China Pacific Construction suit exposes 'build and transfer' flaws

Build-and-transfer system comes in for flak as company goes to court over late payments?

The news that one of China's richest men has sued some local governments for late payments on infrastructure contracts has attracted widespread attention. But beyond the rarity of the legal case, the protagonist of the drama has also helped expose the hidden woes of a prevalent infrastructure financing model in China: build and transfer.

Yan Jiehe, founder of China Pacific Construction Group, said on Monday that he has sued local governments in Hebei, Yunnan, Guizhou, Hunan and Shandong provinces, in a bid to force payment of 900 million yuan ($144 million) his company is owed for infrastructure projects.

CPCG is China's largest privately held infrastructure company in an industry traditionally dominated by State-owned enterprises. Last year it was ranked 166th on the Forbes 500 list of the world's largest companies (only four notches lower than US-based tech giant Google Inc) with $60 billion in annual revenue. Yan and his son were listed as China's seventh-richest people by last year's Hurun report, with a fortune estimated at $14.2 billion.

The high-profile lawsuit is a rarity among its peers as few construction companies would resort to legal redressal when due payments are delayed by local governments, either for fear that they have little chance to win the case, or even if they win, they would not receive future government contracts. CPCG declined China Daily's request for interview, saying it had already spoken at length about the issue.

Yan told Bloomberg earlier that the six lawsuits cover 15 projects and the company is owed even more money from others. He said CPCG is not worried the suits will hurt ties with local governments because the company wants to focus on expanding in overseas markets, especially Europe.

There were already enough indications that Yan was keen to bolster CPCG's international presence. "Our primary overseas market will be Europe. I will revive the reputation of Chinese companies, which was damaged by some State-owned enterprises," Yan told China Daily in an interview last July. He had then approached the newspaper for the interview.

Ivan Chung, senior vice-president at Moody's Investors Service, said: "A possibility is that Yan was fed up with the inordinate payment delays and does not think there are too much growth options left in the domestic market. Maybe he just wants his money back. Lawsuits may help bolster the company's international reputation. Another possibility is that he is being driven too hard by the banks."

But the fact is Yan, famous for his outspoken personality, is speaking for thousands of construction companies on the unspeakable pains of the BT projects. BT is model in which companies pay the money for building roads, bridges and industrial parks before local governments buy back the completed projects later. It was favored by local governments across China as it enables big-ticket projects that they cannot pay for at the moment. Construction companies also embrace the model despite the risk of payment delay, due to copious profits and intense competition.

CPCG itself is the biggest offshoot of the booming of the model. It made its first fortune in the subcontract of a highway project in Nanjing in 1990s. It went on to become the largest private builder, engaging in mega-projects including leveling 700 mountains in suburban Lanzhou to make way for a new city.

Local governments' debt accumulated with Yan's fortune. By mid-2013 debt incurred by BT projects accounted for about 8 percent－or 1.5 trillion yuan－of total local government debt, second only to bank loans. The ratio is much higher in less-developed areas. In southwest Guizhou for example, BT debt is the largest form of government debt, accounting for 39.5 percent.

In many cases, BT projects not only involve local governments and contractors, but also banks, trusts that lend to cash-hungry companies at high rates and package the debt into wealth-management products sold to ordinary investors. A payment failure increases turbulence along the chain.

The property market downturn may trigger more repayment problems, analysts said, as revenue from land sales slumped and land was used as collateral in many landings.

Chung said the problem is not BT itself, but the execution of the contracts. Rights and responsibilities are not defined clearly in many cases and local officials did not consider repayment in the first place.