Despite the legal logjam, Mexico's next govt may continue to rely on PPPs

Less than three months before Mexico's government hands over power to the new administration, there is still plenty of uncertainty regarding the potential changes that president-elect Claudia Sheinbaum will make regarding private sector participation in the public works sector.

The legal landscape for public works projects in the country thus remains fraught with challenges, with the rigid regulation of public works contracts stifling necessary modifications. This inflexibility, combined with a lack of attention to legal and contractual details after contracts are signed, often results in significant disputes as projects progress.

Meanwhile, dispute resolution is complicated and proposed judicial reforms could worsen the situation, rendering the system inactive and inaccessible, which would particularly affect contracts managed by entities like federal oil firm Pemex. This could lead to the introduction of inexperienced judges and politicize decisions, further hindering fair settlement of disputes.

The current administration's stance against public-private partnerships (PPPs), due to its ideological position and allegations of corruption, may be misguided, as despite the criticism, they are crucial for leveraging private sector expertise and funding. 

BNamericas speaks to Roberto Hernández, a lawyer and expert in international construction law, to find out more about the challenges that await public works contracts and what might happen when the new government takes over.

BNamericas: What legal issues have you identified in projects in Latin America?

Hernández: I think there are multiple issues. The regulation of public works contracts is very inflexible and is tied to state oversight bodies. Therefore, contracts that require flexibility to develop optimally can't be modified.

If a public servant deviates slightly from the law and an audit occurs by the comptroller's office or the public function secretariat – they are sanctioned without hesitation, so they prefer to stick to the safe path.

The second issue is the lack of attention that many project stakeholders give to the law and the contract once it's signed. This can eventually cause a lot of problems when the works are advanced. For example, when the contractor performs work that goes beyond what they should have done and the modifications weren't properly formalized, or when there is a force majeure event and it's not reported, controversies arise that could have been avoided.

Finally, in terms of dispute resolution, public works contracts are usually handled by courts that are part of the state. There is no objectivity or impartiality. In many places, there isn't even judicial independence, which some fear could happen in Mexico with the announced judicial reform, which would definitely impact public works contracts.

BNamericas: How would judicial reform impact contracts?

Hernández: It will have a huge impact on business. Regardless of whether it's an issue of the division of powers or democracy, from the perspective of protecting contractors' interests, it's very serious.

Disputes arising from public works contracts are currently handled by the federal court of administrative justice. This special court won't be affected. But there are other works contracts managed by, for example, Pemex, which are handled by the federal judicial branch.

The impact is as follows: If you change the entire judicial system, you leave it inactive. For instance, in a contract with the State where termination is demanded due to non-compliance when the State fails, the judicial system becomes inoperative, making access to justice impossible for those who need it. The courts are overloaded.

Second, there are lots of judges with experience who have handled previous cases. Now, I'm not saying the judges elected through popular vote can't be better, but they wouldn't have the experience that others have and there will be a costly learning curve in terms of time.

Finally, we need to ask whether voting implies a political burden. If so, judges would almost hold the position of a lawmaker and, as we've seen in practice, a lawmaker doesn't rule in favor of what the people want but in favor of their party.

From a business perspective, I don't like the idea of reform because it will make access to justice very difficult and create a difficult path for many contractors who will need to use it.

BNamericas: Is there a legal basis for the current administration's crusade against public-private partnerships and other private participation mechanisms due to corruption allegations, which the next administration will likely continue? Doesn't the government have the necessary tools to combat corruption?

Hernández: I believe attacking public-private mechanisms from a corruption angle is a grave mistake. There's a report by the UK Audit Office from four or five years ago discussing the pros and cons of PPPs. They conclude that they’re not as good as they seem and have multiple issues to address. Without a doubt, the scheme itself is questionable in many places, but it's important to understand that it’s not just about a lack of state funds, but a complex strategic partnership.

Now, public-private partnerships are closely tied to private sector participation, which supports the concept of neoliberalism. But in Mexico, our administration is left wing, and these concepts are contradictory. We have to respect what the population voted for: the cancellation of private sector involvement and loans. I don't think there should be allegations of corruption, but this scheme simply doesn’t align with our administration's political philosophy.

