The Projects and Construction Review: Switzerland
Supported by low interest rates and immigration, construction activity in Switzerland remains at a high level; this applies to both the residential and commercial building sectors. In particular, the number of major construction projects has increased steadily in recent years. As regards public sector investments, transport-related projects are the growth drivers. It is expected that population growth and rising mobility will maintain the high level of demand for infrastructure and transport-related construction and will pose financing problems for the public sector.
The 2010 Neumatt Burgdorf project (Burgdorf project) was Switzerland's first public-private partnership (PPP) project to be carried out based on international project finance standards. The project encompasses the demolition of old buildings at the site and the planning, financing, construction and operation of administrative premises and a prison (with 110 beds); it successfully started operations in 2012. The Burgdorf project was meant to be a pilot project. Although it was quite successful, no further PPP projects based on international project finance standards have followed since, as politics is rather critical of this type of financing. However, various PPP projects based on alternative financing structures have been or are currently being realised (hospitals, universities. etc.).
The year in review
The year 2020 in Switzerland – like everywhere else in the world – was strongly influenced by the covid-19 pandemic. In Switzerland, the construction sector was able to operate virtually without interruption by implementing appropriate protection concepts. However, the resulting difficult construction site management and delivery difficulties led to numerous delays.
Documents and transactional structures
i Transactional structures
Transactional structures of project financing commonly follow international standards. Typically, the infrastructure is built and operated by a project company. The project company is established in the form of a special purpose vehicle (SPV). In relation to the legal form of the SPV, a Swiss company (Aktiengesellschaft) is the preferred option; however, a Swiss company with limited liability (GmbH) is also viable. If a foreign SPV is used, the SPV is usually domiciled in a country that has entered into a double taxation treaty with Switzerland to avoid withholding tax and to facilitate an exit by means of a share deal.
To a large extent, the construction of the project is financed by lenders. For this purpose, the project company enters into a credit agreement with a syndicate of banks. The shares of the project company are owned by the project sponsor. Several sponsors enter into a shareholders' agreement that governs their rights and duties as shareholders. The project sponsors provide the equity needed for the balance of the finance in the form of share capital, a contribution to the general reserves of the project company and subordinated debt.
The project company has no employees of its own and will generally outsource its constructional and operational duties to subcontractors, ideally to a general contractor to avoid interface issues.
Documentation in Swiss project finance transactions is consistent with international standards. In major projects, in particular if syndication of the loan is intended, the credit agreement is based on the standard form issued by the Loan Market Association. For smaller projects, Swiss banks usually provide shorter standard forms of their own.
Project finance requires mitigation of the completion risk. As a result, the project company usually mandates a total or a general contractor, which takes sole responsibility for the proper delivery of all construction work on a turnkey basis for a fixed price on the basis of a construction contract. The design and planning work is either included in the contract (total contractor) or is performed by a general planner.
A facility manager enters into an operation and maintenance agreement with the project company. To mitigate all operational risks, this is usually concluded as a general contractor agreement. In addition to the operation and maintenance agreement, the parties may enter into service-level agreements.
In PPP projects, in many cases a government concession is required. The concession is granted in the form of either a unilateral decree or a contract governed by public law. Further, as the case may be, the project company enters into agreements with (equipment) suppliers and purchasers. Other typical ancillary contracts include interest hedge agreements, insurance contracts, direct agreements (between the project contractors and the lenders) and the appointment of independent experts.
iii Delivery methods and standard forms
In a Swiss domestic set-up, parties often use the standard form for general contractor issued by the Swiss Engineers and Architects Association (SIA), which has also prepared various general conditions of which SIA Rule 118 (General Conditions for Construction Works, amended edition published in 2013) is widely used. These general conditions only apply if specifically agreed by the parties. As an exception, the Swiss Supreme Court has ruled that two Swiss construction companies were deemed to have tacitly accepted the SIA standards.2
As regards public procurement, the Coordination Conference of Building and Property Bodies of Public Sector Developers (KBOB) provides a standard form for general and total contractor agreement. KBOB contracts are now also used more often for private projects.
In the international context, the most frequently used standard forms are the various sets of conditions issued by the Geneva-based International Federation of Consulting Engineers (FIDIC).
Risk allocation and management
i Management of risk
The management of risks is essential in the context of project finance and requires a tailor-made analysis of each project to identify and assess these risks and determine who should bear them. In general, the parties will have to deal with different types of risks.
