Defence contract disputes and risk allocation in South Korea

Disputes and risk allocation

How are disputes between the government and defence contractor resolved?

Disputes between the government and a defence contractor over bidding or contract-related issues involved in defence and security procurements, such as bidding procedures, bidding outcomes or delay penalties, are settled through civil litigation.

In addition, in the case of defence and security procurements of more than a certain amount (7 billion won for a construction contract; 150 million won for a commodity contract; and 150 million won for a service contract), disputes between the government and a defence contractor may also be settled through the appeal process under the ACSP or through the mediation process by the State Contract Dispute Mediation Committee. A defence contractor may directly file a lawsuit in court without exhausting dispute resolution processes outside the court system. Alternative dispute resolution processes are not frequently used in practice.

On the other hand, if a defence contractor has committed unfair bidding, misstatement of cost or breach of contract, the government (ie, the DAPA in the case of a contract administered by the DAPA, and the MND in the case of a contract administered by the national defence authorities) may restrict the defence contractor’s eligibility to participate in bidding for a certain period of time. Disputes over such restriction are resolved by administrative appeal or administrative litigation.

To what extent is alternative dispute resolution used to resolve conflicts? What is typical for this jurisdiction?

The DAPA resolves disputes related to procurements of weapon systems through litigation or arbitration. In the case of domestic procurements, the parties generally stipulate in their contract to resolve disputes through litigation. In the case of overseas procurements, it is common to resolve disputes through arbitration. However, in some cases, disputes related to overseas procurements may also be stipulated to be resolved through litigation in Korea.

The arbitration clause included in the DAPA’s general terms and conditions stipulates that disputes shall be finally settled by arbitration conducted in Seoul, Korea in accordance with the Commercial Arbitration Rules of the Korean Commercial Arbitration Board. The arbitration clause may be modified depending on negotiations between the DAPA and the contractor.

What limits exist on the government’s ability to indemnify the contractor in this jurisdiction and must the contractor indemnify the government in a defence procurement?

There is no particular limitation on the scope of the government’s liability toward a defence contractor. Accordingly, where the government breaches the defence procurement contract, it shall be responsible for damages caused to the contractor in the same way as ordinary contracts - provided that a special clause about damages of delayed payment is included in the defence procurement contract to stipulate that the damages shall be calculated by multiplying the number of days of delay by the average lending rate of financial institutions for the given month.

On the other hand, if the contractor fails to perform the contract, it shall be liable to the government in accordance with general legal principles, unless otherwise specifically provided in the contract.

Can the government agree to limit the contractor’s liability under the contract? Are there limits to the contractor’s potential recovery against the government for breach?

As a general principle, government contracts must be entered into in compliance with all relevant laws and regulations, and contracting officers generally have very little discretion in executing contracts. In other words, contracting officers are restricted from arbitrarily limiting the contractor’s liability under the contract.

On the other hand, the DAPA’s general terms and conditions for overseas procurements partially mitigate the liability of the contractor by limiting the total amount of delay penalty to 10 per cent of the contract price. In addition, depending on negotiations with the contractor, the government may further agree to limit the scope of product liability claims as suggested by the contractor.

Is there risk of non-payment when the government enters into a contract but does not ensure there are adequate funds to meet the contractual obligations?

There is little risk that the Korean government will not meet payment obligations under procurement contracts. A weapon system is not procured without first securing a budget and the Korean government is responsible for executing payment obligations under government procurement contracts from the single national treasury, even if they are signed by an individual government agency such as the DAPA. The Korean government maintains a sound level of reserves to perform such payment obligations.

Under what circumstances must a contractor provide a parent guarantee?

A parent guarantee is not required in a government procurement contract. The contractor is directly required to pay a performance bond to cover the risk of potential damages at each stage of the conclusion and performance of the contract. In particular, in the case of overseas procurements, the government demands a performance bond of at least 10 per cent of the contract value within 30 days after opening a letter of credit or within a period specified in the contract. The performance bond must be paid in cash or by an irrevocable standby letter of credit. If the contractor fails to pay the performance bond within a specified period without justifiable grounds, the DAPA reviews and determines whether the contract should be terminated. Bond deposits are attributable to the Treasury when the contractor does not fulfil its contractual obligations.