ABSTRACT

The drafting of PPP documents is complex and little has been written about it. The genesis and present state of PPP documents both in the UK and here in Australia are outlined. Typical documentation includes the: Concession Deed or Project Agreement; Output Specifications; Construction Contract; Operation and Maintenance Agreement; and Financing Documents. Each of these documents is discussed with a focus on road projects.

The UK has had extensive experience dating from the early 1980s and has now standardised its forms and procedures for generating equitable and reasonable rates of returns for government and private sector partners.

Australia while also undertaking many PPP projects in various States, appears to be at an early stage in the development cycle of standardisation. The Australian PPP market currently has: a lack of standardisation in process across the States; a lack of deal flow; a widely adopted philosophy of risk transfer; tendering processes that are perceived as being operated unfairly; a stranglehold by local financiers or funders on the process; and a lack of international construction contractors and lenders.

Improving documentation quality, professional ethics, transparency and equitable risk strategy should help to overcome problems.

Keywords:     Private Public Partnerships, drafting project contracts, risk assessment, risk management, financing, government, construction contractor.

 

1.0          INTRODUCTION

The writer would like to acknowledge the help in producing this paper of Nicholas Hallett and Forbes Johnston of Mott MacDonald, Ian Radford of Pinsent Masons, Mark Lynch of Thiess Contractors and Ahmed El Gamal of Department of Primary Industries. 

The drafting of PPP documents is complex and little has been written about it.

To set some bounds the paper assumes a Queensland toll road project as a point of reference for PPP projects.

PPP projects should be considered to be major projects rather than major financing projects.  They represent 10‑15% of the total number of major projects and should be subject to principles of successful major project delivery in particular: 

·         a principal may contract into trouble but cannot contract out of trouble completely;

·         PPP contracts are best thought of as relational contracts characterised by the interdependence of the parties necessitating sophisticated management of performance and extensive co‑operation.

The article says a little about the UK history of drafting PPP documents and suggests that recent UK and Australian successes promise:

·         a reduction in Government project transaction costs of up to 40%;

·         a similar reduction in project transaction time;  and

·         a reversal of the declining quality of project documentation.

 

1.1               “GETTING IT RIGHT FIRST TIME” – THE TRENDS IN DOCUMENT PRODUCTION

Industry trends in documentation (Queensland Division of Engineers Australia, 2005) show:

·         Project documentation is declining in quality and this decline is contributing an additional 10 to 15% or more to project costs in Australia.  This is estimated to equate to approximately A$12 billion per annum.

·         For complex projects, relationship contract formats should be preferred such as alliances, partnering and incentive based contracts that involve negotiated fee structures where risks of cost overruns and underruns are shared between the parties on an agreed equitable basis.

·         Standard form contracts should be used whenever possible.

·         The problem of poor documentation is particularly evident in building and infrastructure projects where proper design and project documentation should be: fit for purpose; unambiguous and coherent; timely, accurate, and complete; easily communicated and constructed, with the best possible economy and safety; and aligned with the owner’s requirements.

·         There is poor understanding and skilling in risk assessment and management processes on the part of owners, consultants and constructors.

·         There needs to be industry wide recognition that fair and equitable risk management and allocation processes play a significant role in coordination and integration of the supply chain.

·         Documentation as a deliverable under professional consultants’ commissions will require a strong focus on these aspects of project delivery.

·         Each sector of the industry needs to play its part in arresting and reversing the declining standard of project:  Project owners by the proper preparation of project briefs, by putting consultant capability and value ahead of low fees and by effective risk management;  financiers and lawyers by espousing cooperative approaches and by crafting contracts which are a fair contract between equals rather than tight outdated master servant contracts.

 

2.0          TYPICAL DOCUMENTS

 

2.1              INTRODUCTION

The types of PPP document can be divided into construction or commercial documents and are:

·         subject to the drafting and interpretation principles that govern any other legal document;  and

·         .affected by industry trends in the production and management of such documentation including standardisation to minimise transaction costs.

