds the freedom to contract insofar as it allows contracting parties to freely agree on the terms and conditions of their contracts, provided such terms and conditions are not contrary to law, morals, good customs, public order or public policy.11

The Civil Code does not impose any specific requirements for the enforceability of construction contracts. There is no requirement under the Civil Code that contracts must be recorded in writing. This means oral contracts are enforceable, although this is subject to the application of the Statute of Frauds, which requires certain contracts, including those relating to goods, chattels or things in action at a price not less than 500 pesos, to be reduced to writing.12 By way of example, in the construction context, the Statute of Frauds would apply to an EPC contract (due to the procurement aspect of that contract) and, therefore, an EPC contract should be made in writing to ensure that it is enforceable.

Except where a provision of the Civil Code is drafted in mandatory or prohibitive terms, the applicable sections of the Civil Code are not compulsory—meaning parties are generally at liberty to contract out of them as they see fit. Subject to the mandatory or prohibitive terms of the Civil Code, where a construction contract contains provisions that are inconsistent with provisions of the Civil Code, the courts will generally look at the parties' intentions and treat the contract as the law between the parties, i.e., apply the doctrine of pacta sunt servanda, such that the terms of the contract will prevail over the Civil Code.

Examples of non-compulsory provisions of the Civil Code that parties to a construction contract may consider expressly contracting out of include:

  • Article 2200, which permits recovery of lost profit, in addition to actual damages and
  • Articles 1714, 1561 and 1566, which provide that where a contractor has carried out works using its own materials, the contractor is deemed to have given a warranty against hidden defects, unless: (a) the construction contract provides otherwise; and (b) the contractor was not aware of the relevant defects

a. Penalty or liquidated damages clauses

Under the Civil Code, liquidated damages provisions, defined as "damages agreed upon by the parties to a contract to be paid in case of breach thereof,"13 are generally enforceable. However, if the amount of liquidated damages provided for in the contract is found to be iniquitous or unconscionable14 the court (or an arbitral tribunal applying Philippine law) has the authority to equitably reduce such amount while still enforcing the liquidated damages provision.15 In reducing the amount of liquidated damages, the courts of the Philippines will consider, among other things, the actual loss suffered, or likely to be suffered, by the employer as a result of the relevant breach. The courts, however, cannot increase the amount of liquidated damages, although they may, in addition to liquidated damages, award exemplary damages.

b. Exclusion and limitation of liability clauses

Under the law of the Philippines, provisions seeking to exclude liability for future fraud are void.16 Similarly, and in the context of construction contracts, provisions seeking to exclude or limit a contractor's liability for defective work are void if the contractor acted fraudulently. Provisions seeking to exclude or limit liability for gross negligence and willful misconduct may also be considered contrary to public policy and, therefore, unenforceable. Aside from these limitations, the law of the Philippines generally does not restrict the losses or types of liability that can be excluded or limited by parties to a construction contract.

c. Conditional payment clauses

Philippine law recognizes certain conditional payment obligations, such as pay-when-paid clauses,17 provided such clauses are not contrary to law, morals, good customs, public order or public policy. 18 Under the Civil Code, conditional obligations that depend upon the will of a third person will take effect, assuming conformity of such obligations with mandatory provisions of Philippine law. Insofar as pay-when-paid clauses typically make payment by a contractor to its subcontractor contingent on the contractor's receipt of payment from the employer, such clauses would therefore fall within this category of conditional obligations.

Similarly, a pay-if-paid clause, which provides that a contractor is not required to pay subcontractors unless and until it receives payment from the employer, is also enforceable under Philippine law.19 A pay-if-paid clause, in simple terms, is a condition precedent to payment that shifts the burden of potential non-payment to the subcontractor. In effect, the subcontractor assumes the risk of the owner's non-payment.

 

How does a contractor secure adequate cash flow in the Philippines?

Pursuant to Presidential Decree No. 1746, the Construction Industry Authority of the Philippines (CIAP) has a duty to promote, accelerate and regulate the growth and development of the construction industry. The CIAP has recommended prevailing industry best practice with respect to payment terms for parties to a construction contract, which have the effect of helping contractors in the Philippines secure adequate cash flow.

Under CIAP Document 102 (Uniform General Conditions of Contract for Private Construction, as amended) for private construction projects, payment mechanisms such as monthly payments are frequently used to manage a contractor's cash flow.20 CIAP Document 102 recommends that an owner make an advance payment to the contractor for mobilization and purchase of materials, and that such payment is to be recouped pro rata in subsequent milestone payments.21 It should be noted, however, that CIAP Document 102 will only apply to a private construction contract to the extent necessary to deal with conflicts in, or supplement omissions from, that contract.

