Adjustment Mechanisms in Publich-Private Partnership (PPP) Contracts
A contract is said to be well formed if it is able to cover all the possibilities and provide guidance about what will happen in each and every situation. However, this benchmark cannot really be applied to PPP contracts used for building infrastructure projects. This is because infrastructure projects are extremely long term in nature. They tend to continue for years and sometimes even decades.
Hence, no matter how much due diligence is followed, it is impossible to predict the possible outcomes with any reasonable degree of certainty. Hence, preparing for these possible outcomes is also difficult, if not impossible. Therefore, when it comes to infrastructure projects and contracts, a good contract allows adjustments to be made with mutual consent of all the parties involved.
There are various types of PPP provisions which are open to adjustment in PPP contracts. Some of these provisions have been listed in the article below:
- Financial Equilibrium: The law allows operators of PPP projects to make certain unilateral changes to the contract. Even though these changes are unilateral, they have been designed to be fair in nature. These changes can only be made if certain events have taken place which are beyond the control of the operator. These events are generally classified into categories such as force majeure, unexpected government intervention and unexpected slowdown in the overall economy.
The degree to which one party can modify the contract is based on the type of disruption being faced and also the severity of such disruption. Also, before entering into the contract, a financial model is decided which gives either operator the authorization to modify key financial terms in a contract to a reasonable degree. The upper and lower limits of these modifications are decided in advance. The basic idea is that no party should be at a disadvantage because of the long term nature of infrastructure contracts.
- Changing Requirements: Since PPP projects are undertaken for long periods of time, it is difficult to accurately forecast the service requirements over a period of time. For instance, when a road is built, it is difficult to ascertain the amount of money that will be required in order to maintain the road in proper condition. This amount may also be changed based on the new technologies which become available in the market.
The price of the service as well as the scope of the service to be provided may change rapidly based on factors beyond the control of the service provider. PPP contracts must have adjustment mechanisms in place in order to deal with such changes.
The autonomy with which the changes can be made is decided based upon who is initiating the changes as well as the scope of the changes being requested. Service providers may include small tasks without levying any additional charges. On the other hand, they may even agree to forego certain changes if the changes they are proposing put them in an advantageous position.
- Changes to Tariff: The long term nature of public private partnerships projects makes it necessary to modify the tariff schedule every few years. There are different ways in which this can be done. Sometimes, it is linked to a complex formula where there are many parameters which are used to arrive at the final tariff.
In other contracts, something as simple as the government provided inflation numbers are used to modify the tariffs. Also, in some contracts, tariffs are changed every year whereas in other contracts changes are triggered based on external circumstances which are specified in the contract.
In many projects, there might not be any tariffs. In such cases, costs are benchmarked with the inflation rate. This is because the outflow of cash from the government to the contractor need to be adjusted to reflect the escalating costs.
In most cases, simple indexation does not work. Suppliers are not willing to provide services if their revenues will increase only by the indexed numbers. This is because over the long run, the actual inflation is far greater than the government provided inflation numbers. As a result, the service providers would actually be at a loss if they accepted the terms.
- Refinancing: In many cases, the risks inherent in the project decrease largely after certain milestones are met. In this case, it is possible for the infrastructure company to ask the debt holders to accept a lower rate of return. Alternatively, they could also ask to repay the existing debt holders with loan taken from new creditors at more favourable terms.
A good PPP contract must have provisions which allows the refinancing of debt to reflect the current risk which is present in the business. In some cases, the contract requires the gain from refinancing to be split between the old creditors and the infrastructure company.
The basic idea is that the contract must be drafted in such a way that both parties are considerate towards the need of one another. If one party uses external circumstances to try to usurp the needs of the other, the contract should be able to prevent that.
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- Risks Faced By Infrastructure Projects in Emerging Markets
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- Parties Involved in Infrastructure Debt Issuance
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- Managing Revenue Risks in an Infrastructure Project
- Cost Overruns in Infrastructure Projects
- Causes for Cost Overruns in Infrastructure Projects
- Third-Party Risks in an Infrastructure Project
- Vendor Finance in Infrastructure Projects
- Securitization in Infrastructure Finance
- Leasing in Infrastructure Finance
- Strategic Use of Land in Infrastructure Financing
- Usage of Collateralized Debt Obligations (CDO) in Infrastructure Finance
- Infrastructure Investments in Renewable Energy
- Should the Government be an Equity Partner in Infrastructure Projects?
- Lifecycle of Public Private Partnership (PPP) Projects
- Payment Mechanisms in Public-Private Partnerships
- Adjustment Mechanisms in Publich-Private Partnership (PPP) Contracts
- Early Termination of a Public Private Partnership