In our ongoing #PPPSeries, we have previously explored the definition, scope, and key actors involved in Public Private Partnership (“PPP”) projects. This third instalment delves into the key aspects of PPP Project Agreements. (References: the PPP Proclamation No. 1076/2018 (“Proclamation”), the PPP Amendment Proclamation No.1283/2023, and the PPP Directive No. 55/2018 (“PPP Directive”)
Project Agreements
As defined under Article 2(7) of the PPP Proclamation, Project Agreements primarily encompass the PPP agreement, which is the main agreement concluded between the contracting authority and the private entity. Project Agreements may also include other agreements essential for project implementation. These include agreements between the private party and other public bodies. (such as the Ministry of Finance to provide government support to the project company). The Project Management Team(PMT), as per Article 10(3) of the PPP Directive, plays a pivotal role in drafting the Project Agreements, aided by the PPP Department and transaction advisors. These documents are made available to qualified bidders during the procurement process. Bidders may also be allowed to comment on the draft Project Agreements.
The PPP Agreement
The PPP agreement is the cornerstone document that sets the overall tone and objectives of the PPP project. The nature of the PPP agreement varies with the project type. For example, in energy projects, the Power Purchase Agreement (PPA) serves as the PPP agreement, while in health projects, a service agreement may serve as the PPP Agreement. PPP agreements, by their very nature, are long-term, typically spanning 20-30 years. (while in exceptional circumstances, it may be concluded for less than 20 years). The duration of the PPP Agreement is determined by factors like asset lifespan, financing availability, and market standards. Consequently, the public sector represented by the relevant contracting authority and the private entity will execute the PPP Agreement setting out their key rights and obligations under the agreement.
Essential Elements of the PPP Agreement
The PPP Agreement, governed by standard contract rules, is prepared by the PMT and shaped through negotiations between the parties. While the contracting parties are at liberty to determine the scope and application of the PPP Agreement, the PPP Proclamation establishes the framework for what should be incorporated in a PPP Agreement. The law provides that the PPP Agreement needs to specify the duties and obligations of the parties, the risk allocation, the contract period, the type of services to be delivered and the compensation mechanism for the private party. Additionally, the PPP Directive provides that the project agreements must provide events that may trigger the termination of the agreements, including, as appropriate, a material breach of the project agreements, the occurrence of the force majeure event, a payment default or any other events.
Risk Allocation
Risk allocation in PPPs is a fundamental aspect where risks are assigned to the party best equipped to manage, mitigate, or alleviate them. The appeal of a PPP project lies in the balanced distribution of these risks between the contracting authority and the private party. This necessitates that the risk allocation, after being deliberated upon by both parties, is provided in the PPP Agreement. Such careful crafting ensures that each risk is managed by the party most capable of handling it, thereby enhancing the overall efficacy and attractiveness of the PPP project. Commonly identified risks are divided as follows:
Risks allocated to the Public Sector (Contracting Authority)
- Regulatory Risks – Changes in legal obligations due to amendments in laws or regulations
- Political risks or Force Majeure events such as war and civil unrest
- Sovereign Risk: risk of the public entity defaulting on its financial obligations.
Risks allocated to the Private Sector (Project Company)
- Design, Construction, financing and operation risks
- Revenue risk, input-supply or raw material risks
- Residual value risk or the risk with the sustainability of the project after the expiry of the project duration period.
- Contract mismatch risk or the mismatch between the PPP Agreement and other project agreements such as loan agreements and insurance contracts
Payment Modalities
Payment constitutes a critical element in the PPP Agreement, outlining the remuneration framework for the project company’s services. According to Article 46(2) of the PPP Proclamation, the payment arrangement between the contracting authority and the project company can be structured in one of the following three ways:
- Direct Compensation: this involves a payment made by or on behalf of the contracting authority directly to the project company.
- Service Tariffs or Fees: under this modality, the private party collects tariffs or fees from the end-users or consumers of the provided service.
- Hybrid Model – a combination of such compensation and such charges or fees.
It is essential that the PPP Agreement explicitly defines the remuneration mechanism for the project company, tailored to the specific design and requirements of the project. This clarity is vital to ensure that the financial compensations and incentives align with the project’s scope, objectives, and operational dynamics.
