Consortium agreements: Key to a happy ‘marriage’

By Wang Jihong and Li Xiaodan, Zhong Lun Law Firm
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To meet the requirements of government, social investors often form a consortium to make a joint bidding for PPP/concession projects. It is common to participate as a consortium in PPP/concession projects that require large investments and long durations. Unlike other traditional consortium bids to become contractors only, after the PPP (public-private partnership) project is awarded, the members of the consortium often need to establish a project company as shareholders and co-operate for more than 10 years, or even decades.

Wang Jihong, Partner, Zhong Lun Law Firm
Wang Jihong
Partner
Zhong Lun Law Firm

In spite of such a long period of co-operation, during the bidding phase of the project, the government often only attaches a rough-and-ready consortium agreement template to the procurement documents. The consortium members often hastily sign the consortium agreement under tight time constraints in accordance with the template provided in the procurement documents, in order to get the project as soon as possible. However, after winning the bid, the parties perhaps find they cannot reach consensus on some key issues and then come to a deadlock. Such problems are becoming increasingly prominent.

The authors recently encountered such problems in an expressway PPP project with an investment of more than RMB40 billion (US$5.82 billion) and a co-operation period of up to 33 years. In the bidding stage, the consortium members signed the consortium agreement hastily, based on the template provided in the procurement documents. After winning the project, the project company could not be established because the parties could not agree on some core issues.

Due to the inability to meet the requirements of the establishment of the project company and the capital contribution specified in the investment agreement, the consortium members should assume joint and several liability to each other and would face the government’s confiscation of the bid bond and the risk of other material breaches of the contract.

In such situations, it is more likely for the state-owned enterprises of the consortium to become the main object of being held accountable to the government due to their high credit and strength. Therefore, social investors should attach great importance to the problems involved in these bids in the form of a consortium.

Professional due diligence is a prerequisite. Although the consortium is a temporary legal entity, the legal attributes of the joint and several liabilities of the consortium members determine the importance of choosing the partners in the consortium. Therefore, it is essential to conduct professional legal, financial and credibility investigations on the partners before signing a formal consortium agreement.

Li Xiaodan Associate Zhong Lun Law Firm
Li Xiaodan
Associate
Zhong Lun Law Firm

In some cases handled by the authors, private enterprises would boast about their co-operation strength, but when it came to due diligence, these private enterprises were unable, or simply refused, to provide presentable materials. Such attitudes often reflect insufficient strength, irregular operations, or a lack of basic modern corporate governance philosophy, from the partners. The consortium leader should pay high attention to such situations. If the consortium agreement is concluded due to the tight bidding time, it may sow the seeds of disputes for the next few years, or even decades. Meanwhile, since it is difficult for the consortium members to withdraw from the project after successful bidding, the authors suggest that relevant parties, especially the consortium leader, should conduct and complete due diligence on the partners in the first instance.

Timing and methods of execution of the consortium agreement. Bidding documents contain the format text of the consortium agreement and require consortium members to submit a signed agreement in accordance with such format at the time of bidding. According to the authors experience, the terms of the consortium agreement attached to the bidding documents are often relatively simple, and far from achieving the purpose of allocating rights and obligations, as well as the assumption of responsibilities, among consortium members. The authors suggest that parties enter into a detailed supplementary consortium agreement or cooperation agreement at the time of execution of the consortium agreement, attached to the bidding documents.

Essential terms of the consortium agreement. The consortium agreement attached to the bidding documents usually only includes the simple division of responsibilities among the consortium parties, their joint and several liability, execution of agreement with the tender, etc. According to the authors’ practice, the following matters are usually the necessary terms of a consortium agreement: the content of the work of the parties, and the sharing of rights and responsibility; capital contribution, capital increase, and the allocation of financing obligations for the project; the framework between a general contractor and subcontractors in the projects construction; the sharing and submission of the performance bond of the project; the operation and management of the project; the organizational structure of the project company and the distribution of posts in the corporate governance; the liability for breach of contract; the termination of the agreement and the withdrawal of the defaulting party; and the resolution of the dispute.

Withdrawal of the defaulting party. According to the provisions of the Company Law, if a shareholder of a limited liability company fails to fulfil its capital contribution obligations as agreed, it may lose its shareholder status via resolution of a shareholders meeting. The consortium, as the social investor selected by the government, is different from the shareholders of ordinary limited liability companies.

The following matters must also be noted when the shareholder qualification of the defaulting party is required to be cancelled due to breach of the contract by such consortium party: (1) the withdrawal mechanism should be agreed upon in the consortium agreement in advance and submitted to the government for record; (2) the withdrawal mechanism should also be specified in the shareholders’ agreement and the articles of association of the project company; (3) under the increasingly stringent policy of changing the shareholders of PPP projects, it is usually required to obtain consent of the government concerning the withdrawal of a defaulting party of the consortium.

The relationship among members of the consortium is like a marriage. The parties often see each others merits during the “dating” stage, and respective shortcomings are exposed after the “marriage”. The methods of maintaining the interests of all parties and the mechanisms of maintaining and dissolving the “marriage” relationship become particularly important. The preset of the “divorce” method is undoubtedly an effective means to solve this problem.

Wang Jihong is a partner and Li Xiaodan is an associate at Zhong Lun Law Firm

(Zhong Lun Law Firm)

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