Building in Latin America: When Projects Go South (of the Border)

By Israel Almodovar

October 31, 2019

In collaboration with Todd Metz, Founding Partner – Varela, Lee, Metz & Guarino

INTRODUCTION

A period of rapid broad-based increase in international commodity prices, also known as a commodity supercycle, started in the early 2000s.[1] The economies in Latin America — largely dependent on the export of commodities, especially in the mining sector — benefited from these price increases with an outstanding growth in the region’s gross domestic product (GDP).[2] As a result, the need for large-scale infrastructure projects to support the commodity boom led to an influx of international construction-related companies into the region. From owners to contractors and other construction industry players, Latin America became a hot spot for multicultural projects. But as the supercycle slowed down, starting around 2011, so did GDP growth in Latin America.[3]

Chart showing Latin American GDP.

This slowdown, combined with other factors such as corruption allegations, increased political uncertainty, and slow recovery of global oil prices, had a direct impact on the construction industry in the region.[4] However, as shown in the following graphic, after a few years of contraction, the industry is forecasted to start rebounding in 2018 based on projections of global oil price increases, dissipation of political uncertainties, and the predicted support by both stronger government spending and greater private investment in the construction industry.[5]

Graph showing contruction industry trends.

Moreover, the use of the public-private partnership (PPP) structure has become more popular in the region, requiring an adequate regulatory framework,[6] as well as teams with extensive experience in design, construction, operations, and project financing. These projects involve not only the mining projects to directly support the commodities market, but also the infrastructure projects to support the economic growth and social progress of the region.[7] As a result, the influx of international construction industry players into Latin America is expected to continue for both private and public projects.

In the following sections, and based on our experience, we describe several challenges that international construction industry players face in developing and managing projects in Latin America. With that said, we cannot forget that, while there is a tendency to view Latin America as a homogeneous region, it is really the amalgamation of more than 20 countries with a common language, but different laws, codes, regulatory environments, and cultures.

APPLICABLE CODES AND STANDARDS

Due to the nature of the work that requires the participation of international players in Latin America, most of these projects are contracted under engineering, procurement, and construction structures. In addition, a significant number of these projects are procured under PPP agreements, which include operations and, usually, financing.

The applicable codes and standards play a key role, especially in the engineering and operational phases of these projects. It is in this area where the diversity of Latin America becomes evident. For example, several of these countries are in highly seismic areas, requiring special attention to the local seismic requirements. Another typical issue is the use of international standards. In some instances, contracts require the use of United States standards, some of which may be unknown to some of the project participants, while others recognize several international standards. Some of these risks are mitigated by engaging local design consultants who have insight into obtaining proper permits (a potentially time-consuming effort) and who fully understand local requirements. In addition, companies often involve experts in international standards, although it requires certain coordination efforts among their design teams to obtain the desired compliance results.

Environmental regulations, important from an operational standpoint, are closely linked to project design. There has been a push in recent years for projects to be environmentally friendly not only during the construction phase, but also, and more importantly, during their operations. As a result, projects have to be designed to comply with these local regulations, equipment should be procured in order to meet the necessary requirements, and operations must be vigilant in maintaining the proper levels of service.

EQUIPMENT AND MATERIALS

The project participants have to recognize early on what equipment and materials will need to be imported. A similar assessment has to be done for equipment that will be used to construct the project. Once that assessment is done, the analysis switches to the regulatory structure and prohibitions the host country has in place related to importing materials and equipment, and obtaining clearance through customs. This is more than reading the regulations; a true understanding of how the process works and potential pitfalls, costs, and delays should be taken into account during negotiations and before entering into the contract.

Concessions from the host government may be required in order for the equipment and materials to be brought in. It is important to engage a highly qualified and reputable in-country consultant to assist in the customs clearance process to increase the likelihood of timely delivery. This includes careful review and correction of the necessary paperwork long before the shipments arrive in port. It also includes practical advice as to packing and identifying the contents in order to avoid inspection delays once the equipment or materials arrive. In addition to impacts to the project, customs delays often result in increased direct costs in the form of port and handling charges. If problems occur, the contractor must react quickly to identify the root cause and implement measures to avoid repeated mistakes. This may include increasing qualified staff and oversight at the point of origin of the equipment and materials. With respect to construction equipment, the contractor must understand the regulations and costs associated with removing (or abandoning) the equipment when the project is done.

