Some PPP Contract

Concepts

James Ballingall
March 2011
Agenda
- Benefits/process of standardisation
- Impact of current market
- Principles of a “Standard” PFI project
- The Drivers
- Structure
- Guarantees
- Direct Agreements
- Termination
- Supervening Events
- Change in Service
- Change of ownership
- Risk apportionment exercise

2
Benefits/process of Standardisation
• Need for a strong sponsor and regulatory platform
• Recommended / required drafting
• Enforcement regime
• Roll out policy
• Optimise balance of risk transfer
• Improve quality of contracts
• Achieve consistency
• Reduce negotiation time/cost
• Reduce procurement time

3
Principles of a “standard” PFI project
1. Authority transfers responsibility and risk for asset/service to
Contractor
2. Contractor takes on obligations for c.20-30 years
3. Contractor builds, manages, maintains asset and provides
service
4. Lenders fund Contractor on limited recourse basis
5. Authority pays “Unitary Charge” for available/acceptable
service
6. The PFI Contract (and associated documents) must
regulate a network of relationships
4
The Drivers
• Authority needs to ensure continuous delivery of value for
money asset and services

• Contractor and Lenders want maximum certainty in return for

accepting risk

5
Basic Contractual Structure
Authority

PPP
Contract

Loan
SPV* Lenders
Agreement

D&B O&M
Sub-Contract Sub-Contract

D&B O&M
Sub-Contractor Sub-Contractor

* Special Purpose Vehicle. The terms “SPV” and “Contractor” are used interchangeably in this presentation
6
Guarantees
Lenders Authority

Loan PPP
Agreement Contract

SPV

Construction FM
Sub-Contract Sub-Contract
Guarantee Guarantee
Construction FM Contractor1
Contractor*

Parent Co. Parent Co. FM

Construction Contractor
Contractor

*
May also provide collateral warranty to Authority guaranteed by Parent Co.
7
Guarantees
• Guarantees will be capped
• If Construction Sub-Contractor a joint venture, consider joint
and several guarantee and counter-indemnities
• Usually no guarantee to the Authority (except of Collateral
Warranties)
• Guarantees will be assigned by way of security to the
Lenders

8
Funding and Security Arrangements

Authority Share Charge

PPP U.Charge
%UC
Contract
Subordinated Debt

Shareholder (1) Equity

Shareholder (2) SPV Loan Lenders

Shareholder (3) Agreement
Interest-Subordinated
Debt Loan
Dividends
Security
Agreement

Intercreditor
Arrangements
Fixed prices to sub-contracts

9
Direct Agreement : (SoPC Chapter 30)

Authority

Direct
PPP Contract Agreement

Loan
SPV Lenders
Agreement

10
Direct Agreement
• Parties - Authority, Senior Lenders, Contractor

• Purpose - deals with relationship between these parties

following a termination notice given under the
Concession Agreement for Contractor Default

• Why? - concern of Senior Lenders re. pay out

- opportunity to rectify defaults/maximise realisation

• Form of Direct Agreement specified in SoPC (Chapter 31)

11
Direct Agreement : The Mechanics

• Termination Notice
• Notice of liabilities provided to Agent
• A 120 /90 day grace period from the date of the Termination
Notice commences (the “Required Period”)
• During Required Period Lenders may
– Rectify default
– Decide to Step-in
– If neither, contract terminates

12
Direct Agreement : Step-In

Authority

Direct
PPP Contract Agreement

SPV/ Loan
Lenders Agreement Lenders

Lenders
Step-In
13
Direct Agreement : Step-In

• May occur at any time during Required Period or while Event

of Default is subsisting
• The assumption by a Representative of the rights of the
Contractor
• Payment of outstanding amounts/discharge of obligations
• Continues to perform Service
• Re-tenders Contract
• Unlimited Step-in Period (so long as no default)

14
Direct Agreement : Step-Out

• At any time
• Representative released from obligations
• Contract continues unless terminated

15
Direct Agreement : Novation

Authority

Direct
Agreement
PPP Contract

New (2) “New”

Funding Agreement Lenders
SPV SPV

(1) Lenders
Step-In
16
Direct Agreement : Novation and Subordination Issues

• To a Suitable Substitute Contractor i.e. acceptable to

Authority
• Before or during Step-in
• Clean slate
• Essentially a sale of the Project
• Authority Subordination

17
Early Termination : (SoPC Chapter 21)

• 6 categories
– Authority Default (Breach)
– Authority Voluntary Termination
– Contractor Default (Breach)
– Force Majeure
– Corrupt Gifts and Fraud
– Breach of Refinancing Provisions

