Contracting for Public-Private Partnerships

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Contracting forPublic-Private Partnerships

• United Nations Development Programme
• Special Unit for South-South Cooperation
• Training Course
• Wes Strickland, Esq.
• Hatch Parent
• Arlington, VA
• September 18, 2006

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Outline

1. Overview of contract types
2. General contract terms
3. Special contract terms for each structure
4. Final observations

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I. Overview of Contract Types

• Operation and maintenance (OM)
• Design build operate maintain (DBOM)
• Design build finance operate (DBFO)
• Build own operate (BOO)
• Build own operate transfer (BOOT)
• Buy build operate (BBO)
• Privatization

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Key Structural Questions

• What is the partnership project?
• In what jurisdictions will the project exist?
• Under what legal authority does the public
  partner undertake the project?
• What type of entity is the private partner?
• Are there pre-existing assets being contributed?
• Are new assets being constructed?
• Who will own the assets?
• What capital resources are available to the
  partners?
• Who will provide any needed capital and how?

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Key Structural Questions (2)

• What will the private partner do?
• What payment will the private partner receive?
• How will the private partners success be
  measured and rewarded (or punished)?
• How will taxes be impacted? (after tax analysis)
• How long will the partnership last?
• What types of outside permits/approvals will be
  required?
• Who is the end user, the public partner or the
  public at large?
• Sponsored (public at large) or managed
  (public partner)

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Basic Structural Principles

• PPPs are partnerships, and each partner should
  act in good faith to further the purposes of the
  partnership
• Good partnerships are based on clear
  understandings of each partners role
• Tasks should be assigned to each partner
  according to their ability
• Compensation should be based on each partners
  tasks and assumption of risk

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OM Contracts

• Utilized when public sector partner already owns
  an asset for which it needs management services
• Public partner maintains ownership of initial
  assets
• Private partner provides specific services for a
  fee

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DBOM/DBFO Contracts

• Utilized when a new asset needs to be designed,
  built and possibly financed
• Like OM contract, but adding capital component
• Allows access to private capital markets
• Higher risk for private partner than OM
• May avoid some public labor force issues

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Concessions

• Utilized when public partner desires to have
  private partner take total responsibility for
  delivering service directly to the public,
  subject to contractual or regulatory terms
• Utilities
• Transportation infrastructure, e.g., toll roads,
  bridges, airports
• BOO, BOOT or BBO
• Franchise
• Affermage contracts

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Triangular Structures (2)
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Triangular Structures
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II. General Contract Terms

• Contracting to meet basic structural principles
• Basic terms of PPPs
• Jurisdictional limitations

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Contracting to ImplementBasic Structural
Principles

• Include all potential tasks in contract
• Define each task as specifically as possible, and
  the duties of each partner to accomplish that
  task
• Define all conditions that must be met prior to
  each duty arising, or that might cause a duty to
  cease
• Define success and what happens based on success
  or failure
• Reward/punishment
• New strategy

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Outline of Basic PPP Contract

• Recitals
• Definitions
• Agreement clauses
• Project definition, duties of the partners
• Performance standards, covenants and monitoring
• Payments
• Risk allocation
• Security for performance

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Outline of Basic PPP Contract (2)

• Agreement clauses (cont.)
• Term and termination
• Wrap-up upon termination
• Delay and force majeure
• Indemnification
• Affiliate guarantees
• Dispute resolution

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Outline of Basic PPP Contract (3)

• Agreement clauses (cont.)
• Environmental liability
• Permitting responsibility
• Acquisition
• Violations and fines
• Relations with public end users
• Default

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Outline of Basic PPP Contract (4)

• Conditions
• Occurrence of milestones in larger public
  planning efforts
• Environmental studies
• Economic studies
• Cross-performance conditions

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Outline of Basic PPP Contract (5)

• General provisions
• Representations and warranties
• Insurance
• Subcontracts
• Confidentiality
• Choice/conflict of laws
• Notices

