In an effort to promote standardization and expedited negotiation of contracts for Public-Private Partnerships (PPPs), the World Bank Group introduced the 2017 Edition of the Guidance on PPP Contractual Provisions (the Guidance). The Guidance provides both sample language for contracts as well as commentaries to explain legal options. While the Guidance provides improved and more detailed advice as compared with the 2015 version, it continues to emphasize the preferences and requirements of the private sector partner without commensurate consideration of the perspective of the government. In response, the following comments on the Guidance are offered to help ensure that PPP contracts achieve an appropriate balance between investor rights, on the one hand, and the rights of the government and people, on the other.
In addition to initial overarching observations, comments are offered on each of the sections addressed by the Guidance; namely:
2-Material Adverse Government Action
3-Change in Law
6-Lenders’ Step-In Rights
7-Confidentiality and Transparency
8-Governing Law and Dispute Resolution
9-Bond Financing and Corporate Financing
First, the Guidance does not allocate the risk of PPPs between governments and private investors in a balanced manner. Rather, it places disproportionate risk on governments (referred to as the “Contracting Authority” in the Guidance). Although this may result in better pricing for governments on the front end, the true project costs are in some cases simply being loaded onto the back end. For instance, this would be the case if governments are forced to compensate investors for certain disruptions or delays in project caused by events beyond the government’s control.
Risks for the government and the general population could rise in the case of mega-PPPs, not only due to the magnitude of investments, but also because they are more prone to cost and schedule overruns and benefit shortfalls than smaller projects. In addition to those risks, governments may also provide the private investor with guarantees (e.g., minimum revenue guarantees) and other commitments that trigger burdensome financial obligations for the government in the long-term.
When risks are disproportionately allocated to the public sector, gains tend to be privatized and losses socialized. In such circumstances, governments may be required to take on additional debt or to divert resources from essential economic and/or social services to compensate the private partner when risks materialize. Such dynamics fuel inequality and even social unrest.
Second, under the Guidance’s recommended drafting language, if a government changes the law as part of a bona fide, non-discriminatory effort to regulate environmental and social issues in the public’s interest, this may trigger a duty to compensate the private partner. In most instances, such an outcome would be contrary to international jurisprudence. The duty to compensate would also have a “chilling effect” on changes in law that might otherwise be highly desirable, or even required by international law. For example, achieving the goals of the Paris Climate Agreement will require substantially strengthened legislation in almost all countries, such as legislation on fossil fuel subsidies or carbon pricing, incentives for renewable energies, or requirements for performance standards in order to ensure resilience to extreme climate or weather events. Such legislation might be discouraged by PPP contracts that follow the advice of the Guidance, as it may negatively affect investor returns and therefore could trigger claims for compensation by the host government.
Third, the Guidance encourages governments to enter into various contractual provisions that potentially restrict their ability to carry out important governmental functions, yet it does not address related social and environmental concerns that are of import to society. For example, the introductory section on “PPPs in Context” should note the importance of environmental and social impact assessments (ESIAs) and human rights impact assessments (HRIAs), and the need to allocate responsibility between the parties to a PPP for the identification, avoidance, mitigation, and management of the environmental and social impacts of their projects. Relatedly, governments could be advised to consider the capability of potential PPP partners to manage environmental and social/human rights risk in order to strengthen governments’ ability to meet their own environmental and human rights obligations and to minimize the risk that the project encounters delays and shut-downs. The “PPPs in Context” section should also offer guidance on climate change, a subject that is addressed only in a single sentence in a footnote despite the recognition in World Bank reports that climate change risks, mitigation and adaptation issues have become critical to infrastructure projects and should be expressly addressed in PPP contracts.
Indeed, the Guidance misses the opportunity to underscore the potential of PPPs to make contributions to sustainable development. While it focuses on the legal and regulatory environment that promotes private sector investment and risk allocation, the Guidance fails to mention the role of infrastructure in promoting sustainable development. Where it does mention environmental and human rights considerations, it does so in relation to risks of negative impacts. While ‘doing no harm’ is a crucial component of sustainable infrastructure, the Guidance must also address how sustainable infrastructure helps countries realize their national sustainable development visions and goals, including environmental and social sustainability, climate resilience, and local economic development.