 

2.2              DEFINING SOME TERMS

 

2.2.1        PPP and PFI

A PPP is best described as an arrangement between the private and public sectors to deliver cost effective and high quality services to the public sector over an extended period of time. A PPP is a flexible arrangement and its structure varies according to the type of service delivered and the risk allocation between the participants. In some cases the private sector may design, construct and maintain the asset, while Government provides the essential service or core service (eg hospital service) while in other cases the private sector provider provides both the asset and the services (eg a toll road).

There is a distinction between PFI (Private Finance Initiative, a UK term) and PPP, which is not widely understood. PFI is only one type of PPP used in the UK. A PFI is based on Government paying a private sector provider for the supply of service delivered through an asset developed by or transferred to the private sector provider.

For new highways (and in due course the management of the existing network), the focus is on the availability and performance of the network to specified standards, with payment deductions imposed on the private sector service provider if they do not meet availability and performance targets.  The result has been a very noticeable shift to better consideration of whole life issues within design and construction.

 

2.2.2        Accommodation projects and linear infrastructure projects

With economic infrastructure such as a toll road the private sector provides the infrastructure directly to the end user in exchange for a fee or toll. With social infrastructure, such as hospitals, prisons, schools, courts and police facilities, the private sector provides services directly to the public sector in exchange for a concession (Millhouse, 2002; Queensland Govt., 2002).

 

2.3              TYPICAL PROJECT STRUCTURE

The following shows a typical PPP project structure (adapted from Radford, 2003):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2.4             TYPICAL PROJECT DOCUMENTS

 

2.4.1        The Project Agreement or Project Deed

This is likely to include:

·         Monitoring or compliance rights for Government during development and construction.

·         An obligation on Government to obtain and transfer to the DBFO Co any land rights.

·         Undertakings by Government to carry out any works which are necessary on its part for the project.

·         “Step-In” rights entitling Government to intervene and run the project without terminating the Project Agreement if the DBFO Co fails to meet required performance standards.

·         Termination and compensation provisions.

·         Provisions dealing with the transfer of assets and personnel at the end of the concession period or earlier termination.

·         Provisions for variations and increased costs.

·         A payment mechanism which reduces the service payments if the Output Specifications are not satisfied.

 

2.4.2        Output Specification

The Output Specification will state the Government’s desired outcomes and the private sector service provider’s responsibilities to meet them. The specification should state outputs desired by Government to ensure it avoids design risks it is not well placed to manage.  It is not a detailed design specification.  The focus is on Government needs not how they are to be met.

The Public Private Partnerships Guidance Material (Queensland Government, 2002) describes the nature and role of the Output Specification and gives an outline for a Road/Transport Project.

 

2.4.3        Construction Contract

The Construction Contract is between the DBFO Co and the Construction Contractor. The DBFO Co will seek to pass to the Construction Contractor all design and construction obligations and risks. Hitherto this has been done by a fixed price D&C contract. The drafting has been a complete ‘pass‑down,’ clause by clause, from the Project Agreement.

 

Even in the UK where, as we shall see, the Project Agreement is rigidly standardised as a result of SoPC3 this method governs the risk allocation and drafting of the construction contract because there is no equivalent standard form construction contract.

 

The Construction Contractor is therefore in the position of a subcontractor with influence over the content of the Project Agreement only insofar as any investment group or division of the Construction Contractor has a place at the table in the negotiation of the Project Agreement.

 

The ‘pass‑down’ approach will not always be applicable and particularly in specialist subcontracts it can produce unintelligibly onerous results.

 

2.4.4        Operation and Maintenance Agreement

The DBFO Co subcontracts by one or more Operation and Maintenance agreements the provision of all on-going services during the operating phase of the concession imposed on the DBFO Co under the Project Agreement.  The DBFO Co may also enter into a contract with a facilities management contractor to co-ordinate the provision of the operating services during the operation phase life of the concession. The construction contractors employed may themselves enter into sub-contracts in order to carry out their obligations to the DBFO Co.

