A Standard Contract for PPPs the World Over: Recommended PPP Contractual Provisions Submitted to the G20

BACKGROUND

With the G20 Summit barely two weeks away, the G20 is preparing new measures to promote private investment in large infrastructure projects as a way to accelerate global growth. 

The G20 consists of the major shareholders of most existing and new Development Finance Institutions (DFIs).  As a result, the G20 is a conduit – through the DFIs, such as the World Bank Group (WBG) – to the PPP and investment promotion units in governments around the world.

In order to accelerate and replicate PPPs worldwide, international organizations are standardizing many aspects of PPPs – from feasibility studies, to contracts, and procurement.  Such standardization is expected to bring the time for preparation of the average project from 7 to 3 years.

At the request of the G20, the World Bank Group and The Public-Private Infrastructure Advisory Facility (PPIAF) submitted model PPP contract language to the September, 2015, G20 Meeting of Finance Ministers and Central Bank Governors. Because the WBG/PPIAF acknowledged that only certain aspects of a complex PPP scheme could lend itself to standardization, its proposals leave many of the more complex details of any PPP contract to be negotiated on a project-by-project basis. Nevertheless, with some adaptations, its proposed model is to be disseminated worldwide – to developed and developing countries alike.

The merits of the WBG/PPIAF proposals must be assessed in light of the past two decades of experience with the PPP model – largely in developed countries – which provides ample evidence of the model’s frequent failure to deliver viable projects at reasonable costs, or to do so in manner that comports with democratic norms of accountability. 

Indeed, when it comes to megaprojects of the type promoted by the G20, the Oxford Said School of Business thoroughly documents how nine out of ten projects have significant (over 50%) cost overruns and benefit shortfalls. [1]

The problems with PPPs are now widely acknowledged even by determined proponents of the model, who admit that it “has become tarnished by its waste, inflexibility and lack of transparency,”[2] and are now proposing reforms they claim will ameliorate these problems.[3]  It is somewhat remarkable therefore that several aspects of the WBG/PPIAF proposals simply ignore the problems that have plagued many PPPs, and the proposed solutions to them.  This is particularly true in respect of the allocation of risk between the public and private partner, as the following examples illustrate.

THE STANDARD PPP CONTRACT

To begin with, it is important to appreciate the fact that PPPs are considerably more risky than the conventional procurement relationships they are proposed to replace.  As described by WBG/PPIAF proposals, PPPs are based on “a network of complex legal agreements” that define the relationship between the public body and the private partner.  Even more complexity is introduced because the private partner is often a consortium of transnational corporations (engineering, construction and other service providers and their sub-contractors) international lenders (including hedge funds), and local subsidiaries incorporated for the specific project to limit the liability of the international corporate parents.

As complex as the principal PPP network of agreements may be, contracts among the members of the consortium, which are always formulated behind an opaque screen of business confidentiality, may be even more byzantine.  This is because each member of the consortium will be assisted by a team of lawyers and financial consultants working to maximize profits (including by tax avoidance), and to minimize risks for their clients. Because the failure rate for PPPs is so high, risk avoidance is a central objective.  It is not surprising therefore that WBG/PPIAF proposals are primarily concerned with the allocation of risk under a PPP.

Because the WBG/PPIAF recognizes that much of the legal framework for PPPs must be negotiated to reflect the particular project involved and the legal system within which it will be situated, its proposals concern a handful of “typically encountered provisions” of a PPP agreement.  These are addressed under eight headings: Force Majeur; Material Adverse Government Action; Change of Law: Termination Payments; Refinancing; Lenders Step-in Rights; Confidentiality and Transparency; and Dispute Resolution.

In putting forward these proposals, the WBG/PPIAF candidly admits that its focus is “the protection of lenders’ rights and the sharing of the benefits of refinancing.”  Its proposals clearly warrant careful scrutiny, but for present purposes even a cursory assessment of a few of the WBG/PPIAF proposed PPP contract provisions reveals that its admitted “focus” might justifiably be described as a single-minded preoccupation with the rights of private investors, often to the great prejudice of the very communities that are ostensibly the beneficiaries of the projects involved.

MATERIAL ADVERSE GOVERNMENT ACTION, AND CHANGE OF LAW

For example, the proposed contract language presented under these two headings would allocate the risks – arising from shifts in the landscape of public policy and law, but also from events, such as labour protests, over which the government may have little control – to the public partner.  In such cases the public authority will be obliged to compensate the private partner for costs and losses arising from such changes or events.