Contracts with the government of the Philippines for the construction of buildings and other infrastructure works are generally governed by the Government Procurement Reform Act (GPRA). Pursuant to the GPRA, and its Implementing Rules and Regulations, the Government Procurement Policy Board has issued standard bidding documents for the procurement of government contracts involving the disbursement of public funds for the construction of infrastructure works. These bidding documents envisage payment of an advance payment to the contractor of an amount not exceeding 15 percent of the contract price, with the advance payment being proportionately repaid by the contractor through deductions from its progress payments.

 

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

Philippine law states that in the event of a breach of contract, the injured party may choose between "specific performance" (i.e., the fulfillment of the obligation), and the rescission of the obligation, if the breach is so substantial and fundamental as to defeat the object of the parties in making the agreement.22

If expressly provided for in the construction contract, parties may also terminate the contract for specified reasons, such as bankruptcy or insolvency.23 Typically, a contractor is given the right to suspend work or terminate the contract upon written notice to the employer if the employer fails to pay the contractor an approved request for payment.

 

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

The Civil Code excuses contractual performance, or allows for the amendment, of parties' obligations if one of these things occurs: (i) a force majeure event;24 (ii) legal or physical impossibility;25 or (iii) a difficulty beyond the contemplation of the parties.26

The principle of force majeure under the Civil Code provides that "no person shall be responsible for those events which could not be foreseen, or which, though foreseen, were inevitable."27 In the context of construction contracts, this may include natural occurrences such as floods, typhoons, or an "act of man", such as wars, riots or terrorism. However, parties are free to contractually expand, or limit, the scope of events that may constitute force majeure.

Separately, the Civil Code provides that an obligor will be released from an obligation when the obligation becomes legally or physically impossible without the fault of the obligor.28 An event of legal impossibility refers to instances where the obligation is prohibited or prevented by law (e.g., the non-renewal of a work permit or contractor license, preventing a contractor from continuing its work). On the other hand, physical impossibility refers to an act that can no longer be fulfilled by reason of its nature. For instance, a contractor would not be in breach for failing to complete works on a building destroyed by fire through no fault of their own.

Philippine law does not provide clear guidance on the differences between force majeure and legal or physical impossibility. The two principles differ in that force majeure focuses on the nature of the event that caused the breach (i.e., whether the event was foreseeable or inevitable) and legal or physical impossibility focuses on the obligation undertaken by the parties (i.e., whether the obligation becomes impossible to perform).

The Civil Code also permits an obligor to be released from its obligation, in whole or in part, where the service has become manifestly difficult beyond the contemplation of the parties.29 This includes scenarios where there have been exceptional changes in circumstances, taking into account the risks assumed by the parties when the contract was signed.

 

How can disputes under construction contracts be resolved?

Disputes under construction contracts can be resolved through litigation or alternative dispute resolution methods recognized under the Republic Act No. 9285 (The Alternative Dispute Resolution Act of 2004) such as arbitration, mediation and the use of dispute boards.

  • Litigation: Disputes arising from construction contracts that do not contain arbitration clauses are resolved through litigation before the first and second-level courts in the Philippines
  • Arbitration: By virtue of Executive Order No. 1008 (Creating an Arbitration Machinery in the Construction Industry Authority of the Philippines), the Construction Industry Arbitration Commission (CIAC) was created in 1985. The CIAC's primary functions are to (i) formulate and implement an arbitration program for the construction industry; (ii) articulate policies and stipulate rules and procedures for construction arbitrations; and (iii) supervise the arbitration program and exercise the authority necessary with regards to the appointment, replacement or challenging of arbitrators.30

An interesting feature of Philippine law, as it relates to the resolution of construction disputes, is that where: (i) parties to a contract have voluntarily agreed to submit any disputes to arbitration; and (ii) the relevant dispute arises from, or in connection with, a contract entered into by parties involved in construction in the Philippines, that arbitration must be conducted under the auspices, and will fall within the exclusive jurisdiction of, the CIAC. Importantly, where these two requirements are met, the CIAC's mandatory jurisdiction will apply even where the CIAC is not specified in the arbitration agreement, and even where the arbitration agreement makes provision for another arbitral institution.