18
Early Termination : Authority Default/Voluntary
Termination
• 4 types of Authority Default - expropriation
- material breach
- failure to pay
- breach of assignment clause
• Additional events to be considered on project-by-project basis
• Last resort – no “hair triggers”
• Voluntary termination on 6 months’ notice

19
Early Termination : Authority Default/Voluntary
Termination
• Compensation same for Authority Default and Voluntary
Termination

• Objective is to ensure Contractor and financiers fully

compensated

• Compensation the sum of:

– senior debt
– equity return (three options)
– redundancy costs
– Sub-Contractors Breakage Costs: losses and profits (to be mitigated)

20
Early Termination : Contractor Default

• Specific events in SoPC

• Always check they are all there

• Opportunity to rectify where appropriate

• Ability to terminate subject to Direct Agreement

21
Early Termination : Compensation on Termination for
Contractor Default
• Market value approach

• Compensation based on market value of the unexpired term

of the Contract

• Incentivises Lenders to step-in and rescue projects rather

than relying on termination payment

• No windfall gain for Authority

• Meaning of “liquid market”

22
Early Termination : Re-tendering Election and Liquid
Market
• Best way to establish market value of Contract is to re-tender it
and see what people bid

• If Authority chooses to re-tender it will pay highest bid price to

Contractor

• If Authority chooses not to re-tender or cannot because no Liquid

Market, it pays the Estimated Fair Value of the Contract to the
Contractor (the “No Re-tendering Procedure”)
– an assessed value of the amount it would have received on a re-tendering
– based on discounted future revenues and expenses
– preferred route of Lenders as they think provides greater certainty

23
Early Termination : Re-tendering Election and Liquid
Market

Adjusted Estimated
Fair Value

Termination Notice
Authority not want
to re-tender
No rectification

Do Lenders want to prevent termination Contract terminates

No
Lenders step-in Yes of Project Agreement? Action within
Required Period (90-120 days)
Authority wants to re-tender
Enforce security or novate and gives notice within 20
to a third party Business Days

Lenders accept a Liquid Market

Liquid Market Test DRP
Lenders assert no Liquid Market
if dispute.

Contract re-tendered “market value”

Contract terminated and
Is a Liquid Market paid to outgoing Contractor. Project
Adjusted Estimated Fair No Liquid Market continues with new Contractor
Value paid to Contractor

24
Early Termination : Termination on Force Majeure

• Compensation based on principle that neither party at

fault and financial consequences should be shared

• Senior debt, redundancy payment and Sub-Contractor

losses paid

• Shareholders paid:
– equity less distributions; and
– subordinated debt less interest paid

25
Early Termination : Termination for Corrupt Gifts/Breach of
Refinancing
• Senior Debt only

• Incentivise Contractor not to do it!

26
Supervening Events : (SoPC Chapter 5)

• 3 categories of events where fair to relieve Contractor of

liability to commence/provide Service:
– Compensation Events
 time and money

– Relief Events
 relief from termination
 deductions can still be made

– Force Majeure Events

 termination after a limited period (e.g. 6 months)
 deductions can still be made
27
Supervening Events : Compensation Events

• Definition limited to breaches by the Authority of its obligations (in

exceptional circumstances can extend this e.g. some latent defects).

• Arise prior to Service Commencement only – exceptionally can be

extended through operational period

• Authority’s risk

• Result in delay and/or increased costs

• Previously included Authority changes and specific/discriminatory

changes in law – these now covered separately

• Obligations will be limited and specific e.g. access to sites (but n.b.
covenant not to impede or to co-operate)
28
Supervening Events : Consequences of Compensation
Events
• Contractor allowed extra time to achieve Service
Commencement

• Contractor compensated for increased costs and Cap

Ex in a lump sum payment

• Unitary charge adjusted to reflect increased costs after

Service Commencement

• Authority not allowed to terminate for Contractor Default

29
Supervening Events : Relief Events

• Main categories:
– fire, flood, earthquakes, riot etc;
– power/fuel/transport shortage;
– general strikes

• Prevent performance
• Contractor bears financial risk i.e. increased costs/less revenue
• Relief from termination
• Contractor in better position to manage and instigate
consequences through insurance (usually), risk management and
planning
30
Supervening Events : Relief Events (cont’d)

• Parties consult to discuss issues, duration, action to

mitigate

• Obligation on Contractor to rectify matters and mitigate

consequences

31
Supervening Events : Force Majeure Events

• Limited to war/terrorism/contamination/pressure waves

• Events which have a “catastrophic effect” on ability to perform

• On occurrence parties consult to try and find a way to continue

• Parties relieved from obligations to extent affected

• Contractor paid only to extent it performs

• Right to terminate after 6 months – SPV has limited reserves

• Authority can prevent termination by paying as if Service being

provided
32
Changes
• PPP contracts are long term contracts therefore changes to the
Authority’s requirements may be necessary, e.g. to allow for changes
in policy.

