Region explores benefits of PPPs
MARTIN PRESTON* looks at what measures need to be put in place and what issues need to be addressed to attract private sector investment in PPP projects in the region.
01 May 2010
PUBLIC-private partnerships (PPPs) have been used as a means of procuring infrastructure assets as diverse as roads, schools, hospitals, IT systems, waste and wastewater treatment plants in a number of jurisdictions, including the UK, Australia, South Africa, and South Korea.
The intention is that the public sector will enter into a long-term agreement with a private sector entity, which will construct (or, in some instances, refurbish) the asset required for the provision of the relevant services and will then provide those services for the duration of the agreement.
A number of countries in the Mena (Middle East and North Africa) region are exploring the possibility of using PPP structures to procure the provision of certain services.
The first thing that will be required is a regulatory framework giving the public sector the capacity and authority to enter into long-term agreements for the procurement of services through the PPP model. Since many of the services that are typically procured on a PPP basis are those that would usually be provided by a public body, specific legislation to enable these services to be provided by the private sector will usually be required.
In addition to having the capacity and authority to enter into the contract for the provision of services (the concession agreement), a private sector entity looking to enter into the concession agreement (the concessionaire) and its lenders (typically, a concessionaire will fund construction through debt procured on a project finance basis, with the debt being repaid out of the income generated under the concession agreement) will want to ensure that either the concession agreement and/or the local law addresses issues set out below:
Investors’ rights
The jurisdiction will need to be one with which investors are comfortable. One area of particular concern will be the treatment of early termination of the concession agreement, both in terms of the events of default that may trigger termination and the consequences of early termination (essentially, what compensation is payable and whether it is enough to repay the debt and, in some instances, the equity). Convertibility of currency and the ability to repatriate payments for the services and compensation payments will also be of concern to the concessionaire and its lenders.
Lenders’ rights
The lenders will be concerned to protect the debt that they have advanced to the project. As well as ensuring that the termination events are not hair trigger events and contain adequate cure periods, the lenders will want the ability to step in and cure defaults if the granting authority is able to terminate the concession agreement for concessionaire breach. The usual mechanism for this is a direct agreement, which suspends the granting authority’s right to terminate the concession agreement while the lenders (or a party appointed on their behalf) attempt to remedy the breach. The lenders will also want to ensure that the relevant jurisdiction affords them the opportunity to take and enforce security over the project.
Demand risk & affordability
Critical to the concessionaire and its lenders’ analysis of the viability of the project will be the source of revenue. There are essentially two options here. One is that the concessionaire charges the end-user directly (for example, a toll road, where the road users pay the concessionaire directly). In this scenario, the concessionaire takes demand and collection risk. This will require due diligence to ensure that there is likely to be sufficient demand for the asset or services being procured. Exclusivity and restrictions on the procuring of competing assets or services (or compensation if they are so procured) will also need to be addressed. A concessionaire will not want to construct, for example, a road if subsequently other transport infrastructure is constructed which adversely impacts on the demand for that road. Legislation may also need to be passed to allow the concessionaire to levy charges directly on the public.
The second option is that payment is made by the granting authority on the basis of availability. In other words, if, in this example, the road is available (based on the criteria set out in the concession agreement, which will need to be carefully reviewed by the concessionaire, its lenders and their advisers), payment is made by the granting authority irrespective of usage. This second option is generally preferable for concessionaires and lenders, since it removes demand and collection risk, although the ability of the granting authority to make the availability payments will be paramount.
Taxation & change of law
The impact of taxation on payments received under the concession agreement will be factored into the financial model. Therefore, the concessionaire will need protection from any changes to taxation that impact on the viability of the project or the concessionaire’s return. Similarly, any changes in law should usually entitle the concessionaire to relief under the concession agreement.
As well as the specific issues listed above, as with all contracts, risk allocation needs to be addressed. Partnerships Victoria, an Australian body responsible for the development of PPP in Victoria, categorises the main risks in PPP projects as site risk; design, construction and commissioning risk; financial risk; operating risk; market risk; interface and network risk; industrial relations risk; legislative and government policy risk; force majeure risk; and asset ownership risk.
The general principle is that a risk should be borne by the party that is best placed to manage or control that particular risk. However, the parties will often have conflicting views as to which of them is best placed to manage or control a particular risk. Consequently, significant time is often spent negotiating the allocation of these risks between the parties.
* Martin Preston is a partner in Norton Rose (Middle East) LLP. Legal queries related to the construction sector can be addressed to Norton Rose (Middle East) LLP through Gulf Construction magazine at editor@gulfconstructionworldwide.com.
Norton Rose Group has had a presence in the Middle East for more than 30 years and has advised developers, lenders, and contractors in relation to the legal aspects of a wide variety of construction and infrastructure projects in the region.
With a combined team located in both the Bahrain, Abu Dhabi and Dubai offices, Norton Rose (Middle East) LLP is able to provide both contentious and non-contentious support to financiers, developers, contractors and specialist contractors in the region.
