Getting to grips with PPP/BOT projects
Given the expected increase in the number of PPP/BOT projects across a number of Middle East and North Africa (Mena) jurisdictions in the next few years, Martin Preston provides guidelines to what a contractor bidding for such projects can expect.
01 March 2011
THE structure of a typical public private partnership (PPP)/build-operate-transfer (BOT) project involves a company that is established solely for the purpose of the project (the project company).
The project company will fund the project to a large extent from bank finance. One feature of project finance transactions is that the banks look to the project itself for the repayment of the debt, and this results in close scrutiny of the project documents by the banks and their lawyers.
Unlike a corporate loan, the project company will not have extensive assets which the lenders can go against if the project company fails to meet its loan repayments. Instead, their recourse is against the project itself.
The project company will enter into a concession agreement with the granting authority. This will usually involve both construction and operational obligations. Sometimes, a project company will take over existing infrastructure and operate that but typically there will be a requirement to both construct and operate a project.
This may not be obviously apparent, as concession agreements usually contain an output specification, which describes the services to be provided and the project company has to build the required infrastructure to provide those services. In most instances, however, the granting authority will want to exercise some control (even if just by way of signing off on designs) over what is constructed. Additionally, many projects are let on the basis that the asset being constructed will be transferred to the granting authority at the end of the concession period, so the granting authority will have an interest in what is being constructed.
As a result of this structure, the banks will require that all construction risks in the concession agreement are passed down to the contractor. If there are problems with construction, the banks want to know that a single party is responsible for rectifying these, rather than there being any room for dispute between the project company and the contractor in relation to a delay or defect affecting the project.
Additionally, the project company will not typically receive any payments from the granting authority for the construction of the works. Instead, these will be funded by a mixture of equity contributed by the shareholders in the project company and the bank debt.
The economics of the project require that the bank debt is repaid out of the income received in the operational phase of the project. Any increase in the construction costs will jeopardise the ability of the project to repay the debt and to provide a return to the shareholders.
Consequently, the banks will require a lumpsum turnkey contract with only limited rights for the contractor to claim additional time and money. These will, essentially, be limited to where the project company is entitled to additional time and money under the concession agreement or has itself delayed the contractor.
Delays to construction completion will, in most cases, delay the project’s revenue stream, which will impact on the financial viability of the project. Prolonged delay could also lead to the concession agreement being terminated. For that reason, the completion date under the construction contract will usually be earlier than that under the concession agreement so that the project company has a “buffer”, enabling it to levy liquidated damages and, ultimately, terminate the construction contract and appoint a replacement contractor before the concession agreement is terminated by the granting authority.
Extensions of time will be granted to the contractor if and to the extent that the project company is entitled to an extension of time under the concession agreement. Additionally, the project company should grant an extension of time to the contractor for delays that the project company itself has caused (but which are not the result of an event entitling the project company to an extension of time under the concession agreement) to preserve its right to claim liquidated damages for delay under the construction contract.
Claims for additional money by the contractor should also be restricted to amounts received by the project company under the concession agreement. So variations to the works will not be permitted unless the project company is entitled to an additional payment under the concession agreement because of, for example, a change in law that affects the construction of the works.
Another feature of project finance transactions is the need for the contractor to enter into direct agreement in favour of both the lenders and the granting authority. The lenders direct agreement will allow the lenders (or a party nominated by the lenders) to step in and replace the project company under the construction contract in the event that the latter is in breach of the finance documents. The granting authority direct agreement will enable the granting authority (or its nominee) to assume this role if the concession agreement is terminated.
In either case, these arrangements will be of benefit to the contractor as it will continue to be paid while the lenders or the granting authority work out how to proceed with the project in the absence of the project company.
* Martin Preston is a partner at Norton Rose (Middle East). 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 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.