Completion risk is the risk that the project will not be completed in time or at all. In the case of cash flow-related lending (as is the case in project finance), completion in due time is crucial, as interest continues to accrue and may not be covered by the projected cash flow. Usually, the completion risk is mitigated from the project company to the total contractor, who must accept contractual penalties and provide a completion guarantee. In addition, the lenders may insist on additional guarantees by the sponsors.
There can be a risk that government permits for a project will not be granted or will be granted only subject to costly conditions; usually, obtaining all substantial permits is a condition precedent to drawdown under the credit agreement.
Lenders are generally not prepared to take any environmental risks. With respect to existing contamination of a site, environmental risks may be passed to the total or general contractor (who will price in the risk) if it has been assessed in environmental due diligence. Future environmental risks are usually transferred to the operator and must be insured.
The risks relating to the operation and the maintenance of the project are usually transferred to the facility manager, who must secure the proper fulfilment of his or her duties by providing performance guarantees.
ii Limitation of liability
Pursuant to the general provisions of the Swiss Code of Obligations, a party is liable for any damages resulting from non-performance, unless it demonstrates that it has no responsibility for the non-performance. Negligence is sufficient to trigger liability; a concurrent fault of the injured party does not limit the non-performing party's liability, but may result in reduced damages.
Under Swiss law, the parties may agree upon a limitation of the contractor's liability (e.g., stipulation of a cap). However, liability for gross negligence and wilful intent cannot be contractually excluded or capped.
As a general principle, liability of the contractor is limited in the event of force majeure. However, the parties usually include some language to specify the scope of force majeure and the consequences related to it (extension of timescales, compensation of the contractor for additional costs).
In its relationship with the owner, the contractor is solely liable for the performance of the contract and thus for the work of the subcontractors. If instructions given by the owner risk causing delay or defects, or increase the costs of the work, it is incumbent upon the contractor to immediately and specifically point out this risk to the owner; the contractor may be liable for any consequences by failing to do so.
No third-party contractual claims are possible against the contractor; if indirect damages are not contractually excluded, the contractor may face a claim from the owner trying to recover any damages it was obliged to pay because of third-party damages.
iii Political risks
Switzerland is known for its political stability. Hence, mitigation of political risk is not a main issue in construction or financing contracts. Certain political risks, such as war and strikes, are usually included in the force majeure provisions. However, because of the numerous participation rights provided for by the Swiss political system, a project might be substantially delayed or even halted. This risk can arise even at a late stage of the project. As a result, early binding decisions regarding politically relevant issues are crucial.
Once the required permits or concessions are granted (in particular the building permit), the owner may profit from a broad protection of its property rights on a constitutional level; Article 26 of the Swiss Constitution grants full compensation in the event of expropriation. Moreover, having realised a building project based on a building permit, an owner is protected by means of the principle of confidence: such a building permit must not be revoked.
The protection of the property rights is granted irrespective of the nationality of the principal.
Security and collateral
In project finance structures, the Swiss standard security package is comprised of a number of elements. Mortgages are the classic security interest in real estate financing. However, properties in administrative use are subject to a specific legal regime. In Switzerland, such mortgages may be granted in the form of an actual mortgage or a mortgage note. The mortgage note is issued in bearer form or registered form. Generally, the mortgage note is the preferred security interest because of its nature as a tradable security that can itself be sold and pledged. Since 2012, mortgages may also be established by means of a registered mortgage certificate. Registered mortgage certificates are instruments that are easily transferable and may also be pledged. Mortgages are established by a notarised deed and registration on the land register.
Lenders must be aware that certain legal liens may arise that would rank ahead of any contractual security right over the real property. These legal liens may exist to secure any unpaid real estate capital gains tax, transfer tax or mechanics liens. As a result, contractual provisions must be included in the documentation to avoid the creation of any such security interest.
Receivables are normally assigned by way of global assignment. The assignment is non-accessory to the secured obligation. During the term of the agreement, the assignor must regularly deliver to the assignee its lists of receivables, showing the assigned receivables, as continuing evidence of the claims assignment. Third-party debtors are often not notified of the assignment until the borrower's default. As long as third-party debtors are not aware of the assignment, they can validly fulfil their obligations by payment to the assignor. Global assignments are used very often.
Under Swiss law, future receivables can be assigned, but they would fall within the bankruptcy estate of the assignor if they come into existence after the opening of bankruptcy proceedings over the assignor. The assignment requires a written agreement between the assignor and the assignee, clearly determining the claims that are allowed to be assigned, especially with regard to any global assignment of future claims.
