Contracting for Public-Private Partnerships

1. 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

2. Outline • Overview of contract types • General contract terms • Special contract terms for each structure • Final observations

3. I. Overview of Contract Types • Operation and maintenance (O&M) • Design build operate maintain (DBOM) • Design build finance operate (DBFO) • Build own operate (BOO) • Build own operate transfer (BOOT) • Buy build operate (BBO) • Privatization

4. 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?

5. Key Structural Questions (2) • What will the private partner do? • What payment will the private partner receive? • How will the private partner’s 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)

6. 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 partner’s role • Tasks should be assigned to each partner according to their ability • Compensation should be based on each partner’s tasks and assumption of risk

7. O&M 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

8. DBOM/DBFO Contracts • Utilized when a new asset needs to be designed, built and possibly financed • Like O&M contract, but adding capital component • Allows access to private capital markets • Higher risk for private partner than O&M • May avoid some public labor force issues

9. 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

10. Triangular Structures (2)

11. Triangular Structures

12. II. General Contract Terms • Contracting to meet basic structural principles • Basic terms of PPPs • Jurisdictional limitations

13. 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

14. 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

15. 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

16. Outline of Basic PPP Contract (3) • Agreement clauses (cont.) • Environmental liability • Permitting responsibility • Acquisition • Violations and fines • Relations with public end users • Default

17. Outline of Basic PPP Contract (4) • Conditions • Occurrence of milestones in larger public planning efforts • Environmental studies • Economic studies • Cross-performance conditions

18. Outline of Basic PPP Contract (5) • General provisions • Representations and warranties • Insurance • Subcontracts • Confidentiality • Choice/conflict of laws • Notices

19. 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

20. 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

21. 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

22. III. Special Contract Termsfor Each Structure

23. O&M 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

24. O&M 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

25. O&M Contracts (3) • Transition • Services • Labor force

26. 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 O&M • Additional payments for adequate return on capital component • Timeline for completion • Building for growth • Payment for insufficient demands

27. 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

28. 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

29. 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

30. 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

31. 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

32. 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

33. 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

34. 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

35. Wes StricklandHatch & Parent21 E. Carrillo StreetSanta Barbara, CA 93101(805) 963-7000WStrickland@HatchParent.com