Construction Arbitration in Brazil

Introduction

The Brazilian construction market has had a turbulent political and economic climate since 2015, mainly due to Operation Car Wash, an investigation led by the federal police and federal prosecutors that focused on the involvement of companies and political leaders in corruption. Brazil’s major construction companies have been at the centre of these investigations and have suffered from a significant reduction in public financing for construction initiatives.

To foster investments in the sector, in the face of a decrease in public financing, the government has created the Programme of Investment Partnerships (PPI) to increase the contribution of private capital to infrastructure projects in Brazil. The purpose of the PPI is to expand and strengthen the relationship between the state and the private sector through partnership contracts (including concessions, public–private partnerships, permissions or leasing of public assets and any other public–private arrangements that have a similar legal structure).

PPIs have so far been a part of 166 infrastructure projects across many sectors (airports, power, generation, transmission, railroads, highways, mining, military and ports), amounting to over 1.4 trillion reais in investments.^[2]

Also, owing to the deterioration of major construction companies involved in Operation Car Wash, there has been an increase in activity of medium-sized construction companies and foreign players in the construction and project development markets. These new players have secured some stability in the construction market despite the economic and political crisis – the sector is still one of the most relevant industry branches in the Brazilian economy.^[3]

PPIs, similar to the whole construction market in Brazil, suffered the effects of the coronavirus pandemic in early 2020, and experienced a decrease in investment due to the downturn in works during lockdown and the interruption of basic economic activities, with a total drop in retail sales of construction materials of almost 18 per cent in comparison to the same month in 2019.^[4] Despite this, the sector has shown extreme resilience, with a strong rebound and rapid increase of investment, particularly with the strengthening of the real estate construction market.

The Brazilian construction industry can be divided into private construction projects and public construction projects. There are different sets of rules and standards that apply to these two very different categories.

Private construction contracts

In general, private agreements are governed by the Brazilian Civil Code (BCC). The BCC is divided into two sections:

• a general part, dealing with issues involving personhood, assets, legal transactions, statute of limitations and prescription; and
• a special part, where one can find rules on obligations (which include contract law), corporations, property, family and succession.

The sections related to legal transactions and obligations are generally applicable to all contracts – including construction contracts.

General aspects of Brazilian contract law

In general, Brazilian contract law is founded on the principles of freedom of contract and pacta sunt servanda, meaning that, as long as parties fulfil basic legal requirements of contract formation and unless otherwise provided by a mandatory rule, they are allowed to regulate their relationship by means of binding terms and conditions agreed between them.

However, the BCC requires the parties to exercise their rights in accordance with the standards of good faith, as provided by Articles 113, 187 and 422 of the BCC.^[5] This duty is applicable to all contracts, imposing on parties a duty to act fairly during the conclusion, interpretation and performance of any contract.

Further, parties should conduct their business taking into consideration the social purpose of the contract as commanded by Article 421 of the BCC,^[6] by dealing and performing their obligations in view of the final outcome intended by the contract and in a manner fruitful to society as a whole. Both the principle of good faith and the social purpose of contract principles seek to avoid the abusive behaviour from contracting parties, in a way to protect parties from bad-faith conduct.

Moreover, as per Article 112 of the BCC, contracts are interpreted according to the parties’ will.^[7] Hence, there is no parole evidence rule under Brazilian law; the conduct of the parties and the circumstances of the case are often considered when interpreting not only the will of the parties, but the reasonability of their conduct during performance and of the applicable contractual or legal remedies.

Specific rules concerning construction contracts in Brazil

In addition to general rules of contract law, construction contracts in Brazil are generally regulated by Articles 610 to 626 of the BCC. Pursuant to the BCC, a contract is considered a construction contract when the contractor’s scope includes: (1) the works for the implementation of the project; or (2) the supply of works and materials. In this sense, even though engineering procurement construction contracts are not specifically regulated by law, they are treated and regulated, for the most part, as construction contracts. There is no specific formality required by law for the execution of a construction contract, but it is highly recommended to do this in writing.

Most of the projects developed in Brazil use bespoke contracts (that is, contracts specifically drafted for a particular project) rather than standard form contracts. However, international standard forms such as International Federation of Consulting Engineers (FIDIC) contracts and the new engineering contract standard forms have gained some popularity over the past decade, especially in projects involving foreign parties (including foreign sponsors, partners or lenders). It may be too soon to say that FIDIC-based whole contracts are common, but it is somehow usual to see parties and counsels placing isolated clauses into their own drafts.