 

Operation and Maintenance Agreements are one category of agreement where use of a relational contract should be considered because technical obsolescence or market volatility may make it impossible to predict maintenance requirements for more than a fraction of the concession period.

 

2.4.5        Financing Documents

The project must be capable of being financed and financial models will be produced showing how the cash inflows will be sufficient to service the cash outflows over the life of the Concession.

 

Sources of finance available to the DBFO Co may include internal funds, share capital or bank loans. Bank loans may be available for a long period of time.  Interest will be rolled up during the construction period and added to the principal amount of the debt because, revenue will not be generated until the project facilities are completed and service payments commence.  In order for the project to be bankable, it will be necessary for the banks to be satisfied that their loans, together with interest, are capable of being repaid over their life out of the revenue which the concession is likely to produce.

 

3.0          DRAFTING ‑ THE UK HISTORY

 

3.1              1981‑1999 – THE BATES REVIEWS

In 1992 private finance was given a boost by the announcement of a new policy, the “Private Finance Initiative”, where the Government actively encouraged the private sector to take the lead in joint ventures with Government.

Before May 1997 PFI projects were commissioned in transport, health, defence, office accommodation, information systems, prisons, education, and water resources. However, despite the growth in PFI there was still a considerable delay in bringing projects from conception to completion.

 

In 1997 the Bates Committee undertook a thorough review of PFI with the intention of removing the barriers hindering the delivery of projects and proposed:

 

·         rationalising the institutional structure;

·         improving the process and aiming for standardisation;

·         gaining and retaining knowledge and skills; and

·         minimising bid costs.

 

In 1999 The Treasury Taskforce published guidance on the standard terms and conditions expected in a PFI contract. The TTF Guidance comprised a commentary setting out the principles to be followed together with some specific drafting.

 

After a further review by Bates in 1999, a permanent body majority owned by the private sector (but with a significant Government minority stake), Partnerships UK, was established in 2000 to:

 

·         continue to offer project management skills to Government bodies;

·         undertake audits of Business Cases/financial models on behalf of HM Treasury;

·         continue to work with Government bodies to improve the operation of their PFI procurement programmes;

·         provide support to local authorities promoting PFI schemes; and

·         provide initial seed capital for projects.

It also introduced new guidelines adopting whole life cycle service costing for PFI.

 

3.2              1999‑2004 STANDARDISATION

The Standardisation of PFI Contracts was developed and refined over three editions (SoPC1, 2 and 3 – see UK Government, 2004):

 

·         To promote a common understanding of the main risks;

·         To allow consistency of approach and pricing across a range of similar projects; and

·         To reduce the time and costs of negotiation by enabling all parties concerned to agree a standard approach without extended negotiations.

 

An important feature of SoPC3 for drafting purposes is the division of post contract events into compensation events, relief events, and force majeure events.  These are exceptions to the principle of absolute transfer of construction risk to the DBFO Co which would generally be accepted in Australia (see eg Public Private Partnerships Guidance Material, Queensland Government, 2002).

 

In the UK all PFI schemes must be SoPC3 compliant.  To avoid uncontrolled sector specific derogations from the model contract at time of writing all derogations from SoPC3 require specific prior approval from HM Treasury.

 

4.0          DRAFTING ‑ THE AUSTRALIAN HISTORY

The private sector for some time has been involved in the provision of public infrastructure in particular in road transport infrastructure in New South Wales (NSW) and Victoria.  Projects have largely been BOOT (Build-Own-Operate-Transfer) arrangements, under which a private sector service provider contracts to build infrastructure, owns it for an extended term (retaining maintenance risks), operates it and then transfers ownership to Government. Examples include the Melbourne CityLink tollway, the Sydney M2, M5 and Eastern Distributor to the Sydney Airport and many items of the Sydney Olympic structure (Jones, 2003).

 

In the 90s a number of RTA road projects in NSW, provided an understanding of the project documents to a relatively small number of parties and advisers.