If an SPV is involved, the standard security package also includes a pledge over the shares in favour of the lenders. There are no special registration requirements with respect to a share pledge; however, as a perfection formality, the share pledge requires a valid agreement and the physical transfer of the relevant shares to the pledgee. In addition, in the case of registered shares, the share certificate must be duly endorsed (normally an endorsement in blank is provided in blank to facilitate the enforcement). In the case of registered shares, the pledge can be registered in the company's share ledger.
Generally, there are no limitations on granting this type of security to a foreign lender provided that, pursuant to the articles of association of the company, the company does not require a majority of Swiss shareholders. Further, the share pledge might trigger the need for a Lex Koller permit (see Section IX.ii).
Swiss law provides that the shareholder's voting and participation rights remain with the pledgor. Consequently, the features of a pledge agreement need to be examined to ensure that voting and participation rights can be exercised.
A bank account can be pledged pursuant to a pledge agreement or assigned pursuant to a security assignment agreement to a domestic or foreign secured party.
Lenders must be aware that any rights the account bank might have over a bank account pursuant to its general terms and conditions (e.g., set-off rights or pledge rights) rank ahead of the security interest of the pledgee, unless waived by the account bank. Such a waiver might be difficult to obtain in practice.
Bank accounts can be pledged by means of a written accounts pledge agreement. The account bank must be given notice to create and perfect the second-ranking security interest. The right to withdraw funds is not usually restricted as long as no default has occurred.
Swiss law does not specifically provide an instrument equivalent to the floating charge used in England. Movable assets need to be physically transferred to the pledgor or a third-party pledge-holder to perfect the pledge. Therefore, the concept of a floating charge over movable assets that need to be available for the operations of the pledgor is not feasible.
Under Swiss law, subordination of debt is achieved contractually through an agreement between the debtor and the subordinated creditor in which the creditor's claims are subordinated to certain other claims.
Further, multiparty agreements with a more complex ranking system of subordinated debt are possible. The debtor and the creditor may agree that the creditor will rank as senior to any other creditor of the debtor, provided that the creditors agree to be ranked junior.
If a company is overindebted, the board of directors must notify the relevant bankruptcy court, which, on notification, will start bankruptcy proceedings. The notification duty can be avoided if creditors subordinate their claims through a contractual agreement.
Principally, the lenders can reserve the right to step in and take over the project company's position if the project company is not performing. This step-in right requires an agreement with the shareholders of the project company (purchase option) if the project company is to continue its business, or with the contractors (usually by means of a direct agreement) if a new company is to take over the project. Frequently, both forms of step-in right are combined.
In the context of a PPP, it is a matter of dispute as to whether the public procurement regulations restrict the ability to stipulate step-in rights.
Bonds and insurance
i Performance guarantee and defects warranty
In construction contracts, the contractor (in the context of project finance, typically the general contractor) must provide a performance guarantee. Upon completion, the contractor must provide a warranty as regards the defects of the construction. The performance guarantee and the defects warranty are secured, generally either by a bank guarantee or by a surety.
By means of a bank guarantee, the guarantor bank undertakes to pay to the beneficiary, upon its first demand, any amount up to a defined maximum. This guarantee is irrevocable and unconditional and may be exercised if certain obligations are not fulfilled properly.
Swiss law also recognises the concept of surety. In a surety contract, the grantor fulfils the obligations of the principal obligor (borrower) if the latter is unable to do so. The main difference between this and the guarantee is that the grantor has available to it all legal defences available to the principal obligor, because the surety does not create an independent contractual claim (unlike the guarantee). The surety must be limited to a maximum amount and must be in writing to be valid. The grantor is only obliged to pay once the main obligor is in arrears in relation to its performance and either has been issued with payment reminders to no avail or is manifestly insolvent.
Usually, an insurance adviser is appointed who will carry out the insurance due diligence and define the minimum standard of insurance coverage.
Typically, the contractor must take out insurance for civil liability relating to damages arising from the construction. Tender conditions may require that the bidders furnish proof of this insurance and maintain cover throughout the project.
In addition, the project company, as the owner of the site, must ensure there is sufficient insurance for civil liability relating to damages resulting from the property.
Enforcement of security and bankruptcy proceedings
Enforcement of security and bankruptcy proceedings adheres to the rules set out in the Debt Enforcement and Bankruptcy Act (DEBA). To a certain extent, the parties can agree on specific enforcement mechanisms. However, pursuant to mandatory law, the collateral must not immediately fall into the property of the pledgee if its claims are not satisfied.