In certain instances, such as an outright expropriation, the proposed allocation of risk is understandable. In others, such as the good faith regulation to reduce greenhouse gas emissions or to protect public health, the justification for compensating PPP investors for the costs such reforms may impose is far from obvious. Moreover, as the WBG/PPIAF admits, such an arrangement would privilege PPP investors relative to those in any other domestic enterprise that may be similarly impacted.  That structural inequity might well discourage domestic capital formation and investment, or lead to calls from all sectors for similar compensation.  Such a result would obviously impose a palpable chill on the development of progressive policy and law.  Moreover, many of the events that would allow a private investor to claim compensation are simply typical business risks that an investor in any enterprise must take into account.  

TERMINATION PAYMENTS

Another illustration of the bias of WBG/PPIAF proposals to favour the interests of private investors, and one that bears directly on the problem of accountability, is the proposal for termination payments – i.e. compensation that must be paid to private investors when PPP projects fail. 

One can understand the rationale for compensating investors in cases where PPP failure is clearly due to the conduct of the public partner. But even in that case, the WBG/PPIAF proposal that such investors “be made whole” (i.e., compensated for both actual losses and future profits) is likely to impose a punishing financial burden on countries, who may also be deprived of the critical infrastructure they must nevertheless pay for. Moreover, the expansive way in which public default is defined can leave countries on the hook for problems over which they may have little control.[4]

The WBG/PPIAF’s one-sided priorities are even more apparent in the proposal to compensate private investors even in the event of their own default. In such a case, the public partner is to receive no compensation for financial losses or those suffered from being deprived of the facilities and services that were contracted for. Instead it is the private investor who must be compensated.

Thus, section 2 of the schedule on termination payments provides the following:

2. Termination upon Private Partner Default

If the Contracting Authority terminates this PPP Contract in the event of a [Private Partner Event of Default], the Contracting Authority shall pay to the Private Partner a compensation amount equal to [80 to 85]% of the Outstanding Senior Debt.

It would difficult to conceive of more egregiously one-sided contract terms.

DISPUTE RESOLUTION

WBG/PPIAF proposals for the resolution of PPP disputes are just as problematic. There is no doubt that PPP contracts, which are extremely complex and span several decades, need to provide recourse to fair and transparent dispute resolution processes. While the dispute procedures proposed by the WBG/PPIAF contain some sensible proposals, they are seriously marred by their reliance on a globally controversial system of investor–state arbitration.[5]

The world is waking up to the fact that investor–state dispute settlement (ISDS) is neither fair nor independent, but rather exhibits a systemic bias in favour of investors at the expense of public policy and democratic governance. In consequence, many countries are taking steps to limit their exposure to ISDS. Even the European Commission (EC), under intense public pressure, has proposed reforms to replace traditional ISDS processes in its internal and external trade and investment treaties with an international investment court.[6]

The importance given to ISDS by the WBG/PPIAF drafters is fully consistent with the report’s general privileging of the rights of private proponents and financiers. Yet, in overlooking or neglecting the rights of governments, citizens, and taxpayers, the recommended dispute resolution mechanisms fail the crucial test of balance.

The report proposes the following stepped process for dispute resolution: 

• A mutual commitment to try to resolve disagreements promptly and amicably.      
• Agreement that technical disputes can be referred to an expert to recommend resolution. 
• More intractable issues can be brought before a dispute board comprised of representatives of both parties, which may be empowered to reach a binding resolution by consensus.

The report notes that, given the “the time and the cost of international arbitration, serious consideration should be given to the use of mandatory alternative dispute resolution mechanisms (such as dispute boards).”  Yet if such a board fails to resolve the dispute within a mere 30 days, the report states that “the Dispute shall be referred to and finally settled by international arbitration (clause 23, p. 52)” Clearly, under such rules, most disputes would proceed to investor-state dispute settlement.

It is remarkable that a development institution would sanction completely bypassing a country’s domestic courts in disputes related to PPP projects.[7]  At the very least, a firm requirement to exhaust local remedies is essential to building capacity and strengthening local institutions in developing countries, including their courts. Indeed, if the domestic courts of a country are viewed by foreign investors or financiers to be so untrustworthy that they must be sidelined, complex instruments such as PPPs are likely inappropriate.

One approach for ensuring a fairer and more independent dispute resolution process than traditional ISDS could be to establish a permanent international body to adjudicate disputes related to public contracts, including PPPs, modeled on the EC proposal for an investment court. Following the commission’s recommendations, such a body could include a permanent roster of arbitrators, with a strict code of conduct prohibiting conflicts of interests.[8]  To create a truly impartial and independent system, it is essential to take dispute resolution out of the hands of self-interested, private arbitrators.

As noted, experience with PPP projects – especially megaprojects – reveals the model to be fraught with problems of accountability, transparency, poor performance, and failure. There are serious reasons to doubt the utility of the model, even in countries that might have the capacity to negotiate, monitor, and enforce PPP contracts. Instead of addressing these problems, the WBG/PPIAF standard contract is fixed on protecting the interests of private investors. That myopic perspective is certain to exacerbate the problems of PPP project waste and failure that are now widely recognized.