In any event, if the provisions of Articles 610 to 626 of the BCC are not derogated by the parties, they constitute implied terms to construction contracts. These provisions establish some basic rules regarding:

• transfer of risk;
• payment terms;
• acceptance and inspection of works;
• change orders; and
• suspension and termination scenarios.

As a general rule, the provisions of the BCC regarding construction contracts may be derogated by the agreement of the parties. However, there are some mandatory rules that must be observed. For instance, Article 618 of the BCC provides that the contractor shall be liable for the soundness and safety of the works for a period of five years. This warranty was designed to protect not only the employer but also any party that may be affected by the works and is, as a consequence, irrevocable and not subject to waiver by contract. This is considered a mandatory rule under Brazilian law.

Public procurement contracts

Brazil is a federation composed of a federal government, 26 states and the Federal District, and a high number of local municipalities – each with very different rules applicable to public procurement contracts in their sphere of jurisdiction. As a general rule, though, public procurement is governed by the Federal Constitution, which has strict rules on the activity of public entities, by Law No. 8,666/93 (the Public Procurement Act) and by Law No. 13,303/16 (the State-Owned Companies Act), which applies to all levels of government.

Public bidding

Article 37, XXI, of the Federal Constitution provides for government entities to conduct public bidding procedures before awarding the procurement of construction, engineering works, services, purchases and sales. To regulate such provision, the federal government enacted the Public Procurement Act in 1993, recently updated by Law No. 14,133/21, which brought many innovations such as the implementation of a new modality of public procurement denominated ‘competitive dialogue’ that allows the establishment of a dialogue between the public administration and the bidders, to provide innovative and bespoke solutions for contracts involving complex technological or technical innovation.

The Public Procurement Act regulates public procurement procedures and contracts entered into by federal, state and municipal governments. In theory, the Public Procurement Act is meant to provide general rules that would be complemented by state or municipal legislation based on local circumstances. However, in practice, the Public Procurement Act is relatively detailed, leaving little margin for the states and municipalities to further legislate on the matter. General rules of private contract law apply when rules of public procurement are silent.

According to Article 1 of Law No. 14,133/21, all public entities, autocracies and public foundations, among others, are subject to the rules contained therein. State-owned companies (or companies in which the state has a direct or indirect controlling interest), however, continue to be governed by Law No. 13,303/16, with exceptions pertaining to the application of the Brazilian Criminal Code in cases of crime or fraud perpetrated in relation to public procurements or contracts entered into by the government.

Additional federal rules on public procurement include the following:

• Law No. 9,472/97 provides for the National Communications Agency and authorises the agency to create its own public procurement rules;
• Law No. 9,478/97 established the National Oil Agency and authorises the agency to create its own public procurement rules, while also allowing Petrobras (a state-owned oil company) to comply with a simplified tender procedure; and
• Law No. 12,598/12 provides special rules for the purchase and development of defence systems.

As well as federal regulation – which applies to all levels of government – states and local authorities also have local procurement regulations, which must abide by the Federal Constitution and the Public Procurement Act. Owing to the fundamental principles of public tendering as provided in the Federal Constitution and in Article 11 of the Public Procurement Act, all tendering rules and regulations shall aim to seek the best value-for-money offer, meanwhile respecting the isonomy between competitors, preventing overpricing and promoting innovation and national sustainable development. This is the main goal of the provisions included in all public procurement rules, including the Public Procurement Act.

General features of public construction contracts

The Public Procurement Act and other legal provisions concerning public contracts allow the employer (the public entity) to provide for clauses that would not be possible in a private relationship. For example, the government entity has the right to unilaterally amend the contract to increase the works by up to 25 per cent (50 per cent in cases of restoration works for buildings and equipment). Subject to a proportional increase of the contract price, the contractor shall be obliged to undertake the works under the same conditions originally contracted.

Moreover, in accordance with Articles 104, II and 137, VIII, the employer may terminate the contract in cases where there is considerable public interest, being subject only to indemnifying the contractor for the works performed up to the termination and demobilisation, but without any termination fee or loss profits being due to contractor, as would happen in a private construction contract.

In sum, considering the complexity of public procurement rules in Brazilian law, it is important to always confirm the existence of specific provisions before applying rules of private contract law.

Disputes involving construction contracts

Most private construction disputes in Brazil are solved via arbitration – especially in big projects, where stakes (and risks) are higher. In the private sector, very few cases are settled via court proceedings; usually only claims related to home or small-business renovations go to court. Owing to the high ramifications of state entities in Brazil, most public construction disputes are still settled in court. However, owing to a recent increase in the use of arbitration by public entities, larger projects and public contracts are being sent to arbitration. Recently, however, there has been a spike in the use of other alternative dispute resolution (ADR) methods (especially mediation and dispute boards) to solve construction disputes in Brazil.