From a contractual standpoint, the parties should identify who bears the risk of delays in the various phases from the point of origin through delivery to the site, including customs clearance delays. This risk is usually borne by the contractor, as it is in the best position to ensure compliance with regulations and practices. The issue becomes more complicated, however, if the process is affected by issues such as changes in customs regulations and/or staffing of the customs offices, strikes, increases in port traffic, and transportation restrictions. Whether these issues would allow for adjustment in contract price or time would depend on the contract terms. Failure to consider these issues up front will likely lead to a meaningful dispute.

LABOR

The proper assessment of how the project can and will be staffed will, in a large part, dictate the success or failure of the project. The first issue is the availability of qualified in-country labor. The assessment must include whether other major projects will be competing for labor when the project is scheduled to go forward and whether that changes if the project is delayed. The next issue is what it will take to attract labor to the project. In addition to compensation, issues include accommodations at or near the project site, time off, and travel to/from hometowns for travelers. Local labor requirements and potential union issues must be taken into account. This includes any required ratios of foreign labor to local labor.

The contractor will also want to bring in its own people to manage and supervise the project, as well as consider bringing in certain skilled labor that may not otherwise be readily available in the country. The contractor must understand the regulatory and practical difficulties that it may face in bringing people into the country and how long they may be allowed to stay. Coordination and contingencies are required, as the visa/ immigration process rarely goes as smoothly as planned.

Labor risk is generally borne by the contractor. Impacts caused by changes in immigration laws or regulations after execution of the contract may be a basis for a change/variation or force majeure event; however, it would still be incumbent upon the contractor to prove there was a change and that any immigration issues did not result from its own failures. Understanding the cost and schedule ramifications of not obtaining the quantity and/or quality of labor needed to perform the work, and taking measures up front to mitigate that risk, is paramount. If unanticipated events occur, notice and documentation of the problems should be undertaken immediately.

LOCAL REGULATIONS

In addition to the issues already discussed, it is important to keep in mind that local regulations vary from country to country. In this regard, there are two specific issues that appear to affect a significant number of projects in many of the countries in this region: (1) archaeological findings; and (2) social and community issues.

With respect to archaeology, many countries in Latin America have a rich history of pre-Columbian societies, and the remnants of those societies are widespread throughout the region. As construction projects are initiated further away from cities, and more in undeveloped areas, the possibility of finding ancient artifacts increases. This is an issue that must be considered in the early stages of the project at various levels.

The involved parties should be aware of the local regulations regarding these types of findings, starting with the required initial explorations, and discussions and clearances from local enforcement agencies. Furthermore, attention should be paid to the process required in case an archaeological finding is made during the project, as this process may be time consuming and significantly delay certain areas of work or the overall project. Issues related to contractual responsibility for obtaining permits and clearances, performing remedial work, potential force majeure declarations, time extensions, and cost considerations should be taken into account as well.

In addition, some jurisdictions will require that a contractor hire an archaeologist as a full-time project employee. However, and more importantly, any found artifacts are typically considered to be national treasures and, as such, the local governments and communities expect the involved parties to manage them with the proper level of respect and professionalism. To the extent archaeology is not given the same amount of priority in the country of origin of the foreign entity, this could be an unexpected cultural and project progress shock.

With respect to social issues, and again considering that a significant number of projects are being built in undeveloped areas, it is important to recognize that local communities will be affected. As a result, it is not uncommon to have consultations with these communities prior to the start of the project to obtain their consent, as well as to understand their concerns and needs. To mitigate these kinds of issues, projects often include not only the main construction work for the development of the project, but also significant social and community improvements, which are, in many cases, a win for everyone involved.

Despite efforts to coordinate with local communities, there has been an increase of those communities filing legal injunctions opposing projects, often resulting in both schedule and cost impacts. Project developers and contractors should be aware of and prepared to address these potential issues. Furthermore, some of these injunctions have been presented by people that are not necessarily the legal owners of the land where construction is taking place, but by people that claim an interest in that land. The developer and contractor should be aware of local regulations regarding land ownership in each specific country.

Thus, it is important to understand the contractual ramifications of these issues, from responsibility to obtain the required permits and consent, to time extensions and potential additional compensation rights.

These issues are key for one of the initial steps in the construction process: site access. Without the proper release of the site property or right-of-way, the progress of the work could be affected significantly. As such, it is vital to understand, early on, who bears the risk in obtaining the land for the project, and all the intricacies involved in the process of obtaining access to the site.

SECURITY

It is no secret that security is a key concern in Latin America. From potential robberies and stolen materials and equipment to the presence of drug cartels in areas where projects are developed, security can present some complex issues for all parties involved.

Companies typically hire a security consultant to perform assessments for the protection of the site, personnel, materials, and equipment, as well as work in place. It is important that this consultant has local experience and contacts, as they will provide the best source of information and intelligence during the course of the project.