Ownership of Assets and Creation of Securities
PPP Agreements should provide for rights to the ownership of assets and the authorization for creating securities over these assets. As mandated by Article 48 of the PPP Proclamation, the PPP agreement must delineate clearly which assets are under the ownership of the contracting authority and which are vested with the project company. The law empowers the project company to use the project assets as real security (mortgages) for financing purposes and create security interests over both movable and immovable assets that it owns or acquires throughout the project. Consequently, the PPP Agreement is required to include specific provisions enabling the private party to leverage these assets as securities.
Assignment of Project Agreements
The PPP agreement must explicitly define the conditions under which the private party can assign its rights and obligations to third parties. Article 54 of the PPP Proclamation provides that, except in the case of security and substitution of it by another entity as a result of step-in, the private party cannot assign its rights and obligations to third parties without the written consent of the contracting authority. Accordingly, the PPP agreement must outline the conditions under which such assignments of rights and obligations can occur. These conditions serve as a safeguard, ensuring that any transfer of responsibilities aligns with the project’s objectives and the contracting authority’s expectations.
Force Majeure Events and Change in Law
The PPP Agreement would typically provide for a provision that regulates force majeure events or changes in legislation impacting the implementation of the PPP project. Article 55 of the PPP proclamation provides that, the PPP Agreement may provide the extent to which the private party is entitled to compensation if a change in law increases its cost and obligation or decreases its profit. The provision also recognizes that the contracting authority will get compensation if the change of law puts the project company in a favourable position by decreasing its cost and obligation or by increasing its profit.
Step-in Rights and Termination of Project Agreements
Step-in right in PPP Agreements is a provision that allows the contracting authority to take over the project from the private party temporarily. This right is typically exercised in situations where the private party is not meeting its obligations, failing to provide services adequately, or not maintaining the required standards of operation. The PPP Proclamation provides that if the project company fails to provide infrastructural services adequately or causes damage due to negligence, the contracting authority has the right to intervene and provide the services. However, this intervention requires prior notice to the private party to rectify the situation or to ensure uninterrupted service provision. Furthermore, the law permits the contracting authority to replace the project company with another entity if necessary, following the step-in action.
Termination of Project Agreements may occur before or following the end of the project period due to various circumstances. These may include, mutual agreement of the parties, breach of contract, occurrence of force majeure event, failure to meet performance standards, financial difficulty or insolvency, and expiration of the project period. The PPP Agreement must provide the events that may trigger early termination of the PPP Agreement and the method for calculating compensation owed to either party.
Amendment of Project Agreements
In a PPP Project, parties have the flexibility to amend the terms and conditions of the Project Agreements. However, under Article 9(1/c) of the PPP Proclamation, any significant amendments to a PPP agreement must receive approval from the PPP board. The term “significant amendment” is not defined in the PPP Proclamation, leaving room for interpretation. However, amendments that could be considered “significant” include altering the risk allocation matrix initially agreed upon by the parties. Such changes will be substantial enough to require the PPP Board’s approval.
Dispute Resolution
The PPP Proclamation establishes that the method for settling disputes under a PPP Agreement is to be mutually agreed upon by the parties involved. The law permits the use of arbitration and other forms of alternative dispute resolution mechanisms, offering flexibility in resolving conflicts. For disputes that may arise between service users and the private party, the PPP Proclamation allows the contracting authority to mandate the private party to develop a specific mechanism for resolving those disputes. The private party may also determine the dispute resolution process for any conflicts that might occur with its shareholders, lenders, contractors, suppliers, and other related entities.
Conclusion
Project Agreements are the cornerstone of effective PPPs, defining the parties’ main roles and responsibilities, risk allocation and payment structures, asset ownership and dispute resolution. This piece has examined the key elements that go into PPP project agreements as provided by the PPP Proclamation and PPP Directive. The crafting of such agreements in PPP transactions demands careful attention to detail and clarity, ensuring that every aspect, whether it’s managing risks, structuring payments, or resolving disputes, is tailored to support the successful and sustainable execution of the project.