Arbitration in Brazil

Since 1996, with the enactment of the Brazilian Arbitration Act (BAA), and especially after 2002,when the Supreme Court declared the constitutionality of the statute, arbitration has become a mainstay in Brazil. The BAA has been recognised as one of the most progressive arbitration statutes in the world. Additionally, Brazilian courts have since shown a pro-arbitration stance on decisions regarding the matter. All of these elements have caused the use of arbitration to soar in the country.

Evidence of this fact is that, according to the 2019 statistics report of the International Court of Arbitration of the International Chamber of Commerce (ICC) – the leading arbitral institution in the world – Brazil occupied the third place in terms of the number of parties involved in ICC arbitrations around the world,^[8] behind only the United States and India. Also, Brazil’s largest arbitral institution, the Centre for Arbitration and Mediation of the Chamber of Commerce Brazil–Canada (CAM–CCBC), received 97 new requests for arbitration amounting to a total of 8.5 billion reais in dispute in 2019, 13 per cent of which related to construction disputes.^[9]

According to Article 1 of BAA, disputes related to freely transferable patrimonial rights are subject to arbitration. Owing to the increase of arbitrations involving government bodies and administrative matters, a recently enacted statute amended the BAA to allow the submission of disputes involving government bodies to arbitration.

The BAA also states that an arbitration agreement is valid in Brazil if it contains an express declaration of the parties’ intent to submit disputes arising from a contract to arbitration. Moreover, an effective arbitration agreement should also contain, among other provisions:

• indication of an institution to administer the arbitration (and the proper reference to its arbitration rules), or, in the case of ad hoc proceedings, the indication of which rules will serve to guide the arbitration (the United Nations Commission on International Trade Law Arbitration Rules are usually a good choice for ad hoc arbitrations);
• the number of arbitrators (usually either one or three), and the procedure for their appointment;
• the seat of arbitration;
• the language of the proceedings and applicable law; and
• the venue for judicial measures (including injunctive and preliminary relief).

Arbitral institutions in Brazil

Under Brazilian law, arbitrations may be administered by an institution or ad hoc (i.e., without the supervision of an administering institution). There are several reputable arbitral institutions in Brazil, most of them located in São Paulo, Rio de Janeiro and Minas Gerais.

The ICC and CAM–CCBC are the most relevant institutions operating in the country – the ICC inaugurated its São Paulo office in 2018. The city also houses the Chamber for Arbitration and Mediation of São Paulo, administered by two of the most important trade associations in Brazil, CIESP and FIESP (CAM–CIESP–FIESP), and the Arbitration and Mediation Centre attached to the American Chamber of Commerce (AMCHAM).

The most relevant institutions located in Rio de Janeiro are the Brazilian Centre for Mediation and Arbitration (CBMA) and the Mediation and Arbitration Chamber of the Getúlio Vargas Foundation. In Minas Gerais – a state known for its prominence in the construction industry – the most relevant institution is the Business Arbitration Chamber – Brazil (CAMARB).

Institutions are not constricted to a particular city or territory – most of the largest institutions operating in Brazil are able to administer arbitration proceedings in most cities in Brazil and even abroad. Nor are they usually specialised in a particular set of disputes, except for in very specific cases where the institution serves as a trade association and regulates parts of the trade. In this sense, construction disputes represent a significant number of the arbitrations administered by the leading arbitral institutions operating in Brazil.

According to statistics reports of the arbitral institutions operating in Brazil, construction arbitrations filed in Brazil between 2018 and 2021 represent approximately:

• 33 per cent of all cases initiated before ICC Brazil;
• 15 per cent of all cases initiated before CAM–CCBC;
• 6 per cent of all cases initiated before CAM–CIESP–FIESP;
• 6 per cent of all cases initiated before AMCHAM; and
• 16 per cent of all cases initiated before CAMARB.

Although the ICC Hearing Centre was only inaugurated in São Paulo in March 2018, construction cases involving Brazilian parties represent approximately 86 per cent of the total cases filed before ICC Brazil between 2018 and 2019.

Mediation and dispute boards

Other ADR mechanisms are increasingly becoming features in Brazil. Specifically, mediation and dispute boards – usually in connection with arbitration – are constantly used by companies heavily involved in ADR, particularly construction companies. These methods have also attracted significant legislative support.

Regarding mediation, the country enacted the Mediation Act in June 2015. The statute regulates the use of mediation in both judicial and extrajudicial proceedings. It governs matters such as penalties for parties that fail to appear in mediation and the appointment and qualification of mediators.

