Contracting for Public-Private Partnerships United Nations Development Programme Special Unit for South-South Cooperation Training Course Wes Strickland, Esq. Hatch & Parent Arlington, VA September 18, 2006

2 Outline I.Overview of contract types II.General contract terms III.Special contract terms for each structure IV.Final observations

3 I. Overview of Contract Types Operation and maintenance (O&M) Design build operate maintain (DBOM) Design build finance operate (DBFO) Build own operate (BOO) Build own operate transfer (BOOT) Buy build operate (BBO) Privatization

4 Key Structural Questions What is the partnership project? In what jurisdictions will the project exist? Under what legal authority does the public partner undertake the project? What type of entity is the private partner? Are there pre-existing assets being contributed? Are new assets being constructed? Who will own the assets? What capital resources are available to the partners? Who will provide any needed capital and how?

5 Key Structural Questions (2) What will the private partner do? What payment will the private partner receive? How will the private partner’s success be measured and rewarded (or punished)? How will taxes be impacted? (after tax analysis) How long will the partnership last? What types of outside permits/approvals will be required? Who is the end user, the public partner or the public at large? –“Sponsored” (public at large) or “managed” (public partner)

6 Basic Structural Principles PPPs are partnerships, and each partner should act in good faith to further the purposes of the partnership Good partnerships are based on clear understandings of each partner’s role Tasks should be assigned to each partner according to their ability Compensation should be based on each partner’s tasks and assumption of risk

7 O&M Contracts Utilized when public sector partner already owns an asset for which it needs management services Public partner maintains ownership of initial assets Private partner provides specific services for a fee

8 DBOM/DBFO Contracts Utilized when a new asset needs to be designed, built and possibly financed Like O&M contract, but adding capital component Allows access to private capital markets Higher risk for private partner than O&M May avoid some public labor force issues

9 Concessions Utilized when public partner desires to have private partner take total responsibility for delivering service directly to the public, subject to contractual or regulatory terms –Utilities –Transportation infrastructure, e.g., toll roads, bridges, airports BOO, BOOT or BBO “Franchise” Affermage contracts

10 Triangular Structures (2) Private Partner for O&M/Capital Components Public Partner

11 Triangular Structures Public Partner Private Partner for O&M Component Public or Private Partner for Capital Component

12 II. General Contract Terms Contracting to meet basic structural principles Basic terms of PPPs Jurisdictional limitations

13 Contracting to Implement Basic Structural Principles Include all potential tasks in contract Define each task as specifically as possible, and the duties of each partner to accomplish that task Define all conditions that must be met prior to each duty arising, or that might cause a duty to cease Define success and what happens based on success or failure –Reward/punishment –New strategy

14 Outline of Basic PPP Contract Recitals Definitions Agreement clauses –Project definition, duties of the partners –Performance standards, covenants and monitoring –Payments –Risk allocation –Security for performance

15 Outline of Basic PPP Contract (2) Agreement clauses (cont.) –Term and termination –Wrap-up upon termination –Delay and force majeure –Indemnification –Affiliate guarantees –Dispute resolution

16 Outline of Basic PPP Contract (3) Agreement clauses (cont.) –Environmental liability –Permitting responsibility Acquisition Violations and fines –Relations with public end users –Default

17 Outline of Basic PPP Contract (4) Conditions –Occurrence of milestones in larger public planning efforts –Environmental studies –Economic studies –Cross-performance conditions

18 Outline of Basic PPP Contract (5) General provisions –Representations and warranties –Insurance –Subcontracts –Confidentiality –Choice/conflict of laws –Notices

19 Not in PPP Contracts Public partner ceding power to exercise eminent domain for compensation –“Just compensation” –Anti-expropriation rules in international law –Right to reclaim concession during term Public partner transferring critical assets –Natural resources, e.g., water, gas –Usufructuary rights –Agency theory

20 Jurisdictional Limitations Each nation and subnational jurisdiction may impose legal constraints on PPP terms Some countries have comprehensive PPP laws –Brazil 2004 –Mexico 2003 Types of limitations –Term –Investment amounts or ratios

21 Organizational Laws Awareness and contract implications Enabling laws of public partner Franchises required by private partner Foreign company rules –Local jurisdiction entity –Parent guarantees –Affiliate transaction rules –Handling of nonregulated business

22 III. Special Contract Terms for Each Structure

23 O&M Contracts Description of tasks to be performed by private partner List of public assets available for use –Initial condition –Final condition –Capital improvements during term: either party by contract

24 O&M Contracts (2) Expense for agency rather than debt Payment by public partner –Scope of activities –Alternatives: cost plus, formula, formula with cap, regulated rates (see concession) –Performance standards to adjust basic payments both up and down –Performance standards affect risk and therefore required compensation for a private partner

25 O&M Contracts (3) Transition –Services –Labor force

26 DBOM Contracts Define the asset to be built based on the public need –Public partner review and approval –Cost approval / financing Payments –Service component like O&M –Additional payments for adequate return on capital component Timeline for completion –Building for growth –Payment for insufficient demands

27 Concession Contracts Define private partner duties by public service to be provided Exclusive or nonexclusive General design and service standards –More limited review than other types of PPPs –Commercially reasonable service Water example: pressure, water quality Power example: voltage variation, outages –Objective, generally accepted standards

28 Concession Contracts (2) Compensation –Paid from members of the public –Public subsidies for necessary services Minimum income guarantees (temporary or permanent) Public capital contributions (priority of financing) Tax credits or incentives Policy question for public partner re necessary services Cross-subsidies –Sufficiency and security will greatly affect availability of private capital

29 Concession Contracts (3) Contract v. regulatory standards –Contract Difficulty of predicting scenarios Simple approaches create risk (and higher cost) Complex approaches create voluminous contracts that increase chance of disputes –Regulation Requires expert regulatory infrastructure Generally accepted methods (?) Uncertainty and cost of regulation

30 Ratesetting Revenue requirement –Reasonable expenses pass through –Capital costs Debt: return equal to actual interest rate Equity: return equal to that required to gain sufficient capital, based on investments of comparable risk –Concession payments to public partner Rate design –From rate-payer: fixed and/or variable charges –From public partner Implemented by expert, independent organization

31 Ratesetting (2) Rates fair to rate-payers and private partner Calculation of rates should be objective and predictable Rates should be calculated on a full-cost basis –Ensures that investors are protected –Explicit subsidies –Transparency Affordability –No discrimination among similar users –Subsidies may be appropriate for certain classes of user

32 Ratesetting (3) Should allow adjustments for events outside parties’ control –Credit markets –Labor markets –Construction costs –Tax changes Avoid price fluctuations –Limit amount by which rates can grow –Must obtain rate equilibrium

33 IV. Final Observations Many areas for PPPs are socially sensitive because necessary public services, e.g., water –Services should be affordable Contracts should be fair and take public needs into account for this and later PPPs Public partner should be the “face” of the PPP for the public

34 Implementation of Agreement PPPs are partnerships, and you must live with your partner Terms of contracts can be revisited and adjusted on a pre-agreed schedule or upon the occurrence of certain events

Wes Strickland Hatch & Parent 21 E. Carrillo Street Santa Barbara, CA (805)