As a final overarching comment, we note that the Guidance excludes the possibility of the participation of governments in PPPs as shareholders or partners. Instead, the Guidance assumes that the project company (the Private Partner) would be wholly owned by the private sector. While that is one model for PPPs, governments of developing and emerging market countries should have the option to participate in the ownership of the relevant project companies. To exclude that possibility is to deny governments the potential benefits of equity ownership, while potentially putting more onerous financial commitments on governments than they otherwise would be required to undertake. (For example, government obligations to compensate lenders, bondholders, and redundant employees if the private investor exits the project -- as currently envisioned in the Guidance’s sample drafting language -- would not be necessary if, with the exit of the private investor, the government has the right to assume full ownership and continued operation of the project company.) In any case, a wholly privately-owned project company structure is not necessary to provide the project company with significant benefits, such as tax concessions, currency exchange guarantees, and guarantee of the ability of the private party to bring in personnel to manage and operate the project. In fact, the entire structure of a wholly privately-owned project company appears to encourage maximum private participation in PPPs, and to place the maximum risk on the host government while removing any significant risk from the private participants in PPPs.
The following provides our summary comments on the stated sections of the Guidance. [Additional detailed comments can be found in the markup of the Guidance, available from Annotated Guidance on PPP Contract Provisions].
Section 1: Force Majeure
The Guidance’s sample drafting language on force majeure generally reflects the prevailing understanding of the definition of the concept. However, its commentary on the subject tends to encourage Contracting Authorities to take on a greater burden of risk for unforeseeable events than is required under international law. For example, the commentary’s suggestion that civil war events need not be treated as force majeure in “volatile jurisdictions” is clearly at odds with international jurisprudence, which treat them as force majeure events. As discussed below, the Guidance’s section on material adverse government action (“MAGA”), is even more biased toward the Private Partner because its sample drafting language classifies riots, insurrections, civil commotions, terrorism, strikes and go slows – in addition to war events – as MAGA rather than force majeure.
Moreover, the Guidance’s commentary on force majeure unduly favors the Private Partner in its analysis of the effects of an invocation of a force majeure event. It repeatedly suggests, for example, that the Contracting Authority compensate the Private Partner for lost revenue and costs incurred during the occurrence of a force majeure event. The recommendation for such compensation is inconsistent with a basic principle underlying the concept of force majeure, namely, that losses lie where they fall and parties bear their own costs and damages in the case of a force majeure event.
The Guidance’s commentary on force majeure could also be strengthened by highlighting other key aspects of the concept. One example is the important qualification that neither party to a PPP Contract is permitted to invoke the force majeure clause if it directly caused or produced the situation in question.
Even though the Guidance recognizes in a footnote the importance of addressing risks related to climate change, it still does not incorporate relevant language in the sample drafting provisions. The Guidance notes that “there currently is no standardized approach for allocating responsibility in PPP Projects to manage force majeure versus severe and extreme weather risks.” However, as noted in other World Bank publications, it is of critical importance that PPP partners study and address climate risks in project selection, siting and design, and allocate the remaining climate risks appropriately, because of the significant negative impacts climate events can have on the physical and economic performance of infrastructure. Those publications provide detailed examples and explanations of the various ways in which PPP partners can allocate climate risks in their contracts, including through insurance policies and variable force majeure provisions with the capacity to re-allocate climate risks as climate change events become more frequent. We highly recommend that the World Bank draw from such expert analyses and include commentary and draft language concerning climate risk allocation in their Recommended PPP Contractual Provisions.
Section 2: Material Adverse Government Action
As mentioned in the force majeure section above, the Guidance’s commentary and suggested drafting language on MAGA unduly place the risk of war, civil strife, riots, terrorism, and strikes on the Contracting Authority. As explained there, the norm under international law and in practice is to characterize these events as force majeure events, thereby sharing the risks of their occurrence between the contracting parties. The Guidance should be revised to ensure its recommendations do not encourage Contracting Authorities to incur greater risks and costs in PPPs than are reasonable from a legal or business perspective.
The Guidance’s commentary and sample drafting language on MAGA also do not account for the fact that events that could be characterized as MAGA under the recommended PPP contractual provisions may constitute legitimate exercises of state authority and police powers to regulate such matters as public and occupational health and safety, labor standards, and the environment. Similarly, many jurisdictions allow a Contracting Authority to reduce or annul benefits owed under a PPP Contract on grounds of public policy, such as underlying bribery, corruption, or fraud, which the commentary also does not consider. It is recommended, therefore, that any definition of MAGA in the recommended provisions expressly exclude such bona fide exercises of police and other regulatory powers, and authorize the Contracting Authority to cease or diminish payment when the Private Partner has acted in contravention of public policy. Doing so ensures, for example, that any risks associated with such conduct remain with the Private Partner, which would, presumably, have already factored them into its cost-analysis and pricing.
