Public-Private Partnerships for RES Agro-Energy Districts

RuralE.Evolution

Deliverable D 4.2. “Drafting of PPP contract scheme”

RuralE.Evolution

Public-Private Partnerships for RES Agro-energy districts

Issued by: CRB/HANGYA

DATE: February 2011

CONTRACT N°:IEE/07/579/SI2.499063

Table of Contents

1.PPP Contracts

1.1 Introduction

1.2 Concession agreement

1.3 Consortium agreement

1.4 Project vehicle

1.5 Construction contract

1.6 Operation and maintenance agreement

1.7 Other key contracts - supply and offtake contracts

1.8 bibliography

2.ITALY

2.1. Introduction

2.2) Concession Contract

3.PORTUGAL

3.1. Introduction

3.2) PPP Contract

4.4. GREECE

4.1. Introduction

4.2) PPP Contract

5.HUNGARY

5.1. Introduction

5.2 PPP Contract

6.SPAIN

6.1. Introduction

6.2 PPP Contract

1.PPP Contracts

1.1 Introduction

The long-term success of a new infrastructure/serviceproject is dependent on the correct identification of both the benefits and the risks associated with it. Correct identification must be allowed by appropriate allocation of these benefits and risks - the latter to the party best able to minimize or control them at realistic cost. The project sponsors and the PPP key actors should, in conjunction with consultant lawyers, analyze the risks arising under the project, identify each project contract to be put in place, and which party is to take these risks and ensure that the appropriate provisions appear in the relevant contracts to achieve this. The lenders and their advisers will need to satisfy themselves that this has been achieved under the contractual structure and other relevant laws, in a way that is consistent with the assumptions underlying the financial plan.

Given that a number of parties with differing interests will be involved in the project, the final pattern of risk allocation will be made within a contractual framework that reflects the outcome of negotiations and commercial compromise, and one that also takes into account the relevant legislative framework. For example, in those countries that have enacted concession laws, certain areas of risk allocation may be predetermined by those laws and not susceptible to consensual allocation by contract.

There are several different perspectives to keep in mind in any general discussion of project contracts. These documents will typically be long-term commercial agreements and designed to protect the interests of the project sponsors. Secondly, they will allocate the perceived risks associated with the project between the different participants. Finally (at least on a project financing) the resulting allocation will need to be 'bankable'. Each of these considerations will pull the parties to them in somewhat different directions as the documents are structured and negotiated.

There is, of course, no single definition of the term 'project contracts'. It tends to be used loosely to describe all the documents needed to allow the project to go ahead, other than the financing documents. It represents all of the commercial agreements, licences, contracts, leases and corporate documents that underpin the project that is being financed. A typical list might include the following:

• a concession agreement or government licence;
• a consortium (or other collaboration) agreement between the sponsors;
• a shareholders' or other joint venture agreement;
• corporate documents for the eventual SPV (and any other project company);
• management contract for the eventual SPV;
• a construction contract (or engineering, procurement and construction contract (EPC));
• construction sub-contracts, equipment supply agreements and warranties;
• security for the construction contractor's and, depending on the responsibilities assumed by the construction contractor, the equipment supplier's, performance (for example, a performance bond, advance payment bond and/or retention bond);
• an operation and maintenance agreement or technical services agreement;
• a supply contract (for example, fuel and feedstock supply) and, possibly, a transportation contract for those supplies;
• an offtakeagreement for the purchase of the completed facility's product (for example, a power purchase agreement with an electricity supply company or included in the concession agreement or a product purchase agreement with a manufacturer or a throughput (for example, a process plant project) or 'tolling' agreement (on a pipeline project or power project);
• a site lease or other document of entitlement to land;
• possibly specific enabling legislation;
• ancillary government permits and planning consents (for example, import licences, central bank permits, planning consents);
• agreements with local utilities (for example, water and electricity);
• project insurances and related documents; and
• technology/operating licences.

It should be noted that not all the rights required by the key actors will be acquired by contract. Some rights may arise as a matter of general law (for example, the EU is promoting the concept of third party access to transmission systems for such supplies as gas, electricity, rail and telecommunications) while in other cases the rights to be granted as part of a concession may result from the holding of a competitive tender.Generally applicable laws relating to such diverse matters as environmental liability and labour rights will have an effect on the SPV's business. It is necessary to identify on a project-by-project basis the impact of such rights and liabilities. Whether specific provision needs to be made for them,will depend on the nature of the project business and where the associated risks fall.

The project contracts form the heart of any BOT project. The scope of the individual contracts will inevitably vary from project to project. The project contracts encountered on a power project will in many respects look very different from those needed on a road or rail project or a telecommunications financing.

