Building up a storm: Managing Corruption and Fraud Risks in Asia Pacific construction projects

Construction - the Asian powerhouse

Asia is at the centre of the worldwide growth in construction activity. India, China and the United States are expected to account for more than 51 percent of all work done in the global construction and engineering market by 2037. Within Southeast Asia, Indonesia, the Philippines, Malaysia and Vietnam are projected to be the four fastest-growing construction markets, supported by robust demographic growth and foreign investment.

Country-specific factors also support the outlook for continued construction growth in these countries:

• In Indonesia, the new administrative capital Nusantara represents an estimated project value of US$45 billion, with construction expected to take place over 20 years;

• In the Philippines, the government’s “Build Better More” infrastructure programme is expected to spur the development of rail systems, roads, airports and seaports;

• In Vietnam, continued ongoing urbanisation is expected to sustain high growth in housing, infrastructure and related industries.

With growth comes risk

The construction sector’s economic potential brings heightened corruption risks. Since 2010, there have been more than 30 enforcement cases involving the construction sector brought worldwide by the U.S. Department of Justice or U.S. Securities Exchange Commission, for violations of the U.S. Foreign Corrupt Practices Act (FCPA). Of these cases, over 12 involved companies engaging in construction activities in Asia, or Asian-headquartered companies.

In addition to the long arm of the FCPA, anti-corruption enforcement penalties on top of or separate to FCPA enforcement actions have also been brought by national regulators and multilateral development institutions.   There is also additional risk of debarment arising from corrupt activity. In 2023, the World Bank announced debarments of construction companies in Vietnam and Pakistan for offences including bribery and the related submission of falsified documents.

The risks of corruption and related misconduct abound in the construction sector because of a unique confluence of factors, including:

• The significant costs associated with large construction projects, which may facilitate the concealment of illegitimate payments in otherwise proper expenditure;

• The need to liaise with multiple government officials or agencies, as examined more fully below;

• Public tendering processes, in which companies may resort to making improper payments to unfairly influence the agencies or officials administering such tenders;

• The bespoke nature of construction projects can also make it difficult to evaluate or audit how costs are allocated.

The engagement of multiple third parties may also increase corruption risk, as they increase the opportunities for companies to disguise or obscure improper payments. While third-party risks exist in any industry, this risk is particularly high in the construction sector, given the amount and variety of key third parties involved, including joint venture or local content partners, subcontractors and suppliers of specialist equipment.

Sources of Corruption Risk in a Typical Construction Project

The construction sector encompasses a diverse array of projects, including factories, power generation facilities, roads, bridges, ports, and airports. In turn, each phase of a project also presents its own distinct challenges and associated risks, which are dependent on factors such as the scale and jurisdiction of the project, financing, and the nature of construction involved. Notwithstanding this diversity, a typical construction project generally involves several key phases. We analyse below how corruption risks may arise in each one.

Land acquisition and related permits

The process of land acquisition is typically dependent on factors such as whether the land is government-owned, whether the land is located in a particular zoning area, and whether licenses or permits are required to acquire or use the land.

Where  land is government owned, an acquirer would need to exercise vigilance to ensure that its negotiation of the purchase price with government officials involves no improper payments. In the case of government-owned land, the construction company may also need to apply for approvals to allow a change of use; applying for such discretionary approvals has in some cases seen the payment of bribes to ensure that such approvals are obtained.

Tendering

Public tendering processes present a particular risk of corruption, given that the sponsor is a government authority. Many FCPA enforcement matters, in Asia and globally, have involved misconduct in this phase of the project. Often, bribes are paid to third-party agents whose sole role is to transfer improper payments to corrupt government officials, and who perform no substantive work.

Tender process regulations may also require foreign companies to partner with local third parties. Such regulations may limit the range of potential partners to well-connected local businesses – i.e. those connected with government entities, government officials or their families. These regulations may also create commercial risk: restricting the range of permissible third parties may compromise the quality of construction.

Procurement and construction

These activities typically involve the need to obtain a significant number of permits, for activities such as demolition, excavation, stabilisation or piling, health and safety, and occupation, amongst others. These permits create the risk of demands for improper payments not only to the government officials or agencies who issue them, but from others responsible for related inspections that precede or follow them.

Variation Orders and Additional Claims

Lastly, in the case of complex and large-scale construction projects, variation orders form both a common feature and an added corruption risk. A variation order is a formal document issued by the client or contractor for changes in the project, such as in its scope, design, or contract price. Such orders may be manipulated to facilitate schemes of corruption or fraud.

Perhaps the most common example involves a construction company submitting an excessively low bid to win a contract, knowing that corrupt officials, with whom the construction company is in collusion, will later approve a variation order to increase the price. Inflated variation orders may also enable a construction company to improperly generate profits, part of which would be used to pay the government officials who enable such schemes.

Managing corruption risks

Given the significant sources of corruption and fraud risk in the construction sector, companies must take active measures to identify and mitigate such risks within their operations and personnel. These include:

• Setting an unequivocal tone from the top – ensure that the Board and executive-level leadership express strong support for the company’s anti-corruption programme at all times;

• Developing and maintaining adequate written policies and procedures, addressing such matters as approval of payments, provision of gifts and hospitality, approval of procurement, and internal record-keeping requirements;

• Conducting risk-based due diligence before engaging third parties – thoroughly review third-party agents and distributors, so as to fully understand the business rationale for engaging each such party, and ensure that any payments made are for legitimate purposes;

• Conducting regular risk assessments, covering a sufficiently comprehensive range of activities and persons involved in key business activities, including those involved in high-risk activities such as applying for tenders; interacting with public officials; and engaging suppliers, agents, sub-contractors and other third parties;

• Establishing an effective whistleblower programme, available to both internal and external parties; and

• Conducting regular training of employees and third parties, to ensure their awareness of and compliance with anti-corruption measures in place.

How Hogan Lovells can help

Hogan Lovells has extensive experience in helping clients identify and mitigate risks in the construction industry, including conducting pre-acquisition or pre-engagement due diligence; designing and implementing anti-corruption policies and procedures; conducting anti-corruption risk assessments; and providing advice relating to anti-corruption, anti-money laundering and sanctions compliance. We can help at all stages of a construction project: from early-stage planning through to completion. We also have deep expertise in anti-corruption investigations, crisis management and compliance settlement negotiations, both in Asia and emerging markets around the world.

Authored by Nick Williams and Han Liang Lie.