Section 3: Change in Law
As with the Guidance’s commentary and sample drafting language on MAGA, the section on change in law does not adequately consider legitimate exercises of the host State’s police and other legitimate regulatory powers in matters such as public and occupational health and safety, labor standards, and the environment. In particular, Option 1 of the sample drafting language improperly and inadvisably restrains the Contracting Authority’s police and other regulatory powers and ability to meet its international legal obligations concerning the environment and human rights by protecting the Private Partner against all changes in law.
Such language could also infringe upon governments’ right to regulate to mitigate and adapt to climate change. Under a variety of international agreements (UNFCCC and others), governments are encouraged or even required to strengthen laws that reduce emissions and manage climate risks, rather than be penalized for introducing them. Given that it is common for the term of PPP contracts to exceed twenty years, it should be expected that governments will change their legal frameworks, in particular with regard to the environment, human rights, and other social issues.
Indeed, the U.N. Guiding Principles on Business and Human Rights (UNGPs), the Universal Declaration on Human Rights and related human rights conventions, ILO conventions, and other international instruments highlight governments’ international legal duty to respect such rights themselves and to protect against adverse human rights impacts by third parties through effective policies, legislation, regulations, and adjudication. Additionally, under the UNGPs, businesses have a responsibility to respect human rights in their business activities, including in their value chains. Relatedly, under certain international environmental conventions, states are obligated to take a variety of steps to protect the environment. Given that PPPs in various sectors (especially mega-PPPs) raise the risk of severe human rights and environmental impacts, it would be appropriate, at a minimum, for the Guidance to underscore the value of duties and responsibilities cited in the international instruments mentioned.
In our view, it is inappropriate for the World Bank to promote contract clauses that enable investors to demand compensation if a government exercises its rights and fulfills its obligations to regulate in the public interest in this way. Doing so is not only counter-productive to the public good and to the PPP project in the long run, but it is likely to lead to disputes. Moreover, such change in law clauses are unlikely to be permitted to operate at the expense of the State’s police and other regulatory powers, especially (but not exclusively) where the governing law of the PPP contract is the law of the Contracting Authority.
For these reasons, the Guidance should not recommend risk allocation approaches resulting in the Contracting Authority bearing all the risk of change in law. Only a developed risk sharing approach, as reflected in Option 2 of the sample drafting language, amended to account for legitimate exercises of the host State’s police powers by excluding them from the definition of “General Change in Law,” is viable in the long run and fair between the parties. Clauses addressing arbitrary and discriminatory treatment of investors could also be used as a substitute for legal stabilization clauses.
Section 4: Termination Payments
The absence of any accommodation for a PPP in which both the private sector and the Contracting Authority (or other governmental entity) are shareholders is particularly noticeable in the Guidance's commentary and sample drafting language regarding termination payments. These payments would be formulated in a significantly different manner when a government is a shareholder. We strongly recommend that the World Bank include alternative sample drafting language for all topics included in the Guidance addressing the scenario in which a government holds an equity position in the project company. If the World Bank is resistant to including alternative draft language that would accommodate governmental shareholding in the project company (termed the “Private Partner” in the Guidance), that absence of alternative drafting language should be prominently noted in Section 4 and all other relevant sections of the Guidance, with commentary on how the sample drafting language would need to be changed for PPPs in which the government does participate as a shareholder.
The termination payment provisions also do not take into account that any termination payments to Lenders and redundant employees should be made directly to the Lender and relevant employees, and not to the Private Partner. Otherwise, there is an unacceptable risk that such payments would not flow onward to the Lender and redundant employees, to the detriment of the project's viability post-private participation. In addition, termination payments to bondholders and fixed rate lenders should only be required in instances in which bonds and such loans are impaired or they are, respectively, redeemed early or accelerated by their terms.
The sample drafting language also leaves out certain key factors in determining termination payments, including factors that are recognized in the commentary. For example, insurance proceeds received or to be received by the Private Partner or its shareholders should be deducted in determining the relevant termination payments; Option 1(c) in paragraph 1(d) of the sample drafting language should take into account the Private Partner's pre-termination performance; and the deductions set forth in Section 4.3.3 of the commentary should be reflected in the corresponding provisions of the sample drafting language.