Dispute boards first appeared in Brazil in 2000, having been used in the project for the construction of parts of the São Paulo subway network. The inclusion of dispute board provisions in the contracts was the result of the demands of the International Bank for Reconstruction and Development.^[10]

The use of dispute boards has spiked recently, especially in major infrastructure projects in Brazil. For instance, dispute boards were included as a standard procedure in the contracts executed for the preparation of the Rio 2016 Olympic Games.^[11] Following the growth in support of this ADR mechanism, most Brazilian arbitral institutions drafted their own rules for dispute board proceedings.^[12]

On 23 February 2018, the City of São Paulo enacted Municipal Law No. 16,873/2018 (the São Paulo Dispute Board Act), which recognises and regulates the creation of dispute boards for the prevention and resolution of disputes in long-term government contracts entered into by the City of São Paulo. The initiative of the Municipality of São Paulo to regulate the mechanism grants credibility and incentivises the use of dispute boards, which has great potential for practical application within public and private contracts in Brazil.

According to the São Paulo Dispute Board Act, dispute boards shall be composed of three members, preferably two engineers and one lawyer. All board members shall be jointly appointed by the contracting parties. Moreover, the São Paulo Dispute Board Act allows public procurement bids and government contracts to establish that the board’s proceedings shall be governed by the rules of specialised institutions, such as arbitral institutions that already have specific regulations for dispute board procedures.

Law No. 14,133/21 includes dispute boards as an ADR method for controversies arising out of public procurement of administrative contracts entered into by the public administration.

One of the great advantages and innovations of the dispute board procedure is the possibility of establishing a permanent administration board that will monitor the entire development of the project, including by leading regular visits, organising inspections and scheduling periodic meetings with the parties to discuss any claims pending between them. This constant interaction not only allows the board to have deeper knowledge of the project and sensitive points, but also allows disputes to be duly prevented or even remedied before they become a formal claim brought to arbitration. In fact, the statistics of the Dispute Resolution Board Foundation indicate that 99 per cent of the disputes arising in a project and submitted to the board are settled in less than 90 days, and do not evolve into court or arbitral proceedings, therefore saving time and resources of the involved parties.^[13]

Unlike decisions rendered by an arbitral tribunal, determinations of dispute boards do not have a final character and are not equivalent to judicial or arbitral decisions, being subject to an arbitral tribunal or state courts’ review. In this sense, the Brazilian Superior Court of Justice – the second-highest court in the country, and the highest with jurisdiction over private law matters – recently issued a decision affirming that dispute boards differ from arbitration because a dispute board’s decision is not meant to be final. In that case,^[14] the parties had agreed on the appointment of an advising committee that should issue opinions on specific matters and, if one of the parties did not agree with the opinion, a third party was to be appointed, which should issue a final and biding decision. Therefore, the Superior Court stated that, since the parties had agreed that the appointed third party should grant a final and binding decision, it would be acting as an arbitrator and the advising committee as a dispute resolution board.

Main construction claims

Construction projects are complex and represent more risks to the parties than other types of commercial contracts. This is true, particularly, because of their long-term nature and the existence of unexpected elements related to climatic and ground conditions, fluctuations of prices and government interventions, among others, that impair the completion of works. Therefore, construction disputes commonly involve questions of delays and disruptions, changes of scope, subcontractors’ liabilities, etc.

Hidden defects

Under Brazilian law, a hidden defect is a type of defect that is concealed from the person (or entity) acquiring a certain property. They can be summarised as those defects that are manifested after acquisition and that may not be discovered through reasonable inspection. Rules regarding hidden defects may be applicable to turnkey contracts, where the owner is purchasing a complete work from the contractor, or if the contractor was obliged to deliver goods together with the construction services.

According to Article 442 of the BCC,^[15] if a hidden defect is found, the owner may reject delivery and claim reimbursement of amounts paid or a proportionate price reduction, plus damages. To be able to reject the goods or claim any price reduction, the owner has to notify the contractor of its intention within the time limitations provided by law (30 days for movable goods; one year for real-estate property).^[16] The term is usually counted from effective delivery, pursuant to Article 445 of the BCC. However, according to Article 445, Section 1, when the defect, by its nature, could only be known at a later stage, the term is counted as from the moment at which the owner became aware of the defect, provided that this period is limited to a maximum of 180 days in the case of movable property, and one year in the case of real estate property, both counted from the time of delivery.