Protection of project personnel is crucial and it should be comprehensive, including protection at the site, accommodations (be it at a project camp or private residence), and travel to and from the project site. Materials and equipment must be protected while in transit to the site, while stored, and after they have been installed. The latter shall also be part of a comprehensive security plan that includes gates at the site entrance (including random inspections), as well as protection of the perimeter and access roads, which are often unpaved, secluded, and unprotected.

Security during construction should not be the only protection from criminal elements. For instance, if an owner decides to hire an international contractor to perform the fabrication, transportation, and installation of certain pieces of equipment, the owner should take into account the security of these parts throughout the life cycle of the project. One key consideration is ownership and protection of the equipment, at various stages of fabrication and installation, if the contract for the work is terminated. Securing those assets based on the owner’s contractual rights should be part of the comprehensive security plan, as some of these pieces of equipment are fabricated in other countries, which may increase the difficulty of securing them.

CORRUPTION

It is well known that bribery and corruption are pervasive throughout the construction industry, to the point that the losses related to these issues, in addition to mismanagement and inefficiency, are estimated to reach $6 trillion by the year 2030.[8] Combined with the corruption issues that affect Latin America, some of which are making recent news headlines,[9] this can become a recipe for failure if not properly analyzed and mitigated.

Therefore, it is important for international players to understand the local regulations and perform the necessary due diligence with respect to potential local or regional partners, subcontractors, suppliers, and government authorities. The incorporation and enforcement of guidelines such as the Foreign Corrupt Practices Act in contractual documents is suggested to minimize and mitigate the risks associated with potential corruption and bribery issues.

CURRENCY

On all international construction projects, participants must consider who bears the risk of fluctuations in exchange or interest rates and the limits, if any, on repatriation of profits. Because the economies in Latin America have a history of being more volatile than in more developed parts of the world, there is an increased risk that the economics of a project will look vastly different at the end as compared to when it started. “Foreign exchange exposure” refers to the risk of changes in a country’s exchange rate hurting a company. The important issue is recognition of the risk and a plan to manage it. This may be in the form of a contract provision that allows for an adjustment in the contract price if there is significant change in value of one currency as compared to another. There are other products in the market that are available to a participant in order to hedge the risk. The different strategies are beyond the scope of this article, but our experience tells us that currency fluctuation is a risk that is often not fully appreciated until it is too late.

With respect to repatriation, participants need to appreciate restrictions that the host country’s government have in place which block cash flow back to the parent company. Are they taxed at an unfavorable rate? Is a certain percentage of money earned required to be reinvested in the country? The overall economics of the project must include these considerations.

CONCLUSION

There is expected to be significant opportunity in Latin America for international construction industry players due to stronger government spending and greater private investment in the industry. However, along with that opportunity come risks.

The issues addressed here, although not exclusive, are important considerations before entering into any contract. Early planning and attentive contract administration can significantly mitigate or help manage these risks. Again, we need to remember that Latin America is really the amalgamation of more than 20 countries with different laws, codes, and cultures. Therefore, there are no one-size-fits-all rules of thumb. Careful and independent evaluations should be made for each locale.


[1] Bertrand Gruss, “After the Boom — Commodity Prices and Economic Growth in Latin America and the Caribbean” (International Monetary Fund working paper, August 2014).
[2] Ibid.
[3] Data extracted from the World Bank’s database (https://data.worldbank.org/region/latin-america-and-caribbean).
[4] BMI Research, Industry Trend Analysis — Latin America Construction Growth Recovery Shifted to 2018, October 2017, http://www.infrastructure-insight.com/industry-trend-analysis-latin-america-construction-growth-recoveryshifted-2018-nov-2017.
[5] Ibid.
[6] Catalina Garcia-Kilroy and Heinz Rudolph, Private Financing of Public Infrastructure Through PPPs in Latin America and the Caribbean, The World Bank, 2017.
[7] The Economist Intelligence Unit, Evaluating the Environment for Public-Private Partnerships in Latin America and the Caribbean: The 2017 Infrascope, 2017.
[8] Peter Matthews, “This Is Why Construction Is So Corrupt,” World Economic Forum, Feb. 4, 2016, https://www.weforum.org/agenda/2016/02/why-is-the-construction-industry-socorrupt-and-what-can-we-do-about-it/.
[9] David Lipton, Alejandro Werner, and Carlos Goncalves; “Corruption in Latin America: Taking Stock”; IMFBlog; Sept. 21, 2017; https://blogs.imf.org/2017/09/21/corruption-in-latinamerica-taking-stock/.