1.2 Concession agreement

Concession agreements are the backbone of BOT and BOO projects. The government entity initiating a project of this kind will bestow on its sponsors the right and obligation to finance, develop, construct and complete it, and subsequently to operate and maintain it. This amalgam of rights and responsibilities is often loosely referred to as a 'concession', and the relationship between private and public sectors will usually be regulated by contract - by a 'concession agreement'. This agreement will in a sense underpin the entire matrix of contracts needed to implement the project. Many of the key provisions of these other contracts will be driven by its terms. At the very least, they will have to be compatible with it. For that reason, the key participants in the project in addition to the government and the sponsors - the contractors, lenders, investors, guarantors, offtakers, major suppliers, and the like will take a keen interest in the contents of the concession agreement. It will, in other words, define the commercial parameters of the deal, and it will constitute an essential part of the lenders' security package.

In essence, a concession is simply a form of license. On a major project it mayor may not be coupled with an interest in land (a site lease, for example). It is a longterm commercial agreement bestowing the right to develop and implement the project. Partly for that reason, the term 'concession' is sometimes eschewed in favour of 'development agreement', 'project agreement' or 'implementation agreement'.

There are usually several overlapping but different objectives that the parties to a concession agreement will aim to meet. Each of them needs to be given its due weight.

They include the following:

1) Project implementation

The concessionaire will want a clear, enforceable right to implement the project - to develop, finance, construct and operate it. Failure to discharge these obligations will allow it to terminate the concession and take back the project.

2) Public body facilitation

There are usually a number of steps that the public body may be willing or able to take in order to facilitate the project. These can be identified in the agreement. For example, it may be necessary for the concessionaire to obtain a large number of subsidiary permits, licencesand consents in connection with the project's implementation. The agreement can 'grant' and guarantee many of these authorizations, or put in place a procedure to facilitate the private sector sponsor in applying for them. Provision of the project site is another typical example of public facilitation.

The public body may offer a range of commercial incentives to the concessionaire in order to attract interest in the project, and the concession agreement will set these out.

Economic regulation

Conversely, the concession agreement may contain a mechanism for economic regulation of the completed facility by the public body.

Financing

The concession agreement will have to promote the financeability of the project, for lenders, investors and guarantors. At the very least, its terms will have to be compatible with all the different sources of finance. The length of time that the concession is to subsist is the most obvious instance. It will have to be sufficiently long to accommodate the maturity(ies) of the loan(s), and allow the investors to make a suitable return. In addition, certain financial assurances may be essential - relating to the guaranteed availability of foreign exchange, for instance, or protection against political risk. Where a multi-sourced financing is involved, this will make the process of settling the agreement's terms more complex. Account will have to be taken of the requirements of each source of funding.

It will be apparent from what has been abovesaid that a wide range of contentious issues can arise as the terms of the concession agreement are negotiated. One can never anticipate in advance exactly where the areas of greatest difficulty will be. Set out below, however, are some of the major issues typically encountered.

1) Risk allocation

One of the fundamental questions in negotiations is bound to be how the project risks are to be allocated between the parties. Usually the projects will in a sense (at least as a starting point) involve a wholesale assumption of project risk by the concessionaire and the sponsors. The question, then, is what risks will be retained or assumed by the public body? Again, by definition, these risks will be limited. Nevertheless the relevant areas are likely to include [1]:

• political events;
• financial safeguards;
• change of law;
• timely provision of utilities;
• legislative authority;
• licenses, consents and competent authority actions;
• inflation and economic dislocation;
• potential competition;
• subsidies and pricing risk; and
• legislative authority.

The real challenge to the participants in the negotiation process is to find an appropriate balance. Each side strives to impose as much risk on the other as it thinks is possible. In the end, there is no real substitute for a rational approach to risk allocation, leaving risks where they can be managed and controlled most effectively.

Indeed, it is often the case that the most constructive approach is to foster a 'partnership ethic' - to put in place mechanisms that encourage a spirit of cooperation rather than confrontation. The relationship between the parties will be a long-term one, and unforeseen problems will inevitably arise over time. At some stage, revisions will almost certainly be needed to the agreement. If incentives and procedures are structured in such a way as to allow both sides to gain if possible from problem solving, much will have been done to provide for the project's long-term success.

Practical controls

One notorious area of difficulty in negotiations is the extent of the public control over the concessionaire’s activities as the project is implemented. This applies both to construction and operation. The concessionaire will usually seek maximum freedom to implement the project as it sees fit. The concession agreement will contain a number of parameters that the concessionaire will have to meet.

3) Economic control

Not surprisingly, the area where this issue of control tends to cause the greatest anguish is in the context of the charges levied by the concessionaire for the completed facility (fares or tolls). In what circumstances will the concessionaire be allowed to increase them?

