Managing Risks in Public-Private Partnership Projects

Public Procurement and Public-Private Partnerships (PPPs)

Public procurement involves the acquisition of goods, services, and infrastructure by governmental entities from private sector entities. This interaction has historically enabled private companies to contribute to the development and management of public infrastructure, including roads, hospitals, schools, and other civic structures. Under conventional procurement practices, private firms engage in a competitive tender process to secure contracts for infrastructure projects. Upon completion of construction, ownership and management of the asset typically revert to the government. Since different entities handle the design, construction, and operation phases, risk transfer to the private sector primarily occurs during construction.

In contrast, a public-private partnership (PPP) constitutes a prolonged collaboration between a government and a private entity, merging construction with asset operation or management. Consequently, the private sector assumes a heightened risk level, often accepting increased construction costs in exchange for potential long-term operational savings. PPPs serve as a mechanism to address the demand for high-quality infrastructure while mitigating challenges inherent in traditional procurement, such as the government bearing lifecycle cost risks associated with public infrastructure. By leveraging off-balance sheet financing from the private sector, PPPs enable governments to bridge funding gaps and diminish residual risks, all while fostering innovation in construction and design.

However, the COVID-19 pandemic has introduced significant hurdles to both conventional public procurement and PPPs over the project lifecycle. Issues such as financing constraints, construction delays, supply chain disruptions, temporary shutdowns, heightened operational costs due to health regulations, and reduced revenue streams due to decreased service demand have necessitated immediate damage control strategies. Private sector entities involved in these arrangements may explore options like invoking force majeure clauses, seeking compensation, or renegotiating contractual terms, including project durations, to mitigate penalties for non-compliance. Ensuring the viability of projects demands flexibility and transparent communication between public and private stakeholders, thereby safeguarding the interests of all parties involved.

The following outlines potential challenges faced by private entities in PPP contracts amid the COVID-19 crisis, alongside strategies for resolution and future prevention.

Project Financing

In PPP agreements, it is customary for debt to constitute a significant portion of the financing, yet it is crucial for the project company to also secure equity, along with mezzanine capital or subordinated loans, and demand guarantees. Typically, project companies obtain equity through engagement with project sponsors. Therefore, it is paramount for the project company to formalize equity arrangements with sponsors through legally binding contracts before finalizing commitments with the Contracting Authority. Failing to do so could lead to default if sponsors withdraw their support. For projects encountering financing challenges, short-term solutions such as bridge loans and capital injections may be viable, although obtaining equity and new debt may be challenging given the current economic conditions.

Contract Frustration

Premature termination of a PPP contract can occur due to frustration, arising from unforeseen events post-formation that render contract performance impossible, without fault from either party. Unlike force majeure events, which may cause temporary delays, events leading to contract frustration are irreparable. It is crucial to ascertain and secure agreement from both parties regarding the occurrence of frustration. For example, a contract becoming economically unviable is unlikely to qualify as frustration since performance remains difficult but not impossible. However, a change in law restricting entry to a country for public health reasons, as seen in numerous countries due to COVID-19, may qualify as frustration if it renders performance impossible. While there are no judicial remedies for contract frustration in PPP contracts, project companies may explore alternative risk mitigation measures, such as contract frustration insurance.

What occurs in the event of force majeure?

The PPP contract must explicitly state whether the contractor bears liability for paying liquidated damages to the Contracting Authority if the project's completion, or some of its deliverables, fails to meet the contractually agreed-upon deadline. Similarly, the PPP contract should outline that the completion date (or a deliverable due date) is extended for any period during which the Engineering Construction Procurement (EPC) contractor or subcontractor is unable to fulfill their obligations under the PPP contract. Instead of liquidated damages, the contract might specify that the advance payment bond posted for the project will be forfeited if the contractor becomes unable to perform.

The issue of force majeure may become contentious if an unforeseeable event occurs after the facility's development. For example, if a highway is built using a performance-payment model—where contractors are paid based on the facility's performance, regardless of demand—it remains uncertain whether contractors would receive payments if the facility becomes unusable due to force majeure. Given the potential for dispute, MPG recommends that public procurement contracts, irrespective of the PPP model used, should explicitly address various contingencies.

Moreover, project-finance transaction contracts should unambiguously specify step-in right clauses to prevent lenders from unjustly assuming the project company's position in the contract and transferring the infrastructure project to another contractor when the project company is temporarily unable to fulfill its obligations due to force majeure.

For recently concluded contracts and ongoing projects, it is improbable that the effects of COVID-19 will qualify as force majeure in the future, given the pandemic's foreseeable nature. MPG suggests that parties seeking to invoke force majeure due to COVID-19 consider when the pandemic became foreseeable. For future projects, including a contractual clause addressing further COVID-19-related risks is recommended.

A guidance note issued on April 24, 2020, by Thailand's Government Procurement and Supplies Management Commission outlines approaches for government agencies and officials to address disruptions to the public procurement tendering process and contract management:

• If the contract is awarded after the pandemic's onset and the procurement winner cannot sign the contract due to COVID-19 effects, they must notify the awarding government agency in writing. The agency will then select the next lowest or highest-scoring bidder to enter the contract, and neither the initial winner nor the next bidder will face penalties for declining to enter the contract.
• Alternatively, if the contract is concluded before the pandemic's onset, COVID-19 effects will be considered a force majeure event, allowing for an extension of the contract duration or reductions or waivers of penalties for delays during the interruption period. The duration of this period will be determined based on regulations and orders issued by the Thai government regarding operations cessation, venue closures, and activity prohibitions until operations can resume normally.

Conclusion

The available evidence demonstrates the multitude of contingencies that can impact project finance transactions. Private entities involved in PPP agreements are encouraged to anticipate various scenarios when negotiating procurement contracts with Contracting Authorities. Rather than relying on standardized clauses, legal advisors should customize contractual provisions based on specific PPP models and prevailing circumstances.

Both legal and financial advisors need to be well-versed in the host country's legal framework and applicable ICC rules governing guarantee-backed project finance transactions. This understanding is essential for evaluating and mitigating downside risks effectively. Therefore, it is advisable to seek legal counsel from a lawyer with substantial banking experience to hedge risks and ensure the successful execution of capital projects and infrastructure facilities.