In this respect, therefore, the CIAC has exclusive jurisdiction over disputes arising from, or in connection with, construction contracts in the Philippines, whether the dispute arises before or after the completion of the contract or as a result of a breach thereof. This means that even where the relevant contract is not by its nature a construction contract, but the dispute in relation to that contract arises from a construction contract, the arbitration will nevertheless fall within the CIAC's jurisdiction.

By way of example, if a finance contract document is incorporated by reference into a construction contract (for example, in the context of project finance projects), the Philippine courts are likely to rule that any disputes arising under the finance contract document will be arbitrable before the CIAC. This is because the dispute arises from a construction contract. Parties to construction contracts should, therefore, exercise caution when incorporating documents by reference into their construction contract.

There is, however, scope for parties to challenge the jurisdiction of the CIAC on the following grounds:31

  • The dispute is not a construction dispute
  • The respondent was represented by one without capacity to enter into a binding arbitration agreement
  • The arbitration agreement is invalid for some other reason, or does not cover the particular dispute sought to be arbitrated or

Other issues of interpretation or nonfulfillment of pre-conditions to arbitration that are raised in the arbitration agreement

  • Mediation: Under the CIAC Mediation Rules, mediation is defined as a voluntary process in which a mediator selected by the parties in dispute32 facilitates communication and negotiation as well as assists the disputing parties in reaching a voluntary agreement regarding a dispute. A party may initiate the mediation process by delivering a written Request for Mediation to the other party in accordance with the CIAC Mediation Rules. If mediation fails to resolve the dispute after a non-extendable period of 48 days, the parties should refer their dispute to the CIAC for settlement.33

It is worth noting that while the Philippines has signed the Singapore Mediation Convention, an international agreement recognizing mediated settlements, the Convention has not yet come into force.

1 https://data.worldbank.org/indicator/SP.POP.TOTL?locations=PH.
2 https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=PH.
3 https://www.statista.com/statistics/578787/share-of-economic-sectors-in-the-gdp-in-philippines/.
4 The total value of construction contracts in 2020 amounted to PhP 275.81 billion, or USD 5.4 billion (at an exchange rate of PhP 1 = USD 0.02 on 2 October 2021), https://psa.gov.ph/content/construction-statistics-approved-building-permits-philippines-2020.
5 The Projects and Construction Review, 10th Edition, Ocampo, Manalo, Valdez & Lim Law Firm - Angela K Feria and Carlos Alfonso T Ocampo, 'A general introduction to projects and construction in Philippines', available at: https://www.lexology.com/library/detail.aspx?g=55250676-2afd-49f0-a0d6-0522f27678df.
6 https://www.officialgazette.gov.ph/downloads/2018/10oct/20181029-EO-65-RRD.pdf.
7 Art. XII, Sec. 2, 1987 Constitution of the Republic of the Philippines.
8 https://asia.nikkei.com/Economy/Philippines-pushes-to-ease-Asia-s-toughest-foreign-investment-rules.
9 Civil Code of the Philippines, Article 1305.
10 Civil Code of the Philippines, Article 1318.
11 Civil Code of the Philippines, Article 1306.
12 Civil Code of the Philippines, Article 1358.
13 Civil Code of the Philippines, Article 2226.
14 Civil Code of the Philippines, Article 2227.
15 Civil Code of the Philippines, Article 1716.
16 Civil Code of the Philippines, Article 1171.
17 Civil Code of the Philippines, Articles 1182 and 1183.
18 Civil Code of the Philippines, Article 1306.
19 Civil Code of the Philippines, Article 1182.
20 CIAP Document 102, Article 22.
21 CIAP Document 102, Article 32.
22 Civil Code of the Philippines, Article 1191.
23 CIAP Document 102, Article 28.
24 Civil Code of the Philippines, Article 1174.
25 Civil Code of the Philippines, Article 1266.
26 Civil Code of the Philippines, Article 1267.
27 Civil Code of the Philippines, Article 1174.
28 Civil Code of the Philippines, Article 1266.
29 Civil Code of the Philippines, Article 1267.
30 Construction Industry Authority of the Philippines, http://ciap.dti.gov.ph/legal-mandate.
31 CIAC Rules of Procedure, as of 22 June 2019, Section 2.4.1.
32 CIAC Mediation Rules, as of 19 November 2005, Section 6.
33 CIAC Mediation Rules, as of 19 November 2005, Section 10.

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The authors would like to thank Gulapa Law, Philippines, for its contributions to this chapter.

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