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Doing Business in Israel: Infrastructure Projects

Doing Business in israel: Infrastracture

Tel Aviv may be all dug up, and the sidewalks gone, but there is a light at the end of the tunnel – at least at the end of the tunnel between Lincoln Street and Yitzhak Sadeh Street. It isn’t only Tel Aviv that’s dug up. Work on the Jerusalem Light Rail’s Green Line has already begun. The new railway project between Hadera and Lod is already in high gear, as is the cable car project connecting Hutzot HaMifratz to Haifa University. A light rail is also being planned between Nazareth and Haifa. The list goes on and on.


All of these infrastructure projects happening in Israel used to be within the realm of science fiction. In Israel, investments in infrastructure have always been meager compared to other western countries. While Germany began its major advances in infrastructure in the 1980s and Spain in the 1990s, in Israel, we became aware of the imperative to upgrade infrastructures only toward the end of the 2000s.


As of 2022, Israel has invested (or is planning to invest) approximately ILS 100 billion in various infrastructure projects that will take place in the next decade. These include roads, bridges, ports, tunnels, railways, subways, etc. Each project is based on a tender, contracts, and a budget ultimately financed by taxpayers. Consequently, when we see delays and hindrances or become aware of other problematic trends in infrastructure initiatives, we need to try and understand the root cause of the problems and resolve them. Or at least those not defined as resulting from force majeure.


Tenders and Other Woes



So what are the Israeli infrastructure sector’s biggest problems? Two major ones have far-reaching repercussions. The first is that relatively few contractors are capable of contending in large-scale tenders. The second is major delays in projects. These problems arise for several reasons, but the most evident common denominator is the projects’ contracts.


When a government authority wants to launch a megaproject in the infrastructure sector, it publishes a tender. The contract between the contractor that wins the tender and the State of Israel is part of the tender. In most instances, the company that offers the lowest bid wins the tender.


Usually, the tenders for most projects of this magnitude include a prequalification stage (PQ stage). During the PQ stage, contenders must prove they have the know-how, experience, and financial capacity to carry out the project. Only players that pass the PQ stage are eligible to proceed to the next stage of the tender. In this stage, the competition is mainly over who can execute the project at the lowest possible price.


A Binding Agreement



As soon as a company wins the tender, the tender’s rules and conditions are binding upon the company and the client. Minor amendments are possible (such as clarifications of clauses), but the tender contract is mostly inflexible. The reason is that the losing contenders might consider such changes as discriminatory. Infrastructure contracts are unbending by nature, but the State of Israel has made them too rigid.


Even if the government’s motivation for imposing this rigidity is to protect the taxpayers’ money, the outcome – performance delays and few participants in tenders – is costing us much more. In the final analysis, who is to blame for this? Bibi, of course, but not the Bibi that comes to mind (former Prime Minister Benjamin Netanyahu).


Reasonable Risk Division



Of course, we are talking about the “Bibi Roads” case. When thinking about an infrastructure project contract, we need to keep in mind that, unlike a contract to acquire a high-tech company or a real estate deal, infrastructure contracts are long-term contracts for projects that may be underway for years, even under the best circumstances. Furthermore, the circumstances may change during the project’s lifetime. Pandemics and wars may break out, raw material costs may skyrocket, etc. These contracts are risky for construction companies because their profit margins are low relative to the risks involved.


In the past, when a construction company went to court to sue for compensation for a loss caused during its execution of a project, the courts were relatively attentive to its pleas. However, the ruling in the “Bibi Roads” case handed down in November 2019 resulted in a change in practice. The courts are now taking a rigid stance.


This stance considers a contract’s wording as “chiseled in stone.” The outcome is that construction companies assume most of the risks, while knowing that they must tender the lowest possible bid to win. They also know that the chances of a court awarding them compensation for losses is slim. Because of these circumstances, many top-ranking companies and professionals are backing away from contending in tenders in Israel even if they pass the PQ stage. The risk is not worth it.


Professional Arbitration



Many infrastructure projects in Israel rely on foreign companies. Mostly European construction companies that have already completed their infrastructure upgrades in Europe, Chinese companies, and others. Until recently, these foreign companies relied on the existence of a standard international contract from the International Federation of Consulting Engineers (FIDIC) or other international standardized contracts.


FIDIC is an independent organization comprised of highly esteemed engineers. Israel also customarily used contracts prepared by FIDIC (or by other comparable organizations) in the not too distant past. One of the unique aspects of a FIDIC contract is that it contains a mechanism for clarifying professional disputes while a project is underway.


The major advantage of this mechanism is that those independent expert engineers decide, in real-time, which parties are responsible for resolving the professional problem and how, and which of the parties bears the cost of implementing the solution. The parties usually have no right to challenge the professional ruling itself. They can challenge the question of who should bear the costs. This question may also be clarified later (even after project completion).


Judicial Burden



For numerous reasons, the State of Israel decided to eliminate this mechanism. Unfortunately, many construction companies, mainly international, are unwilling to contend in tenders in Israel, inter alia, because this mechanism is missing. We have already seen many project tenders in which, out of seven companies that passed the PQ stage, only two tendered bids in the tender itself. The shrinking of this pool is problematic. It limits the State’s ability to select the best contractors for projects that will have a major impact on the daily lives of millions. It also causes project delays and burdens the judicial system with superfluous hearings.


The problem is well known, as the question of market concentration in the Israeli infrastructure sector has recently been examined by the Israeli competition authorities. However, the most natural solution was ignored: fixing the problematic contracts. In the absence of a professional dispute resolution mechanism, the courts in Israel are finding themselves deliberating questions that should be referred to engineers. It is likely every construction company’s bid nowadays includes the price of losing potential lawsuits and lawyers’ fees.


Balance and Objectivity



The desire for clear contracts and the desire to avoid litigation is obvious. The desire to save taxpayers’ money is also obvious. But it appears that, at the moment, the infrastructure sector is facing not a budgetary crisis but rather a legal one. The solution is simple. Both sides should work together to achieve the project’s successful completion. To avoid a crisis, there is an urgent need to incorporate objective and standardized professional dispute resolution mechanisms in contracts. There is also a need to draft contracts that enable a more balanced distribution of risks.


Until then, it is essential for each of the parties, client and contractor, to ensure it has the support of a skilled legal team that is expert not only in contracts and tender practices, but also in concrete load tables, tunnel bracing, and reinforcement methods, as well as in safety measures to avoid electric shock on electrified railways.



Shai Avnieli is a partner in our firm’s Litigation Department, specializing in infrastructure and energy disputes.

For any additional questions about doing business in Israel in the infrastructure field, the Barnea law firm is at your service.


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