“The ‘Ali Baba’ Arrangement: When the Court Refuses to Save a Commercial Reality”

“What a Recent Construction Case Reveals About the Gap Between Procurement Policy and Market Reality”

Every player in the construction industry knows the ‘Ali Baba’ arrangement. Some call it license lending and others describe it as project parking, fronting arrangements or simply commercial necessity. Regardless of the label, the underlying reality is one party possesses the qualification, registration or procurement eligibility required to secure a project, while another possesses the expertise, manpower, machinery or financial capacity required to execute it.

This arrangement survives because it solves a problem. A contractor may possess the license required to tender for a government project but lack the working capital required to fund mobilization, labor, machinery and project execution. Another may possess the technical capability, operational experience and financial resources necessary to complete the project but lack access to the opportunity itself. The market naturally seeks ways to bridge that gap. The legal difficulty arises when the method used to bridge that gap undermines the policy objective behind the procurement framework itself.

That tension sits at the heart of a recent High Court decision involving a government school construction project in Kedah. The Court found that the arrangement before it amounted to an unlawful “Ali Baba” scheme. The evidence showed that the subcontractor had allegedly determined the tender price, funded the project, controlled its execution and paid the main contractor a fixed commission for the use of its Bumiputera license. The Court concluded that the arrangement was designed to circumvent procurement requirements and was therefore contrary to public policy and void under section 24 of the Contracts Act 1950.

Despite the completion of the project, the performing party was denied recovery. Many legal commentaries will focus on the finding of illegality and that is understandable. But perhaps that is not the most interesting aspect of the case. The more difficult question is this: “If Malaysian courts have been warning against similar arrangements for decades, why do they continue to appear?”

The Issue Is Not Whether the Arrangement Works

One common misconception is that these arrangements fail because they are commercially unsound. In reality, many of them work remarkably well. If such arrangements never produced results, they would have disappeared long ago.

The issue is not whether an “Ali Baba” arrangement works. The issue is whether the law should enforce a commercial success that derives its value from defeating the very policy that enabled the opportunity to exist in the first place. This is a fundamentally different question. The Court is not asked whether the arrangement was commercially sensible. The Court is asked whether the arrangement is consistent with the law and the policy objectives underlying the relevant regulatory framework. Once the Court concludes that an arrangement has undermined those objectives, commercial practicality becomes secondary to public policy.

A Warning That Is Not New

The recent construction case may appear significant because of the attention it has attracted. In truth, the underlying principle is not new. When reading reports of the decision, I was immediately reminded of the observations of Justice Lee Swee Seng in Norman Disney & Young v Affifi Hj Hassan [2010] 1 MLRH 925. The dispute concerned proxy shareholding arrangements in a consulting engineering company. The facts were entirely different from the recent construction case but the underlying concern was remarkably similar.

In both situations, parties had created structures intended to preserve a desired commercial outcome whilst navigating around legal or regulatory restrictions. What makes Norman Disney case particularly important is not merely its conclusion that the arrangement was unenforceable. It is the realism reflected in the judgment.

Justice Lee Swee Seng openly acknowledged that parties often employ nominee arrangements, powers of attorney, call options and other carefully designed structures to preserve commercial objectives whilst maintaining the appearance of compliance. However, the Court was not naive and understood how such arrangements operated. Notwithstanding the recognition of the commercial reality, the Court refused to rescue it.

Importantly, His Lordship issued a warning that remains highly relevant today:

“Those who are so engaged in such an elaborate exercise do so at the risk of their whole investment becoming totally irrecoverable when the matter should come to court.”

That warning captures the essence of the recent construction case and the lesson was never confined to proxy shareholding arrangements. Whether the issue concerns engineering firms, procurement policies, licensing requirements or government contracts, the risk remains the same.

The Paradox of Procurement Policy

The recent decision also exposes a deeper and more uncomfortable issue. Government procurement policies are not simply mechanisms for awarding contracts. They are intended to achieve broader economic and social objectives. Among other things, such policies seek to encourage participation, develop capability and create sustainable commercial opportunities for the groups they are intended to benefit. However, the challenge arises when market behavior responds in ways that policymakers never intended and this creates a paradox.

A policy intended to develop capability may ultimately undermine its own purpose if market participants begin monetizing access rather than developing expertise. There is a significant difference between building a contractor and renting a contractor’s eligibility. From this perspective, the recent case is not merely a dispute over unpaid construction work. It is equally a dispute about the integrity of the procurement framework itself.

What Is the Market Trying to Tell Us?

This is perhaps the most important question arising from the case. If courts have repeatedly condemned similar arrangements for decades, why do they continue to emerge? The answer cannot simply be ignorance of the law.

In practice, project eligibility, technical capability and financing capacity do not always sit within the same entity. The legal problem arises when the structure chosen to achieve that objective undermines the purpose of the regulatory framework itself.

At that point, what appears commercially sensible may become legally vulnerable. The recurring appearance of such arrangements may therefore reveal more than individual misconduct. It may reveal an ongoing tension between procurement objectives, contractor development, financing realities and market behavior. That is a conversation that extends far beyond any individual dispute.

When the Court Refuses to Save a Commercial Reality

The recent construction decision is unlikely to eliminate “Ali Baba” arrangements. Nor did Norman Disney case eliminate proxy structures. The significance of these cases lies elsewhere. They remind us that courts and markets perform fundamentally different functions.

When those objectives collide, commercial practicality does not always prevail. As Justice Lee Swee Seng observed:

“Where agreements are conceived and carried out in the context of circumventing, contradicting and contravening the law, one must concede that it is impossible to separate the stream from the source.”

More than fifteen years later, the same principle continues to resonate. The recent construction case demonstrates that courts remain reluctant to rescue commercial arrangements that undermine the purpose of a regulatory framework, regardless of how practical or profitable those arrangements may appear.

For contractors, developers, financiers and project participants, the lesson extends beyond the doctrine of illegality. The most expensive legal disputes are rarely created in court. They are often created much earlier at the structuring stage, when commercial objectives, regulatory requirements and operational realities are not properly aligned. By the time the dispute reaches litigation, the cost of that misalignment is often irreversible.

Understanding where commercial reality ends and legal risk begin may ultimately be worth far more than winning a case after the dispute has already arisen. “Think of Law, Think of LV Partners.”

This article is written by

Jackson Chung
Lv Partners