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Not in PPP Contracts

• Public partner ceding power to exercise eminent
  domain for compensation
• Just compensation
• Anti-expropriation rules in international law
• Right to reclaim concession during term
• Public partner transferring critical assets
• Natural resources, e.g., water, gas
• Usufructuary rights
• Agency theory

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Jurisdictional Limitations

• Each nation and subnational jurisdiction may
  impose legal constraints on PPP terms
• Some countries have comprehensive PPP laws
• Brazil 2004
• Mexico 2003
• Types of limitations
• Term
• Investment amounts or ratios

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Organizational Laws

• Awareness and contract implications
• Enabling laws of public partner
• Franchises required by private partner
• Foreign company rules
• Local jurisdiction entity
• Parent guarantees
• Affiliate transaction rules
• Handling of nonregulated business

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III. Special Contract Termsfor Each Structure
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OM Contracts

• Description of tasks to be performed by private
  partner
• List of public assets available for use
• Initial condition
• Final condition
• Capital improvements during term either party by
  contract

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OM Contracts (2)

• Expense for agency rather than debt
• Payment by public partner
• Scope of activities
• Alternatives cost plus, formula, formula with
  cap, regulated rates (see concession)
• Performance standards to adjust basic payments
  both up and down
• Performance standards affect risk and therefore
  required compensation for a private partner

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OM Contracts (3)

• Transition
• Services
• Labor force

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DBOM Contracts

• Define the asset to be built based on the public
  need
• Public partner review and approval
• Cost approval / financing
• Payments
• Service component like OM
• Additional payments for adequate return on
  capital component
• Timeline for completion
• Building for growth
• Payment for insufficient demands

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Concession Contracts

• Define private partner duties by public service
  to be provided
• Exclusive or nonexclusive
• General design and service standards
• More limited review than other types of PPPs
• Commercially reasonable service
• Water example pressure, water quality
• Power example voltage variation, outages
• Objective, generally accepted standards

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Concession Contracts (2)

• Compensation
• Paid from members of the public
• Public subsidies for necessary services
• Minimum income guarantees (temporary or
  permanent)
• Public capital contributions (priority of
  financing)
• Tax credits or incentives
• Policy question for public partner re necessary
  services
• Cross-subsidies
• Sufficiency and security will greatly affect
  availability of private capital

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Concession Contracts (3)

• Contract v. regulatory standards
• Contract
• Difficulty of predicting scenarios
• Simple approaches create risk (and higher cost)
• Complex approaches create voluminous contracts
  that increase chance of disputes
• Regulation
• Requires expert regulatory infrastructure
• Generally accepted methods (?)
• Uncertainty and cost of regulation

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Ratesetting

• Revenue requirement
• Reasonable expenses pass through
• Capital costs
• Debt return equal to actual interest rate
• Equity return equal to that required to gain
  sufficient capital, based on investments of
  comparable risk
• Concession payments to public partner
• Rate design
• From rate-payer fixed and/or variable charges
• From public partner
• Implemented by expert, independent organization

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Ratesetting (2)

• Rates fair to rate-payers and private partner
• Calculation of rates should be objective and
  predictable
• Rates should be calculated on a full-cost basis
• Ensures that investors are protected
• Explicit subsidies
• Transparency
• Affordability
• No discrimination among similar users
• Subsidies may be appropriate for certain classes
  of user

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Ratesetting (3)

• Should allow adjustments for events outside
  parties control
• Credit markets
• Labor markets
• Construction costs
• Tax changes
• Avoid price fluctuations
• Limit amount by which rates can grow
• Must obtain rate equilibrium

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IV. Final Observations

• Many areas for PPPs are socially sensitive
  because necessary public services, e.g., water
• Services should be affordable
• Contracts should be fair and take public needs
  into account for this and later PPPs
• Public partner should be the face of the PPP
  for the public

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Implementation of Agreement

• PPPs are partnerships, and you must live with
  your partner
• Terms of contracts can be revisited and adjusted
  on a pre-agreed schedule or upon the occurrence
  of certain events

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Wes StricklandHatch Parent21 E. Carrillo
StreetSanta Barbara, CA 93101(805)
963-7000WStrickland_at_HatchParent.com