 

The experience in Victoria has been more far‑reaching and transparent.  Partnerships Victoria was launched in June 2000 and based on the UK PFI model and provided a framework for the integration of private investment in public infrastructure. Guidance material was published in Victoria to assist the public and private sectors in developing and implementing the new policy. Since then, PPP policies and guidance material have been published in all states and territories promoting: value for money; open and effective competition; innovation; economic growth and employment opportunities; and reasonable risk distribution between the parties.

 

Partnerships Victoria focuses on the purchase of services rather than the assets, bringing with it benefits such as risk transfer, whole of life costing, innovation and asset utilisation. Value for Money is a key driver in Victoria and the debate about on and off-balance sheet financing does not play a significant role in the decision to undertake a PPP perhaps because Victoria has a low debt level.

 

Since November 2003 the Victorian State Government has promoted a National PPP Ministerial Council with the aim of building better support for PPP’s among different governments and facilitating the development of a national PPP market.  Standardisation of documentation and processes features on this agenda.

 

Victoria’s Standard Commercial Principles released in June 2005 represents the latest attempt at a considered Government position in relation to risk allocation, and may therefore be preferred to Appendix A to the Queensland Government (2002) VFM framework.

 

5.0          DRAFTING CONSIDERATIONS

 

5.1               GENERAL DRAFTING CONSIDERATIONS

PPP documents are very sophisticated financing, construction or commercial documents and the draftsperson should follow best practice drafting procedures such as having full and clear instructions and information as to what the document to be drafted is to achieve and finding out as much as possible about the subject matter, etc.

 

5.2              PROJECT SPECIFIC DRAFTING CONSIDERATIONS

 

5.2.1         The Contractual Framework requires:

5.2.2          

·         allocating risk to the party who is best able to manage the risk;

·         establishing clearly defined service requirements and key performance indicators;

·         building in arrangements to deal with the change which is likely over the period of the concession;

·         including value for money mechanisms such as benchmarking; and

·         using dispute resolution mechanisms which avoid litigation.

 

5.2.2        The Partnership Framework

 

A successful partnership requires a framework upon which the parties can build their relationships.  The use of project alliancing and partnering in the construction industry suggests possible frameworks. The parties need to understand and respect each other’s objectives and align their objectives and their business strategies as much as possible during procurement, development and delivery.

 

5.2.3        The stepping down of risk and the Teflon Tube (Radford 2003).

 

The use of standard risk allocation has reduced the time and cost of negotiating a UK PPP contract. In Australia, however standard guidance such as Appendix A in Queensland Government (2002) is only an influential starting point. The parties engaged in each project still need to assess the specific risks associated with their project and allocate them through the Project Agreement.

In a road project PPP demand or market risk cannot be passed down by the DBFO Co to either the construction contractor or the operator. It must therefore be borne by either or both of the DBFO Co and Government.

 

Strategies for dealing with difficult risks such as demand or market risk will usually include:

 

·         Ensuring that the DBFO Co takes a robust line with Government;

·         Ensuring risk management procedures allow the Construction Contractor maximum freedom and opportunity to manage and control construction risk with minimum interference from Government, DBFO Co and/or Operator;

·         Considering risk sharing options with DBFO Co and Shareholders and/or risk sharing between Construction Contractor and Operator; and

·         If all else fails insuring against construction risk, pricing construction risk and/or making sufficient allowance in design and construction programmes for managing risk and/or dealing with the consequences of a risk occurring.

 

The PPP Construction Contractor is generally in a far better position than a D&C Construction Contractor to manage and avoid or mitigate risks because of:

 

·         greater awareness of risks as a consequence of relatively sophisticated risk analysis, a longer project gestation period and the use of lawyers, accountants and lenders;

·         greater opportunity to plan risk management strategies and price difficult to manage risks;

·         more elaborate and sophisticated risk management tools and procedures which give the Construction Contractor greater control over his own destiny than corresponding D&C provisions;

·         greater opportunity to manage and avoid/mitigate risks through design development and change control; and

·         greater transparency and certainty of losses and liabilities likely to be incurred In the event of different categories of Construction Contractor default which should facilitate consequential capping / limiting of liabilities.