• Contractor may wish to vary aspects of service delivery; if this affects

the Authority’s output requirements, the Authority needs to be
consulted.

• PPP contracts should contain a mechanism allowing changes to be

proposed, evaluated and approved and for the cost of such changes
to be calculated and allocated.
• Changes can cause more problems than anything else
33
Change – how stable is the requirement?

• Alternatives: contract length, financial structure, phasing,

early termination rights
• Anticipated and unanticipated changes – use of competitive
pressure
• Price, flexibility and cost certainty need to be balanced

=> flexibility costs money

34
Types of Changes
• Origin
– Authority, Contractor, Change in law
• Value
– Small (most frequent) , medium, large
• Impact
– Financial, works, services (easiest), combination
• Timing
– Construction (minimise) , early operation, steady state operations
• Type
– Function, Capacity, Service
35
Implementation issues – transparency and
vfm
• Change Protocol agreed upfront: who does what, when and
how including management of sub sub-contractors
• For small works: pre-specified and priced small works and
services (possibly indexed)
– Established sub-contractor margins (e.g. in Change Protocol)
– Benchmarking
– Generally determine SPV change management costs, margins and
fees, specialist labour rates at original competitive tender stage
– Open book

36
Implementation issues – larger changes
• Lender and financial due diligence (seek to reduce iterations
of financial model)
• Legal, technical, insurance due diligence
• Benchmarking
• Competitive tendering (run by contractor with
approval/review rights for authority)
• Independent technical advisor
• Build change management into performance regime

37
Change in Service : Authority Changes
Authority Notice of Change
•• Sets
Sets out
out proposed
proposed change
change in in sufficient
sufficient detail
detail to
to allow
allow Contract to estimate cost and impact
•• If
If the
the change
change requires
requires capital
capital expenditure,
expenditure, indicates
indicates whether Authority will fund or whether the Contractor must
must use
use reasonable
reasonable efforts
efforts to
to obtain
obtain
•• Contractor
Contractor may
may object if the change falls within
within an agreed list of objections,
objections, eg
eg the
the change
change would
would be
be in
in breach
breach of
of law
law

Contractor’s Estimate
•• Identifies
Identifies effect
effect on
on obligations,
obligations, impact
impact on
on service,
service, required
required amendments
amendments to the project documents, estimate of costs
costs and
and required
required capital
capital expenditure
expenditure (if
any)
any) and
and any
any necessary
necessary consents
consents and
and approvals.
approvals.

Meeting between Authority and Contractor to agree Contractor’s Estimate

•• Contractor
Contractor to
to minimise
minimise cost
cost increases
increases and
and maximise
maximise reductions
reductions
•• Capital
Capital expenditure
expenditure to
to be
be measured
measured inin aa cost
cost effective
effective manner
manner
•• If
If required
required capital
capital expenditure
expenditure exceeds
exceeds an
an agreed
agreed level
level the
the Authority
Authority may required the contractor to seek and evaluate competitive tenders for the works

Contractor’s
Contractor’sEstimate
Estimateisisagreed
agreedor
orreferred
referredto
toDRP
DRP

Authority
Authority withdraws
withdraws Notice
Notice ofof Change
Change or,or, ifif no
no confirmation
confirmation isis issued
issued Authority
Authorityissues
issuesconfirmation
confirmationof
ofthe
theContractor’s
Contractor’sEstimate
Estimate
within
within aa fixed
fixed period
period of
of agreement
agreement ofof the
the Contractor’s
Contractor’s Estimate,
Estimate, the the
Notice
Notice ofof Change
Change isis deemed
deemed withdrawn.
withdrawn. PartiesParties may
may agree
agree thatthat
Contractor’s
Contractor’sthird
thirdparty
partycosts
costsare
arereimbursed
reimbursed(subject
(subjecttotoconditions).
conditions).

38
Change in Service : Authority Changes (cont’d)
Authority
Authority issues
issues confirmation
confirmation of
of Contractor’s
Contractor’s
Estimate
Estimate

Is
Is capital expenditure
expenditure required?
required?

