Key issues in PPP agreements

By Martin Preston

WITH the exception of power and/or water desalination plants, the GCC states have tended to procure their infrastructure directly rather than looking to the public-private partnership (PPP) model. However, a number of GCC states are now looking to the PPP model as a means of procuring infrastructure projects outside the power and water sectors as well.

PPP structures can be adopted across a number of sectors (transport, healthcare, education and social housing) and offer a number of potential advantages to the procuring authority over direct procurement. These include the transfer of risk to the private sector, the funding of construction costs by the private sector and the availability of private sector expertise in the running of the project.

Under the PPP model, the government enters into a concession agreement with a private sector entity (the Project Company) under which the Project Company undertakes to provide specified services over a fixed term (typically 20 to 25 years). The Project Company will also usually be required to construct (or, in some cases, refurbish) the assets required to provide the services, the cost of which will be recovered by the Project Company from the payments it receives over the duration of the concession agreement.

Given that it is payments under the concession agreement that provide the Project Company with its income from the project, two of the key areas of concern for the Project Company and its lenders will be the payment provisions and the ability of the government to terminate the concession agreement.

There are a number of ways in which a Project Company may receive payment under or pursuant to a concession agreement. It may be granted the right to charge end-users directly for the use of the asset, as is the case with, for example, a toll road. This will often require separate legislation to enable a private sector entity to levy such charges.

In addition to ensuring that any such legislation is passed, the Project Company and its lenders will need to satisfy themselves that there is sufficient demand, that competing infrastructure will not be built during the term of the concession agreement (or, if it is, that the concession agreement provided for the Project Company to be sufficiently compensated for any resulting loss of revenue) and that it is politically acceptable to charge end-users.

If charging end-users directly is likely to be unacceptable politically or if the Project Company is unwilling to accept end-user payment risk, the government may pay the Project Company directly based on usage (a shadow toll). Under this arrangement, the Project Company still takes demand risk but is not required to take collection risk.

It may be that the private sector is unable or unwilling to take demand risk as being something outside of its control and which it is unable to quantify. If this is the case, then the government may make payments to the Project Company based on availability. With availability based payments, it will be important to look at what constitutes availability and what deductions the government can make from payments to the Project Company if all or part of the project is unavailable.

Termination of the concession agreement will be an area of key focus for the Project Company and its lenders as they will want to know in what circumstances the government can bring the concession agreement to an end and what, if any, compensation is payable on termination of the concession agreement.

Termination of the concession agreement may fall into one of three categories: government default, Project Company default and prolonged force majeure. Government default usually includes non-payment (if the government is responsible for payment), the construction of competing assets (if the Project Company is taking demand risk and is not otherwise compensated), compensation, change in law (to the extent that the Project Company cannot be put in the same position it was in before the change in law by the payment of compensation), expropriation and/or breach of the concession agreement by the government. The Project Company and lenders will expect to be paid out in full on a termination for government default (and may want any such payment to be guaranteed by the Ministry of Finance depending on the nature of the government entity which is the counterparty to the concession agreement).

With Project Company default, the Project Company and the lenders will want to ensure that there are no hair trigger events of default and that the Project Company has an opportunity to cure most events of default prior to termination. The lenders will also require a direct agreement enabling them (or someone appointed on their behalf) to step in and rectify a Project Company default before the concession agreement is terminated. Payment on termination for Project Company default will depend on the type of infrastructure but may be limited to repayment of debt. The treatment of force majeure will depend on whether it is natural (and insurable) or political (which is not typically insurable). Usually, termination for prolonged political force majeure will be treated the same as a termination for government default, whereas natural force majeure should be covered by insurance.

Other issues that need to be addressed in the concession agreement include provisions dealing with the site (is it provided by the government or procured by the Project Company, who takes the risk of unforeseen ground conditions and/or pre-existing contamination, etc), allocation of responsibility for obtaining any relevant consents and permits, construction of the works, commencement of the services and remedies for delay, changes in law or other events entitling the Project Company to compensation under the concession agreement, force majeure (both events, which are usually divided into natural and political force majeure events, and consequences) and insurance arrangements.


Gulf Construction

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