Although confusing, the provision actually establishes an additional time for the owner to become aware of hidden defects, which, due to their nature, may only be diagnosed later. Then, once the hidden defect is revealed, the purchaser has 30 days (for movable property) or one year (for real-estate property) to notify the seller.^[17]

Additionally, Article 446 of the BCC sets forth that the terms provided for in Article 445 shall only be counted as from the expiry of any applicable contractual warranty periods. Hence, this provision applies only after contractual warranties have expired.

Change orders

Under normal circumstances, and unless the contract provides otherwise, the contractor shall not have the right to price increases for changes implemented in the project, unless they are expressly commanded in writing by the employer, as per Article 619 of the BCC.^[18]

However, according to Article 619, Sole Paragraph of the BCC,^[19] the employer shall be obliged to pay increases of scope performed by the contractor if the employer is constantly present and supervising the works and could not have been unaware of modifications or increases of scope performed by the contractor.

Delays and disruptions

Brazilian law does not specifically address claims for time and cost relief in virtue of employer-caused delays. For such purposes, although Article 625 of the BCC deals with suspension and termination of the construction contract, when the contract is otherwise silent, it is also applied as grounds for extensions of time or reimbursement of costs for delays and disruptions,^[20] since it provides for the circumstances and events that fall outside the contractor’s scope of responsibility.

Article 625 of the BCC allows the contractor to suspend the works without paying an indemnity to the employer owing to:

• employers’ fault (such as delay in obtaining the applicable licences or authorisations);
• occurrence of force majeure events;
• changes resulting from unforeseeable events (such as geological, hydraulic or similar events) that affect the economic balance of the contract resulting in excessively onerous obligations on the contractor; and
• disproportional change orders requested by the employer with respect to the project already approved, even if the employer agrees to pay the additional costs.

With regard to public procurement contracts, Article 111 of the Public Procurement Act provides for the automatic extension of time to contractors when the scope of the contract has not been completed in the time period provided by the parties. In such cases, when the delay derives from the contractor’s inability to timely conclude the contract, Article 111, Sole Paragraph specifically provides for the application of administrative sanctions and the possibility of unilateral resolution of the contract by the public administration.

Liquidated damages and penalty clauses

Article 408 of the BCC^[21] allows for parties to agree on liquidated damages for the non-performance or delays in the performance of contract obligations. Brazilian law does not refute the concept of penalty clauses for breach of contract. Therefore, there is no distinction between penalty clauses and liquidated damages that are presumed to have both a pre-estimation of damages and a deterring functionality.

If liquidated damages are considered to be excessive (owing to the nature of the contract or to partial performance by the contractor), they may be equitably reduced in accordance with Article 413 of the BCC,^[22] but this does not grant the court the authority to completely set them aside, as happens in certain jurisdictions.^[23] Also, liquidated damages provisions may not set higher amounts than the total value of the construction contract, pursuant to Article 412 of the BCC.^[24]

With regard to the possibility to claim damages in addition to liquidated damages, Article 416, Sole Paragraph sets forth that, unless otherwise stated in the contract, the contractual penalty represents the maximum indemnification due to the innocent party, even if the actual damage incurred exceeds what was provided for in the penalty clause. Therefore, as a rule, a claim for damages in addition to the liquidated damages depends on parties carving out the penalty clause by contemplating such possibility. As a result, if proven, the innocent party will be entitled to receive indemnification for damages further to the liquidated damages established in the contract.

Termination

As a general rule, and in addition to mutual consent, contracts can only be terminated as the result of a breach, pursuant to Article 475 of the BCC.^[25] In these cases, termination demands judicial or arbitral intervention, namely, a court of an arbitral tribunal must order termination of the agreement, which cannot be made unilaterally by any of the parties.

However, Article 474 of the BCC^[26] allows the parties to agree on an express termination clause, by which the parties will provide for the circumstances in which the non-breaching party may terminate the contract unilaterally, without the need of judicial or arbitral intervention. For this reason, it is common to establish: (1) an obligation to notify the breaching party; and (2) a cure period for the breaching party to remedy the breach, leaving less margin for the breaching party to challenge the termination.

Moreover, pursuant to Article 623 of the BCC,^[27] the employer can choose to suspend the construction even when the performance of the works or services has already started, provided that the contractor is compensated for the expenses, the work done, costs incurred and profits in relation to the services already provided, plus a reasonable indemnification calculated in light of the gains that the contractor would receive if the works had been concluded.

Finally, according to Article 478 of the BCC,^[28] if the contract becomes excessively burdensome to one of the parties owing to extraordinary, unforeseeable and unavoidable circumstances, the affected party may claim the termination of the contract. To avoid termination, the other party may offer to modify the conditions of the contract and re-establish its economic balance. In this sense, such termination does not operate automatically and must be declared by the competent court or arbitrator.

Notes