Under a Swiss standard security agreement, the lender may enforce the security (at its option) by private sale (including self-acquisition), by a (privately organised) public auction or by way of an official enforcement proceeding before any competent court or authority pursuant to the DEBA.
Although most security agreements allow lenders to enforce them by way of private sale on the occurrence of an event of default, it is recommended that enforcement is only commenced when the secured obligations are due and payable. Lenders are under an obligation to account for proceeds realised in enforcement and must repay any surplus to the borrower (after deduction of all costs and so on).
With regard to mortgage notes, only a private sale would be possible, but not with regard to the underlying real property (which may only be subject to enforcement proceedings within the framework of the DEBA).
In the case of assets transferred by way of security, enforcement, in the strict sense, is not necessary, as ownership has already been transferred to the secured party. Enforcement in this context means that the obligation to return the transferred assets under the security agreement expires. This follows similar rules that apply to private enforcement (in particular, any surplus remaining after the application of the proceeds of the secured debts must be returned to the party that granted the security).
Under Swiss substantive law, future receivables, which have been assigned to the lenders but have come into existence only after the opening of bankruptcy proceedings against the borrower, fall into the borrower's estate and do not pass to the lenders. However, the security provided by mortgage notes includes all lease receivables that will come into existence from the commencement of enforcement proceedings or from the opening of bankruptcy proceedings against the borrower to the realisation (i.e., sale) of the property.3
The DEBA also includes composition proceedings.4 These provisions were substantially revised as of 1 January 2014. The legislature was guided in part by US Chapter 11 and has specifically provided for a significantly facilitated access to composition proceedings.
i Licensing and permits
Swiss authorities at federal, cantonal and communal level have various regulatory responsibilities relating to zoning and public construction law. Generally, zoning and building regulations are enacted by the cantons and implemented by communal building authorities. As a result, Switzerland has 26 different cantonal zoning and construction regimes. Any change to an existing building or construction requires a building permit.
Projects that will potentially affect the environment require an environmental impact assessment demonstrating the specific measures that must be taken to ensure compliance of the project with the environmental regulations.
ii Responsibility of financial institutions
If the control of the project company by the lenders is too tight, the financial institutions may qualify as shadow directors and, as a result, become liable for the activities of the borrower to a certain extent; therefore, structuring of the supervision of the project company in the credit agreement is crucial to avoid the lenders' liability.
Furthermore, lenders with subsidiaries, branches, offices or appointed representatives in Switzerland must comply with the Federal Law on the Prevention of Money Laundering and the Financing of Terrorism in the Finance Sector.
PPP and other public procurement methods
Neither the federal nor the cantonal legislator in Switzerland has provided a specific formal statutory and regulatory framework for PPP transactions. However, in 2009, the Federal Ordinance on the Public Budget of 6 April 2006 (SR 611.01) was amended by inserting Article 52a, which states that PPP projects must be considered for the fulfilment of public tasks.
In general, there are no major regulatory obstacles to realising public infrastructure projects via PPP schemes. However, the PPP concession model for road infrastructure is not feasible in Switzerland as the Constitution prohibits the levying of any taxes on the use of national roads.
A general ban on negotiations imposed by the cantonal public procurement provisions does impede the procurement process for PPP projects. However, the Burgdorf project has shown that a PPP process is feasible under total contractual competition, which contains rigid requirements concerning the anonymity of participants. As negotiations are allowed under federal procurement law, more flexibility in the PPP tendering process exists at a federal level.
Lenders may also have difficulties receiving the type of full security package that is commonly received in international project finance structures. In relation to real estate, it appears to be difficult for a private partner to obtain (full) ownership rights over any real estate.
Lenders must also be aware that a specific legal regime applies to assets in administrative use. While such assets may be privately owned, they must not be subject to mortgages.
ii Public procurement
The Confederation and each of the 26 cantons has its own procurement law. However, international treaties ratified by the Confederation provide the legal framework for both federal and cantonal procurement legislation. After a long legislative process, the Confederation and the cantons have enacted revised acts on public procurement, the revised Federal Act on Government Procurement of 21 June 2019 (FAPP) at the federal level and the revised Intercantonal Agreement on Public Procurement of 15 November 2019 (IAPP) at the cantonal and municipal level. FAPP and IAPP have been harmonised and implement the standards of the revised General Procurement Agreement dated 30 March 2012, which Switzerland had already signed in 2012 and which could finally be ratified further to these revised acts; it entered into force in Switzerland on 1 January 2021. The relevant legislation explicitly provides for the fundamental principles of public procurement, such as equal treatment, transparency and competition. Furthermore, the Confederation and all cantons have implemented challenge procedures and the award is subject to appeal at an independent court (the Federal Administrative Court and cantonal administrative courts, respectively). To a limited extent, these decisions may be appealed at the Supreme Court.