4) Exceptional events

The aim of any fare-revision clause would be to compensate the concessionaire for the occurrence of identified risks: to allow it to recover losses and costs and/or protect profits. There are various ways of approaching this subject in the concession agreement. Indeed, a variety of different mechanisms are likely to be included, reflecting the range of different risks to which the concessionaire may be exposed and the appropriate response to them. It is usually convenient, however, to draw a number of these threads together in a single provision, sometimes labeled 'exceptional events'.

5) Dispute resolution

Concession agreements are complex, long-term, commercial agreements giving effect to a difficult process of risk allocation. For that reason, the dispute resolution mechanisms they embrace need careful consideration. In fact, three distinct kinds of dispute resolution are likely to be addressed:

• legal disputes involving arbitration or litigation and questions of law;
• expert determination; and
• revisions to the agreement - in particular to give effect to exceptional event clauses (for example, revisions to tolls).

6) Termination

Termination clauses in concession agreements tend to be debated at length because their effect would be to collapse the entire PPP structure. Some of the termination events will be straightforward - the insolvency of the concessionaire, for example, or the nationalisation or expropriation by the public body of (key) project assets.

1.3 Consortium agreement

In almost every large-scale infrastructure project a number of sponsors will come together in order to promote a project and participate in it as a consortium.

Typically in a PPPstructure, a construction company and/or supplier of major plant or feedstock and a future operator of the new business will cooperate to establish or bid for a project. They may be joined by a future purchaser (an offtaker) of the product or service to be provided by the new project business. These parties have a common interest in seeing that the project business is established and financed.

From an early stage the sponsors will need to define their mutual obligations. Questions include:

• What exactly is the role of each party?
• How much human and economic resource will each party commit to different phases of project planning and development?
• How will each party protect its commercial interests in the project, whilst placing suitable restrictions on its potential liabilities?
• How will decisions be made by the consortium/SPVand contracts with it drawn up?
• How will losses be apportioned?

At the initial stages of development, the sponsors may draw up heads of agreement or a memorandum of understanding which focuses on such issues, to decide the form of their initial and future cooperation. The document may be legally binding or may be an expression of intention not intended to create enforceable rights and obligations.

1.4 Project vehicle

Whatever the differing interests amongst the consortium and whatever the rules under whichit operates, clearly the promoters will need to agree the legal form in which the projectbusiness will operate and the nature of their individual participation in that form. They will generally wish to establish a new SPV which is a legal entity distinct from the constituent members of the consortium.

The number and type of available forms will differ from jurisdiction to jurisdiction, but the commonest form is a single purpose limited liability company.

A diagram showing a typical comrporate structure is set out in figure 1.1 As the diagram makes clear, sponsors often hold their shares in any project holding company, through a special purpose company.

Figure 1.1: A typical corporate structure [1]

1.5 Construction contract

This is a fundamental commercial contract for all concerned because:

1. it is likely to absorb a large amount of the SPV's capital expenditure;
2. the quality and efficacy of the design and construction of the project will impact on project expenditure and revenues throughout project operation;
3. the overall construction cost and how certain it is will determine the bankability of the project; and
4. timeliness or delay in completion of the construction will impact on project economics. In particular, in the case of concession-based contracts or licences to operate, completion of construction and commissioning by a specific date is likely to be a fundamental condition of the concession or licence.

The standard industry forms are rarely used without extensive amendment. This is a direct reflection of the process of risk allocation that determines the contents of the project documents. It is also necessary to mirror the construction-related provisions of a concession agreement (if there is one) in the construction contract, to effectively pass down to the contractor the requirements and risks carried by the SPV relative to construction. The construction phase is often considered the riskiest phase of the project. The contractor will inevitably be expected to carry much of this risk in the construction contract, which may have a very substantial value. Quite understandably, however, he will try to limit his exposure to these risks.

The contracting strategy adopted may vary significantly as between one project and another. This can lead to considerable differences in the way issues are approached. A 'traditional form' approach may be adopted, for example, with the employer (the SPV) engaging a design consultant directly himself, and then hiring a contractor separately to implement the construction works. This structure will basically absolve the contractor from liability for design faults in the works and of responsibility for the design development process as the works proceed. Typically, the design consultant (architect or engineer) would also 'administer' the construction contract during the course of the works. This would effectively leave the SPVwith greater responsibility for managing the works than might otherwise be the case. Alternatively, a construction management strategy may be selected. This would involve placing a series of discrete 'works packages' contracts (which might otherwise be subcontracts) directly with the SPV, leaving a project or construction manager with responsibility for organisingand directing them and managing their performance in terms of budget and timetable.

By far the most common approach encountered on PPP project financings, however, is the. :turn-key' design-and-build (or 'engineer-and-construct') contract. This places responsibility for essentially all aspects of design and construction in the hands of a single contractor (or group of contractors), giving the SPV the benefit of single-point responsibility should defects appear in the works, and avoiding the greater administrative and organizational complexity that often goes with the alternative contract strategies.