 

5.2.4        Risk Allocation and Dispute Resolution or risk management?

 

Risk allocation in a PPP is governed by: Service delivery specifications; Payment/pricing structure; and Express contractual provisions adjusting risk allocation.

 

A PPP can be used to transfer the bulk of the risk involved with a major project to the private sector.  A key feature of PPPs is the explicit allocation of risk.  This means that the private sector service provider will need to price the risks into its bid for the project.  Complexities arise when risks need to be allocated between the members of the private sector consortium or the preferred risk allocation is operated inflexibly.

 

Regardless of the project structure, Government cannot transfer ultimate responsibility and accountability to the private sector service provider for the delivery of services it is legally obliged, or has undertaken, to provide to the public.  Similarly no principal can transfer the risk of complete project failure.

 

Until recently, commercial parties were free to agree to their rights, obligations and liabilities.  Freedom of contract also meant risk allocation was generally static. However, the law of contract is now subject to proactive judicial and legislative intervention including the Trade Practices Act (Australia Government, 1974).

 

Finally, any draftsperson of project contracts needs to consider these points:

 

·         A risk matrix is a shorthand version of a contract and as such is the document that all project stakeholders need to understand and have the ability to understand. It is important to ensure the target destination of the contract is the right one;

·         Most of the risks in a project can be dealt with by a principal prior to the selection of the private sector party;

·         If the construction contractor suffers losses due to an inappropriate allocation of risk, the construction contractor can seek to recover those cost overruns by claims, aggravating an inherently adversarial relationship and making litigation a probability rather than a possibility;

·         With the complexities and uncertainties of major projects there may also be no ideal strategy for distributing risk at the time of contracting so that parties must expressly or impliedly agree to adjust initial risk allocation in the light of future events;

·         If overriding weight is given to risk allocation in contract drafting, the risk is that these realities are ignored; and

·         Contract management can make risk management a whole of contract life strategy and the continued use of risk management can lead to significant benefits (MacDonald, 2001).

 

5.3               WHAT CAN BE DONE

Arguably the Australian PPP market has currently: a lack of standardisation in process across the States; a lack of deal flow; a widely adopted philosophy of risk transfer; tendering processes that are perceived as being operated unfairly; a stranglehold held by local financiers or funders on the process; and a lack of international construction contractors and lenders.

 

The last is potentially the most important and what is necessary to attract them includes standardisation of processes and documentation, particularly forms (Hibberd, 2004). 

·         Australia is close to the beginning of this development cycle, reinventing the wheel at great cost with each new PPP project transaction.

·         There is little published information on Australian transaction costs.  This much, however seems clear:

o        Transaction costs mean the fees and commissions payable to parties or their advisers.  These transaction costs will differ in the time at which they will be incurred; their amount and how they will be reimbursed vary according to whether the costs are incurred by Government or PPP Co.

o        Government transaction costs are principally the fees of external advisers, ie legal advisers, financial advisers and technical advisers.

·         These transaction costs are substantial although information about them or their make up is sparse.  The UK Parliamentary Public Accounts Committee has recently suggested adviser costs generally represent between 2 & 2.5% of a project’s capital cost of smaller projects (UK Parliamentary Committee on Public Accounts, 2005).

·         Anecdotally in Australia the transaction costs of a DBFO Co: may range between 5% and 15% of a project’s capital cost; may be payable to a single entity acting as fund arranger; may be payable at times unrelated to the staging of the VFM process eg upfront or as a retainer; and will be factored into the bid price.

·         In addition to containing transaction costs standardisation has allowed the UK to focus on other ways of streamlining PPP projects in particular limiting private sector profit taking.  Three developments need mention here:

o        The first is the treatment of super profits in SoPC3.  A bidder has to include his financial model and this will be analysed because government expects the internal rate of return through the life time of the project to be somewhere between 13% and 15%.  Super profits beyond this will be shared with government.

o        The second way of controlling private sector profit taking is through the Credit Guarantee Fund (CGF) which operates on debt and is a guarantee of payment of that debt, but has not been trialled. 

o        The third way is the funding competition.  Funding competitions are described in OGC Guidance (UK Government, 2002).   

