Subcontracting arrangements play an important role in the delivery of construction projects. However, not every arrangement described as a “subcontract” will necessarily be recognised as such in law. In a recent High Court decision in Alor Setar Development Corporation Sdn Bhd v EE Engineering (Malaysia) Sdn Bhd, the Court examined whether a purported subcontract was, in substance, an illegal “Ali Baba” arrangement, highlighting the importance of ensuring that subcontracting arrangements are commercially genuine and comply with procurement and contractual requirements.
What is an “Ali Baba” Arrangement?
An “Ali Baba” arrangement generally refers to a proxy arrangement in which a Bumiputera contractor lends its licence, registration or procurement status to another party in exchange for a fee or commission, often to circumvent applicable procurement requirements.
Case Background
A Bumiputera construction company (the “Main Contractor”) appointed a non-Bumiputera construction company (the “Subcontractor”) as its subcontractor for a construction project. Following completion of the works, the Subcontractor claimed an outstanding balance of RM538,000.00 under the subcontract. When payment was not forthcoming, the Subcontractor commenced proceedings to recover the outstanding sum. The Main Contractor argued that the purported subcontract was, in substance, an illegal “Ali Baba” arrangement intended to circumvent Bumiputera procurement requirements, and should therefore be void for illegality.
Main Issues before the Court
- Whether the purported subcontract was, in substance, an unlawful “Ali Baba” arrangement rather than a genuine commercial subcontract.
- Whether the purported subcontract was void for illegality and contrary to public policy.
- Whether the Subcontractor could nevertheless recover the outstanding sum through restitutionary remedies notwithstanding the illegality of the underlying arrangement.
Findings of the Sessions Court
The Sessions Court rejected the Main Contractor’s argument that the purported subcontract was an illegal “Ali Baba” arrangement and allowed the Subcontractor’s claim for the outstanding sum. The Court held that the Main Contractor had failed to prove the existence of the alleged arrangement, noting that the Main Contractor had relied largely on hearsay evidence and had not called the lawyer who had allegedly advised that the arrangement was illegal.
Findings of the High Court
The High Court allowed the appeal and held that the Sessions Court had failed to properly appreciate the documentary and oral evidence, which established that the purported subcontract was, in substance, an unlawful “Ali Baba” arrangement rather than a genuine commercial subcontract.
In reaching its decision, the Court relied on several aspects of the parties’ commercial arrangement, including:
- The progress claims by the Subcontractor consistently reflected a 2% deduction from the value of the works. The Court concluded that this represented a fixed commission for the Main Contractor, which it described as an “irrefutable hallmark” of an “Ali Baba” arrangement.
- The witness testimony showed that the Subcontractor prepared the tender documents, determined the tender pricing, managed the execution of the project and assumed the commercial risks, while the Main Contractor merely provided its Bumiputera status and CIDB licence in return for the fixed commission.
- The parties failed to obtain the project owner’s written consent to subcontract the works, contrary to the PAM Contract, which reinforced the Court’s conclusion that the arrangement was designed to circumvent Bumiputera procurement requirements.
The High Court held that the arrangement was void for illegality and contrary to public policy. Accordingly, the Subcontractor was not entitled to recover the outstanding sum.
Key Legal Principles
- The courts will look beyond the contractual labels and examine the commercial substance of an arrangement when determining whether it is void for illegality.
- A party to an illegal contract may be left without any contractual or restitutionary remedy where the underlying arrangement is found to be contrary to public policy.
Key Takeaway
The arrangement was not held to be unlawful merely because the project was fully subcontracted. Rather, the Court distinguished a genuine total subcontract from an “Ali Baba” arrangement, finding that the Main Contractor had merely acted as a front without retaining the responsibilities and level of control ordinarily expected of a main contractor.
Businesses involved in construction and procurement projects should therefore ensure that:
- subcontracting arrangements are commercially genuine and not merely vehicles to satisfy procurement requirements;
- the main contractor retains meaningful responsibility, control and commercial risk throughout the project; and
- subcontracting arrangements comply with the terms of the principal contract, including any applicable consent or approval requirements.
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This article was written by Shawn Ho (Partner) with the assistance of Sonia Lim (Intern) from Donovan & Ho’s corporate practice.
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