Generally, an application for review has no automatic suspensive effect blocking the continuation of the procurement procedure or the conclusion of the contract. However, courts generally grant suspensive effect (typically, solely on the request of the applicant).
Foreign investment and cross-border issues
Basically, Switzerland has not enacted major restrictions on imports of project equipment; nor are there relevant licensing or other requirements specifically for foreign investors.
Cross-border lending by a foreign lender to a borrower in Switzerland does not generally require authorisation from the Federal Financial Market Supervisory Authority (FINMA) or any other regulatory authority. However, a lender with a subsidiary, branch, office or appointed representative in Switzerland is subject to supervision in Switzerland under the Federal Law on Banks and Savings Institutions, and must possess a licence to engage in the business of banking from FINMA.
i Removal of profits and investment
Swiss law does not provide foreign exchange restrictions, or substantial fees, taxes or charges on currency exchange. However, claims in foreign currency will be enforced in Switzerland only in Swiss currency.
There are no controls or laws in force that would prevent either the repatriation of proceeds realised in Switzerland, payments to a foreign lender under security agreements (including guarantees) or a loan agreement. However, interest payments by a Swiss debtor may be subject to the federal withholding tax of 35 per cent if the number of creditors exceeds a certain limit. As a result, it is crucial to include specific tax language in the credit agreement to avoid withholding tax payments.
ii Lex Koller
The acquisition of real estate in Switzerland by persons abroad is restricted under the Federal Law of 16 December 1983 on the Acquisition of Real Estate by Persons Abroad (Lex Koller).
A transaction is subject to a Lex Koller permit if:
- the real estate is acquired by a person abroad (which includes a company domiciled in Switzerland but dominated by foreign nationals);
- the real estate involved is a property that is subject to the Lex Koller permit requirement regime, namely residential real estate; and
- the acquired right is deemed to be the acquisition of residential real estate in the sense understood in the Lex Koller.
These three conditions must be met cumulatively.
In simple terms, the realisation of commercially used premises is not subject to a Lex Koller permit, as is usually the case in the context of private sector project finance. With respect to PPPs, the analysis is more complex, since the Swiss Federal Tribunal ruled some years ago that certain administrative activities do not have commercial character and hence a Lex Koller permit is required. Although this decision is highly disputed among scholars, it has to be considered in the structuring phase of a PPP.
Lex Koller provides that the purchaser must apply for a negative declaration (ruling) by the competent Lex Koller authority stating that no approval is required if there is a doubt whether an acquisition is subject to a Lex Koller permit. A transaction requiring a permit is invalid until a legally binding permit has been obtained.
Subject to certain conditions, financing of residential real estate may also be subject to the Lex Koller restrictions if, because of the financing terms, the purchaser or borrower becomes strongly dependent on the secured lender, granting excessive control rights to the lender and resulting in an ownership-like position of the lender. As a result, the project finance standard security package may raise Lex Koller questions.
Recently, the Swiss parliament rejected a parliamentary motion to extend the Lex Koller restrictions applicable to Swiss residential properties to other properties as well.
There are no state courts specialising in project finance or construction disputes. However, commercial contracts can generally be subject to arbitration.
Contracts for domestic construction projects usually provide for the jurisdiction of the local courts, especially if a public entity is involved. However, the Swiss construction industry has established arbitration rules whereby disputes may be referred to specialised arbitral tribunals.
Switzerland is a major seat of international arbitration, even for infrastructure projects outside the country. The most frequently used arbitration rules are the uniform arbitration rules of the Swiss Chambers of Commerce and those of the International Chamber of Commerce. Enforcement of foreign arbitral awards in Switzerland is governed by the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York, 1958).
Recently, dispute boards have occasionally been established for larger infrastructure projects, but this instrument is not widely used. Mediation is also not yet commonly used, although industry associations have adopted mediation and arbitration rules.
Outlook and conclusions
The future demand for infrastructure and transport-related construction in Switzerland is expected to be high and will increase the need for structured finance. In addition, a hospital financing system was introduced in 2012, known as the diagnosis-related groups-based system, which includes investment allowances in case-based tariffs. As a result, the cantons must cease providing government deficit guarantees and low-cost loans to public hospitals. Project finance may become a valid solution to the provision and financing of infrastructure investment in this area.