Section 5: Refinancing
As noted under the heading "Realising Value Refinancing" in Section 5.1.3 of the Guidance, the refinancing section focuses on circumstances in which "PPP Project developments [are] positive," and the sample drafting language reflects only that situation. As also noted in the commentary, however, there may be instances in which refinancing is sought to rescue the PPP from default, which could be attributable to one of the parties. Furthermore, due to practices such as “dive bidding,” in which an award is made to a private firm that under-represents its full costs, contracts are often renegotiated to allow greater cost recovery by the firm. Because the sample drafting language does not take such scenarios into account, the section should clearly caution the Contracting Authority and the host government that, in a rescue or other negative-impact refinancing situation, different PPP Contract language, including a revised financial allocation that takes into account a party's fault for changed financing provisions, would be needed.
Given that any refinancing could have an impact on amounts payable to or by the Contracting Authority (and to or by users, in the case of "user pays" PPPs), the sample drafting language should be revised to require the Contracting Authority's written consent to any refinancing, not just refinancing that would result in a gain. Likewise, the sample drafting language should explicitly require the Contracting Authority's written agreement to any amendment of the Financial Model after the one approved as part of the winning bid (and if there is no approved Financial Model as part of the winning bid, the agreed Financial Model included in the contract). In addition, to guard against situations in which the Private Partner may not take the initiative to explore refinancing to achieve refinancing gains, the Contracting Authority should be empowered to require the Private Partner to do so, and the Private Partner should have a correlative obligation to act on such a request in good faith. Finally, for present purposes, the sample drafting language only contemplates the allocation of financial gains between the Private Partner and the Contracting Authority, and should be revised to accommodate "user pays" PPPs, in which financial gains should be shared with users.
Section 6: Lenders’ Step-In Rights
The commentary on Lenders' step-in rights generally accommodates Contracting Authority (and Lender) concerns in a situation in which the Private Partner is in default. Section 6.2.4 of the commentary should be strengthened, however, by acknowledging that the timing and duration of step-in must take into account user concerns (as well as those of the Contracting Authority and the Lender). Specifically, Lender step-in rights are triggered where a PPP project has fallen into distress due to the Private Partner's poor performance, to the detriment of users of the project's services (e.g., toll road users, consumers of electricity, water). Thus, to ensure that users are not forced to endure lengthy project dysfunction, the deadlines for a Lender to decide whether to step-in, and if it does step in, to step out (either after achieving proper operation and management of the PPP project or, if it fails to do so, by turning the project over to the host government) should be as short as possible and clearly stated.
Several factors should also be added to the type of provisions to be included in a Direct Agreement, in Section 6.3 of the commentary. Those factors include: (1) pre-agreement on what entity would serve as the "Lenders' 'nominee'" for immediate step-in and, if that entity is no longer available at step-in, agreement on how a replacement "Lenders' 'nominee'" would be selected; (2) a requirement that, before serving, the "Lenders' 'nominee'" and, later, the substitute private partner agree in writing to perform the PPP Contract; and (3) a right for the Contracting Authority to step-into the Lender's place, and the Lender (and/or its "nominee") to exit, under defined circumstances.
Section 7: Confidentiality and Transparency
For reasons that the World Bank has recognized in its 2016 PPP Disclosure Framework, the Guidance’s commentary and sample drafting language related to confidentiality and transparency should more explicitly endorse a clear presumption in favor of requiring the publication and disclosure of as much PPP project information as possible. In particular, by promoting transparency with regard to PPP projects, the World Bank helps establish PPP “best practice” benchmarks for fiscal transparency and the problems of corruption that are endemic in public contracting. The disclosure of various kinds of project information, such as government guarantees and financial support provided to the project or the Private Party’s investment and service obligations, also helps ensure that PPP projects withstand public scrutiny as to their true costs and benefits to the public. Such knowledge is essential for anticipating or carrying out budgetary trade-offs which may be required, since infrastructure often requires up-front “lumpy”, or capital-intensive investments.
In its current form, the Guidance’s draft contractual language on confidentiality and transparency merely gives discretion to the Contracting Authority to disclose the contract and other project information, while the commentary states that "it is for the Contracting Authority to decide whether contractual obligations should go beyond what is legally required" by local law). To most effectively promote transparency, the Guidance should recommend a contractual obligation to disclose government guarantees and/or other financial support for PPP projects to the public, except with regard to specific and limited confidential or commercially sensitive details.
