Legal issues relating to water industry concessions

With the increasing commercialization of the water industry (particularly urban water supply and sewage treatment) in China, there has been a move from the original investment model, in which an investor negotiated and agreed on an acquisition, to the concession model, in which the government conducts a public tender process to select an investor or operator. The Accelerating the Commercialization of Urban Utilities Opinions, issued by the Ministry of Construction in 2002, and the Urban Utility Concessions Administrative Measures, issued in 2004, provide the legal basis for the system of urban utility concessions, including for the water industry.

Bid invitation and submission

In practice, the tender processes conducted by many local governments do not comply with the PRC Invitation and Submission of Bids Law or the 2004 Measures, perhaps due to haste or inexperience. The major problems are set forth below.

Non-compliant invitations to tender

The contents of invitation documents can be overly simple, full of errors, not legally compliant or impracticable. If a bidder requests clarification, the party inviting the tender may communicate with that bidder unofficially, and may be unwilling to give official written clarification or to revise the bid invitation documents. If the bidder insists on official clarification or revision, the bidder may be viewed as pedantic and difficult by parties that are oblivious to the seriousness and legal nature of the tendering procedure.

Difficulty in due diligence

The time, scope and procedure for a bidder to conduct financial and legal due diligence on a project during the tender process can be highly restricted. In some cases, the party issuing the tender will even go as far as to state that it does not give any warranties as to the truthfulness and accuracy of the information in the bid invitation documents. In practice, the bidder, spurred by a wish for commercial gain, may respond rashly before the circumstances of the project and the investment conditions become clear, only finding out after winning the bid that the descriptions of the project in the bid invitation documents were inaccurate. At that point, the parties have no choice but to reassess the project, with the investor conducting detailed due diligence. In this way, the bid invitation and submission procedure becomes meaningless, falling short of the standards required by the PRC Invitation and Submission of Bids Law. Further negotiations between the parties to determine anew the conditions of the project are inevitable.

Accordingly, we recommend ascertaining the form and conditions of the tender based on the true circumstances of the project; and inviting an experienced professional adviser to participate in the tender and evaluation work and to prepare bid invitation documents that are as legally compliant as possible.

The concession agreement

The issues currently affecting the commercialization of the water industry centre on concession rights and concession agreements.

A concession is a right to operate a certain urban utility product or service granted by the government to a project company for a certain period time within a specified scope. The concession agreement defines the rights and obligations of the project company and the government in the course of the operations, including the rights and obligations of the concession operator, the government’s undertakings and guarantees, and the compensation and indemnities to be paid out under various circumstances. Key points to consider in concession agreements are liability for breach of contract and the dispute resolution method.

Risk of breach by the government

Until the concession system became widespread, the duties of the government in water supply and sewage projects were typically specified in such documents as government support letters and minutes of meetings with the local mayor. Alternatively, a more formal method was sometimes adopted, involving the issue by the local government of special administration measures relating to the specific project. However, the case of Changchun Huilü Sewage Treatment Company v Changchun Municipal People’s Government demonstrates some of the problems inherent in such a practice, i.e. for whatever reason, the government can unilaterally retract or change the regulations or undertakings it issues or gives.

Means of dispute resolution

There have been different approaches to the question of how a dispute in the event of a breach by the government should be resolved. One point of view holds that concession rights are a form of administrative permit, and therefore the only option open to concessionaires is administrative action. The author, however, begs to differ, because: (1) according to relevant provisions of the PRC Administrative Permits Law, concession rights should not be classified as an administrative permit; (2) even if one were to concede that concession rights are a form of administrative permit, pursuant to the PRC Administrative Procedure Law and its judicial interpretations, disputes over concession agreements do not fall within the scope of cases accepted for administrative actions; and (3) in an early build-operate-transfer project in China, the Guangxi Laibin Electric Power Plant project, the Supreme People’s Court recognized, in the form of a judicial interpretation, that arbitration could be chosen as a means of resolving disputes over a project agreement.

Accordingly, arbitration is generally recommended as the method of resolving disputes under a concession agreement. Concession projects tend to have a strong technical component, last a long time, involve a large investment, and are characterized by complex legal relationships. The China International Economic and Trade Arbitration Commission, which has a relatively good reputation internationally, has arbitrators who are expert in this field. In contrast, frankly speaking, there is insufficient professional knowledge and experience in local courts to handle such cases.

Furthermore, the PRC still has not achieved full judicial independence, and local courts cannot escape from local administrative interference or the effect of local protectionism.