Agreements should sort payment issues

Martin Preston* of Norton Rose focuses on payment issues that need to be considered between the Grantor** and Company*** in relation to concession agreements ranging from utility developments to large-scale property developments in the region.

The usual position under private utility concession agreements is that the Company is required to construct the infrastructure required for the provision of the utilities but payment does not commence until supply of the utilities has commenced under the agreement.

Typically, the Company will borrow all or part of the funds required to construct the necessary infrastructure, and the payments received during the operation period will cover debt service, other fixed costs, variable costs (such as power) as well as providing the Company with its profit. The Company’s lenders will pay particular attention to the payment terms and will be seeking comfort that revenue will be sufficient to repay the debt that has been taken on by the Company (or, more usually, a special-purpose vehicle set up to carry out the project) for the construction of the required infrastructure.
There are a number of issues to consider in relation to payment. First of all, it will be necessary to determine who will be responsible for making payment to the Company. One option is for the Grantor to make payment to the Company and to recover this from the end-users by way of a service charge or similar payment. Alternatively, payment may be made directly by the end-users to the Company. In this latter case, the Company will either need a direct contractual link with the end-users to enable it to enforce its right to payment against them or the Grantor will have to impose on the end-users an obligation to procure the relevant utilities from the Company and undertake to enforce this obligation on behalf of the Company.
If payment is to be made by end-users, then the Company will have to be satisfied that they are able and willing to pay for the utilities provided. If the Company has any doubts in this respect, it should seek either direct payment from the Grantor or a guarantee from the Grantor that the end-user’s payment obligations will be met.
Linked to payment is the issue of exclusivity. Regardless of whether payment is made by the Grantor or by the end-users, the Company will want to ensure that, if it is to invest in the infrastructure, it will (subject to the Grantor’s ability to terminate the concession agreement for poor or non-performance) have the exclusive right to provide the utilities to the development so that it has a guaranteed revenue stream to recover the cost of the infrastructure. A Company will not wish to pay to construct the relevant infrastructure if another provider is able to supply the same utility to the development in question, and banks will not fund the cost of such infrastructure unless revenue generation is guaranteed in this way.
The basis on which payment is to be made to the Company also needs to be considered. Essentially, there are three options, a payment based on availability, a payment on the basis of consumption or a combination of availability and consumption charges.
An availability-based charge provides the greatest certainty to the Company as payment of a fixed amount is guaranteed, provided that the availability requirements in the contract are satisfied. In other words, provided that the Company complies with its obligations under the concession agreement and is able to provide the utility in question, it is paid irrespective of the demand for that utility.
Payment on the basis of consumption entails more risk for the Company as the Grantor or end-users are only required to pay for the utilities used. This requires the company to take the risk that the project is successful and that the forecast demand is met. If the Company is unwilling (or unable, due to the requirements of its lenders) to accept this risk, it may seek a minimum revenue guarantee to meet its debt service requirements and other fixed costs. This will be of particular relevance if the development is to have phased completion, as initially the demand for the utilities may be insufficient to repay the debt required to construct the infrastructure. If this is accepted, then a minimum revenue guarantee would usually be an availability-based payment and would be payable if the utilities were available even if not used. For consumption in excess of the minimum revenue guarantee, payment would then usually be on the basis of consumption. These payments are usually structured as a capacity charge (also known as a fixed or availability charge), the purpose of which is to cover the Company’s fixed costs such as debt service, insurance and salaries, and a variable charge, which covers the costs of providing the utility, such as fuel and other consumables.
Given that most concession agreements will be for a term of up to 25 years, the Grantor will want to ensure that the price paid for the utilities remains competitive over the life of the concession agreement and the Company will want protection against inflation. Inflation is usually addressed through an indexation provision that allows for payments to be increased by reference to a pre-agreed index or formula. The Grantor’s concerns about value for money are typically met through the operation of a benchmarking mechanism. This involves comparing the cost of the utilities against the price paid for similar utilities on other, similar developments. The Company will usually be required to adjust the price it charges for the utilities to meet the benchmarked figure; alternatively, the Grantor may have the right to terminate the concession agreement if the Company’s price is more than a given amount over the benchmarked figure. Another option is a direct pass through of the Company’s main input costs, such as power and water, with a fixed element paid in addition to these amounts to cover the Company’s overheads and profit.
Grantor**: the developer granting the concession agreement.
Company***: the party to whom the concession is granted.

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