·         As yet there seems to be no real understanding in Australia of the success of changes in PPP processes such as:

o        the measure of standardisation reached in the use of SOP3 since the Treasury guidance issued in April 2005;

o        the determined efforts being made to reign in private sector super profits by means including piloting CGF and funding competitions.

The promise of standardisation is primarily a promise of reducing transaction time and cost and increasing throughput on deals as enormous transaction costs cease to be incurred with every single project.  A project like Southbank Education & Training Precinct Redevelopment Project seems to have taken about 29 months from inception to financial close. The UK experience suggests standardisation could possibly reduce this time to something like 18 months.  That alone suggests the promise of a consequent reduction in the transaction costs to Government of the order of 40%.

 

6.0          CONCLUSIONS

Future PPP drafting needs to focus on three important issues.

 

6.1.1        Risk allocation. The current approach may be unsustainable because:

 

·         We have lost sight of the meaning of the Abrahamson principle that risk is allocated to the person best able to manage. To Government the phrase now means best able to manage ‘at the least cost’. To a bidder the phrase means is that there is risk which the bidder has to price. In what is a market where construction contractors with the capacity to carry out these projects are too few, the approach also means that they will take their pick of what they bid and carry out.

·         The approach underpins risk transfer and generates costly inefficiencies for participants in a PPP project because of this.

One must look more at risk management rather than risk allocation. 

 

6.1.2        D&C Construction Contractors as Operators/Facility Managers

Currently in Australia bids for this kind of project are being driven by financiers whose aims are not those of the long term investor. The D&C Construction Contractor who mutates into the operational facility manager has the potential to be a long term investor and a bid leader.

 

6.1.3        Developments in Contracting

A PPP project is many projects.  It is commonplace that it is a risky short term construction project and a stable long term investment once constructed.  However, even as a construction project it is both a financing project and a design and construct project. This second aspect of the project reinforces risk allocation and underpins the Teflon Tube. It allows little or no room for “efficient co-operation” between the D&C construction contractor and the D&C construction contractor’s subcontractors and suppliers.

However, developments in contracting such as the technique of Early Contractor Involvement (ECI) with which Department of Main Roads is experimenting promise price certainty to principals and financiers and a fair contract to them and other project parties.  In this they offer a further means of getting project documentation right first time in this kind of major project as well as other projects.

 

7.0          REFERENCES

Hibberd, P, 2004, The Place of Standard Forms of Building Contract in the 21st Century, www.scl.org.uk

Jones, D, 2003, Evaluating what’s new in the PPP Pipeline

MacDonald C, 2001, Allocation of Risk in Major Infrastructure Projects - Why Do We Get it so Wrong? ICLR 1 p345

Millhouse, A. 2002, Public Private Partnerships — The Dawn of a New Era for Private Financing

Queensland Division of Engineers Australia, 2005. Getting it Right First Time, http://qld.ieaust.org.au/jetspeed/static/items/2/3209/FinalReport.pdf

Queensland Government, 2002, Public Private Partnerships Guidance Material: Supporting Documents: Business Case Development, Department of State Development. http://www.sdi.qld.gov.au

Radford, I. (2003). PFI Contracting – A Brief Synopsis, London.

UK Parliamentary Committee on Public Accounts (2005), London Underground Public Private Partnerships, http://www.publications.parliament.uk/pa/cm200405/cmselect/cmpubacc/446/446.pdf

UK Government, 2002, OGC Guidance on Certain Financing Issues in PFI contracts, Office of Government Commerce 
http://www.hm-treasury.gov.uk/media/6066B/PPP_GuidanceonCertainFinancing.pdf

UK Government, 2004, Standardisation of PFI Contracts, (www.hm_treasury.gov.uk/documents/public_private_partnerships/key_documents).

Victorian Government, 2005, Partnerships Victoria, Detailed Guidance Material Standard Commercial Principles, http://www.partnerships.vic.gov.au.