BNamericas: What do you think will be the outcome?

Hernández: I think it will be very difficult for the current administration and the ruling party to meet their ideological goals, given the country's current reality. It's almost impossible under the current conditions when Mexico's primary trading partner is the most important capitalist country in the world, when it's the springboard for nearshoring, which I consider being a fallacy, and when Mexico has such important trade partners.

I see it as very difficult. There's no money, so where will it come from? There are two possibilities: international loans, which, if I recall correctly, are rejected under Morena's ideology, or partnerships with the private sector. This would also break their own philosophy, but my prediction is that the next administration won't be able to break away from the inertia of private sector participation because, in practice, the private sector is necessarily a strategic partner to achieve our complex goals.

BNamericas: Why do you consider nearshoring a fallacy?

Hernández: It’s labeled as such because Vietnam and other Asian countries are truly leading the way in this phenomenon. Here, there’s great concern about the supporting infrastructure needed to move it forward.

Vietnam and Malaysia have truly generated nearshoring. Ours is a phenomenon more related to partnerships, proximity and trade relations rather than what it actually is.

BNamericas: Are there tools that could boost nearshoring in Mexico?

Hernández: Yes, one of them is FIDIC [standard] contracts. When discussing public works, the state always has a position of superiority. These contracts establish a situation of greater equality through a manager or administrator, which is the FIDIC contract engineer.

About two months ago in Ecuador, a public works law was enacted recognizing FIDIC contracts as the ones to be used in public works and dispute settlement boards as a means of resolving disputes – something that hasn't happened anywhere else in Latin America. This is a watershed moment because contractors often complain about the State's failure to meet obligations, causing project delays.

The FIDIC engineer isn’t an independent entity but a representative of the contractor, with much clearer contractual management functions than if both parties were acting independently with their own interests. It's an interesting scheme currently used by the Inter-American Development Bank, the World Bank, and the Central American Bank for Economic Integration in all their major projects.

BNamericas: Are they not used in Mexico?

Hernández: In Mexico, they’re widely used in the construction of ports by the concessionaires. They’re also used in El Salvador, Honduras and even the Panama Canal was built using a FIDIC contract.

BNamericas: Could FIDIC contracts coexist with the scenario where the armed forces are building works in Mexico?

Hernández: I don't think a FIDIC contract is applicable to the armed forces because they’re a very strong, demanding contractor and not inclined towards the balance these contracts seek. However, there are other areas at the state and municipal levels where they would be completely applicable.

BNamericas: Could the construction of industrial parks be done with FIDIC contracts?

Hernández: Yes, certainly, and although they’re already used in the private sector, there’s a need for more openness to this type of contract.

BNamericas: Do you consider the public works landscape in Mexico to be negative?

Hernández: I believe engineers have to adapt to the new system. There are no longer open bidding processes as there were before, and not everyone can participate. There are invitations, but it's no longer the open public works scheme it was.

I envision that the tendering, bidding and award process through [public procurement platform] Compranet is over. In the current term, almost all contracts were direct awards: the Dos Bocas refinery, the Maya train, line K of the interoceanic corridor. So, we will have to see what the president-elect will offer. I think the best thing that could happen is a tender and selection scheme by percentages in an auditable process.

The conversation between the public and private sectors during this term has been very complicated. Hopefully, the new administration will be more open to listening and implementing things that benefit both parties. There are many challenges for the industry.

Another important issue is that projects have their own technical execution cycle, and due to the rush to inaugurate rapidly, many are done without sufficient quality. There’s a lack of respect for planning.

BNamericas: Do you think that the flagship projects of the outgoing administration will eventually prove to be white elephants?

Hernández: No. I believe the Maya train will be successful, especially from a tourism perspective, although I'm not sure about its economic success or profitability.

The interoceanic corridor will also be a great success. The project itself is fantastic: a dry corridor, almost like a competitor to the Panama Canal.