Contractor
Contractor must
must use
use reasonable
reasonable endeavours
No Yes to obtain
to obtain funding (unless the
the Authority
Authority has
already elected to
already elected to fund)

Has
Has the
the Contractor
Contractor obtained
obtained funding?
funding?

Yes No

Does
Does the
the Authority
Authority elect
elect to
to fund?
fund?

Yes No

Capital
Capital expenditure
expenditure to
to be funded by
Changes
Changes to
to Unitary
Unitary Change
Change to
to reflect
reflect changes
changes inin
the
the Authority
Authority to
to be
be paid
paid in
in accordance
accordance No
No obligation
obligation on
on Contractor
Contractor to
to carry
carry
operating
operating costs
costs and
and repayment
repayment ofof any
any capital
capital
with
with an
an agreed
agreed schedule
schedule toto reflect
reflect out
out change
change
expenditure
expenditure funded
funded by
by the
the Contactor
Contactor
works
works carried
carried out
out

39
Change in Service : Contractor Changes

Contractor Notice of Change

•• Sets
Sets out
out proposed change
change inin sufficient
sufficient detail
detail to
to allow
allow evaluation
evaluation by Authority
Authority
•• Specifies
Specifies reasons
reasons for
for proposing
proposing the change
•• Indicates
Indicates whether
whether aa variation
variation to
to the
the Unitary
Unitary Charge is proposed (with a detailed cost estimate)
estimate)

Evaluation by the Authority

Meeting
Meetingbetween
betweenthetheAuthority
Authorityand
andthe
theContactor
Contactor
•• Authority may propose changes
Authority may propose changes

Authority
Authorityrejects
rejectsContractor
ContractorNotice
Noticeof
ofChange*
Change* Authority accepts Contractor Notice of Change

Parties
Parties consult
consult and
and agree
agree remaining
remaining details
details
of
ofthe
thechange
change

Increase
Increase inin Unitary
Unitary Charge
Charge (provided
(provided Decrease
Decrease inin Unitary
Unitary Charge
Charge –– ifif the
the change
change will
will
Authority’s
Authority’sacceptance
acceptancespecifically
specificallyagrees
agreestoto result
resultininaadecrease
decreasetotothe
theContractor’s
Contractor’scosts
costs
this)
this)
* Authority cannot reject a change which is required to conform to a Change in Law.
40
Change of Ownership : (SoPC Chapter 18)

• During build phase

• During service phase

• Prohibited parties

• Financial control in Finance Documents

• Shareholder liquidity

• Transfers of Economic Interests

41
Part 4: Risk Apportionment
Questions
Answers

42
Risk Apportionment : Questions

Risk Bidder Authority Lender

Flood delays construction of Project
Strike in the construction industry
Due to increased terrorism, Insurance
premiums increase by 250%

43
Risk Apportionment : Questions

Risk Bidder Authority Lender

The Contractor has a bad claims
history and his premiums increase by
250%
New health and safety legislation
means that all buildings need to be
modified

44
Risk Apportionment : Questions

Risk Bidder Authority Lender

A Shareholder sells its stake in the
SPV to a third party during the
construction period
The ownership of the Shareholder
changes during the construction period

Construction is delayed due to

repeated bomb hoaxes

45
Risk Apportionment : Answers

Risk Bidder Authority Lender

Flood delays construction of Project * * *
Relief event – time no Authority can delay Lenders will want to
money. Mitigate with start of unitary ensure debt service
non-damage delay payments but cannot during any period of
cover terminate delay - seek to cover
debt service by non-
damage delay cover

Strike in the construction industry * * *

As above As above As above

Due to increased terrorism, Insurance premiums * * *

increase by 250% Takes first 30 % price Authority takes 85% Will lenders require
increase risk, and of cost for any reserve account for
shares 15% of further increase over 30% any increase where
price increases bidder is liable?

46
Risk Apportionment : Answers

Risk Bidder Authority Lender

The Contractor has a bad claims history * *
and his premiums increase by 250% No protection Will lenders
require a reserve
against this?

New health and safety legislation means * * *

that all buildings need to be modified Not a specific or Authority takes Lenders require
discriminatory defined capex change in law
change in law. risk reserve account
SPV takes opex – risk transfer!
risk and agreed
% of capex

47
Risk Apportionment : Answers

Risk Bidder Authority Lender

A Shareholder sells its stake in the SPV to a *
third party during the construction period Will usually be a Will be similar
prohibition on restrictions in
share sales funding docs
during
construction.

The ownership of the Shareholder changes *

during the construction period
Construction is delayed due to repeated *
bomb hoaxes Threat of Lenders will want
terrorism not this to be insured.
Force Majeure -
insurance

48
Session End