Public Procurement and PPPs
Public procurement refers to the purchase of goods, works, and services by the government from the private sector; in this way, private companies have long participated in the construction and management of public works, such as roads, hospitals, schools, and public buildings. In conventional procurement, private companies compete in a tender process for an infrastructure project. Typically, once construction is complete, the operation and management of the asset is transferred to the government. As the design, construction, and operation of the asset are generally undertaken by different parties, the transfer of risk to the private sector is therefore limited to the construction phase of the project.
A public private partnership (PPP) is a long-term arrangement between a government and a private-sector company wherein the contract tends to integrate the construction and the operation or management of an asset; correspondingly, the private sector incurs a higher level of risk, and is incentivized to take on higher construction costs if it reduces operational costs in the future. As such, PPPs are a way to meet demand for quality infrastructure while circumventing the problems that plague conventional procurement—for instance, public infrastructure is capital-intensive and requires governments to bear the risks of life-cycle costs. PPPs offer governments the means to meet the funding gap and mitigate residual risk by leveraging off-balance sheet financing provided by the private sector, while simultaneously encouraging innovation in construction and design.
Due to the effects of COVID-19, conventional public procurement and PPP arrangements will likely continue to face challenges throughout the lifecycle of a project. Adverse impacts on financing for projects, construction delays and supply chain disruptions, temporary suspension of operations, additional costs incurred under health regulations, and plummeting revenues due to reduced demand for services have forced parties to these arrangements to devise methods to mitigate damage in the short-term. Private sector parties may look to invoke force majeure, compensation, and change in law clauses, or seek to renegotiate certain terms of the project, such as contract duration, in order to avoid penalties for non-performance. Ultimately, flexibility and open communication between the public and private partners is crucial to ensuring both the stakeholders and the project emerge intact.
The following are a few of the scenarios private parties to PPP contracts may be facing as a result of COVID-19, and possible routes to resolution and future prevention.
Figure 1: Thailand’s 12 categories of infrastructure projects and public services
Although it is common practice for PPP agreements to be mostly financed by debt, it is imperative for the project company to secure equity, as well as mezzanine capital or subordinated loans and demand guarantees. Project companies often secure equity by engaging project sponsors; therefore, it is of the utmost importance that the project company secure the equity by means of legally binding contracts with the sponsors prior to formalizing commitments with the Contracting Authority. Failure to do so may result in default on the part of the project company should the sponsors rescind their offer. For projects facing difficulties with financing, bridge loans and capital injections may offer a solution in the short-term, although access to equity and new debt might be difficult to secure in the current environment.
Figure 2: Sources of financing for PPP projects
A PPP contract may be prematurely terminated because of frustration, due to unforeseen events occurring subsequently to its formation, not caused by either party, which cause the performance of the contract to be impossible. An event causing contract frustration differs from a force majeure event in that it is irremediable, whereas force majeure may result in a temporary delay only. It is critical to ensure, and to obtain the agreement of both parties, that frustration has occurred. For instance, if a contract cannot be performed because the project becomes too expensive, this will not likely qualify as an event of frustration, as performance is merely difficult and not impossible. However, a change of law which prevents entry to a country in the interest of public health, as is the case with many countries due to COVID-19, may qualify as a frustration event if it makes performance impossible. Although there are no judicial remedies to the frustration of a PPP contract, a project company may opt for alternative risk mitigation tools, such as contract frustration insurance.
What happens in the event of force majeure?
The PPP contract will have to expressly and unequivocally state whether the contractor will be liable to pay liquidated damages to the Contracting Authority in the event that completion of the project—or some of its deliverables—do not occur by a contractually agreed-upon date. Similarly, the PPP contract should stipulate that the completion date (or a deliverable due date) is extended by any period during which the Engineering Construction Procurement (EPC) contractor, or subcontractor, is prevented from performing their obligations under the PPP contract. The contract may stipulate that, in lieu of liquidated damages, the contract will forfeit the advance payment bond posted for the project in question should the contractor become unable to perform.
The subject of force majeure may be contentious if an unforeseeable event occurs after the facility has been developed. For instance, if a highway is developed using a performance-payment model—whereby contractors are paid for the performance of the facility, regardless of demand—it is uncertain whether the contractors would be entitled to payments in the event the facility becomes unusable due to force majeure. As this point is often disputed, it is MPG’s opinion that public procurement contracts, regardless of the PPP model that is used, should always expressly contemplate multiple contingencies.
Furthermore, the contracts of project-finance transactions should always clearly and indisputably stipulate step-in right clauses. This should be done to avoid a scenario in which lenders unjustly step-in the project company’s position in the contract and reassign the infrastructure project to another contractor, even when the project company is temporarily unable to perform its obligations due to force majeure.
For contracts that have recently concluded and projects currently underway, it is unlikely that the effects of COVID-19 will qualify as force majeure in the future, as the pandemic is now a foreseeable event. MPG recommends that affected parties attempting to invoke force majeure consider when the pandemic became foreseeable, and in the case of future projects, include a contractual clause that provides for further COVID-19-related risks.
A guidance note issued on 24 April 2020 by Thailand’s Government Procurement and Supplies Management Commission outlines the following approaches for government agencies and officials to take when dealing with disruptions to the public procurement tendering process and contract management:
✓ If the contract is awarded after the start of the pandemic, then in the case that a procurement winner is unable to sign the contract due to the effects of COVID-19, they must submit a written notice to the awarding government agency. The government agency will proceed to select the next lowest bidder or the next highest scoring bidder to enter the contract instead, and the procurement winner, or the next bidder, will not be penalized for refusing to enter the contract.
✓ Alternatively, if the contract is concluded before the start of the pandemic, then the effects of COVID-19 will be considered a force majeure event in order to provide an extension of the contract duration, or to reduce or waive penalties for delays during the period of interruption. The duration of this period will be determined based on regulations and orders issued by the Thai government for the cease of operations, closure of venues, and prohibition of certain activities until operations may resume normally.
Evidence shows that there are many contingencies that can affect project finance transactions. Private parties to PPP agreements are advised to factor in multiple scenarios while entering into procurement contracts with Contracting Authorities. Legal advisors should refrain from using standardized clauses but rather tailor contractual provisions depending on specific PPP models as well as circumstances.
Legal and financial advisors must be cognizant of the host country’s legal framework as well as applicable ICC rules for guarantee-backed project finance transactions to assess and mitigate downside risk; therefore, it is recommended to always seek legal counsel from a lawyer with extensive banking experience to hedge risks and ensure successful delivery of capital projects and infrastructure facilities.