In addition, the scope of information that is considered confidential in the sample drafting language should be narrowed significantly. The Guidance should also note that confidential information can simply be redacted from the relevant PPP documents in order to enable the disclosure of the non-confidential contents of those documents.
Finally, the commentary should also explain in more detail the benefits to the public and to various stakeholders of greater transparency in PPP contracting and project information. Where important public resources or services are at issue, the publication of project information and expansive disclosure should be required under the model PPP contract, even if local legislation does not require such disclosure.
Section 8: Governing Law and Dispute Resolution
The Guidance’s commentary and sample drafting language on governing law and dispute resolution appropriately identifies many of the concerns and considerations relevant to parties to a PPP. Nevertheless, that section could be revised in various ways to better explain to Contracting Authorities how they might benefit from one option versus another. As with other sections of the Guidance, the tendency is to emphasize the preferences and requirements of the Private Partner without commensurate consideration of the perspective of the Contracting Authority.
With regard to the governing law of the model PPP Contract, the Guidance’s commentary only lists disadvantages of local law as the PPP Contract’s governing law, without enumerating the benefits. The sample drafting language similarly reflects a bias against the application of the local law. This is unfounded. PPP contracts commonly provide for local law as their governing law for several reasons, not least of which is that such contracts implicate important domestic public policy issues that are best understood within the local legal framework. Moreover, licenses issued by the Contracting Authority (or other governmental entity) for a PPP project will almost certainly be governed by local law. Adopting local law as the governing law thus leads to a consistent approach and simplifies the resolution of disputes. For these reasons, the Guidance’s sample drafting language should either recommend local law as the contract governing law, or offer local law as a credible option for parties.
As reflected in our detailed mark-up of the Guidance, the dispute resolution section could make several recommendations that would enable its model dispute resolution clause to address various pressing concerns with the investor-state dispute settlement system such as transparency of the proceedings, procedural efficiency, and conflicts of interest in arbitrator selection.
The Guidance helpfully includes a section on informal or alternative dispute resolution mechanisms such as negotiation, mediation, co-mediation and external disputes boards. This kind of dispute resolution could prove particularly helpful for resolving disputes with climate change, environmental, and social issues, among other things. Given the reality of climate change, parties to a PPP should be prepared for the possibility of encountering many differences and disputes regarding climate impacts throughout the life of the project. The parties could avoid incurring high litigation and arbitration costs by contemplating in their contracts a means of periodically communicating and assessing any evolving climate risks that might affect their project, as well as amicably and expeditiously resolving any dispute.
Sections 9 and 10: Bond Financing and Corporate Financing
Compared to the 2015 Edition, the 2017 Edition of the Guidance adds two new sections, i.e., detailed sections on Bond Financing (Section 9) and Corporate Financing (Section 10). Overall, these two new sections provide information useful to host governments in understanding and dealing with the complex areas of bond and corporate financing. However, some additions to these sections are advisable. For example, both sections should indicate early on in their texts that Contracting Authorities need to obtain expert financial and legal advice with regard to bond and corporate financing. As to bond financing, text should also be added to warn Contracting Authorities of the need to institute mechanisms through which the issuers of bonds for the financing of PPP projects can certify to the Contracting Authority their compliance with applicable securities law, regulations, and required authorizations. The “emerging and developed market differences” comment box in Section 9.5.1 should also add language raising the possibility for Contracting Authorities to mitigate construction risk by requiring Private Partners, their affiliates involved in bond financing a PPP project, and/or sub-contractors carrying out project construction to post a surety bond or a letter of credit securing construction completion.
Section 10 on corporate financing would also be strengthened by adding language indicating the option for Contracting Authorities to require bidders to make a deposit, via cash or letter of credit, along with their bids, as is standard for infrastructure tender processes. Text should also be added in Section 10.2.4 providing for the Contracting Authority’s right to conduct due diligence on winning bidders and their affiliates that would finance the PPP project through corporate financing, to ensure that they have the financial wherewithal to do so and that interest rates and other terms of any intra-company group financing are not excessive and are otherwise acceptable. It would also accord with accepted practice to include language in Section 10.2.7 indicating that Contracting Authorities can guard against poor project performance by Private Partners by requiring them to provide performance guarantees, surety bonds, or letters of credit, depending upon the cost and availability of those types of protections.