The following guidance outlines the key issues that should be considered when managing claims made by a Project Company in relation to a PPP contract.
The Procuring Authority should be equipped to manage claims. It should also have a good understanding of the contract mechanisms applicable to the claim and the fundamental risk allocation agreed between the parties in the PPP contract. When a claim is received, the Procuring Authority should act quickly to first assess the merits of the claim and, if the claim has merit, the likely implications of approving the claim (including the financial implications).
How project risks are allocated between the parties is normally carefully developed, negotiated and agreed in the PPP contract, and this allocation should be maintained. Identifying the underlying cause of the claim will allow the Procuring Authority to assess its merit. To be able to properly assess claims, the Procuring Authority should be aware of the circumstances in which the Project Company is entitled to make a claim under the PPP contract (or under the applicable law) so that claims can quickly be assessed on their merit. Some examples of when the Project Company may be entitled to make a claim are detailed in Subsection 3.5.1 (Background).
It is also worth considering the role of the Project Company’s key contractors, from whom many of the Project Company’s claims will likely originate.
The merits of a claim may be encompassed within complex legal documentation. Claims may also be subject to relevant threshold requirements (such as that only material claims can be made) or there may be caps in terms of a maximum amount payable with respect to a claim. These legal boundaries, thresholds and caps also need to be considered. It is important that legal advice is sought at an early stage with respect to claims where the risk allocation is not clear to the contract management team. For example, challenges can arise when the Project Company makes a claim regarding a shared risk or in circumstances where the relevant risk allocation is understood differently by the parties.
The likely consequences of approving the relevant claim should be assessed. This will include an assessment of the financial and timing consequences of approving the claim, including any mitigation measures that can be taken to minimise the cost or time implications. Steps proposed to be undertaken by the Project Company to mitigate delays and costs to the project should be well understood and documented prior to approving a claim. Relevant technical and financial specialists will need to be involved in this process.
The assessment of a claim will be substantially dependent upon the level of information available. It is common for contracts to specify a minimum level of information to be provided by the Project Company when making claims. However, more information may be required. In addition to using its own records, the Procuring Authority should be aware of the rights it typically has under a PPP contract to request more information from the Project Company, or indirectly from the Project Company's contractors. Even if no such obligation exists, it is difficult for the Project Company to argue that the Procuring Authority should not be given access to additional information.
In practice, even where the merit and quantum of a claim is relatively clear, that does not mean that the resolution of the matter will always be straightforward, as many other factors may come into play such as the balance of power between the parties and the existence of other claims and objectives.
The assessment of the claim and its consequences should consider the availability of any relevant insurance either held by the Procuring Authority, by the Project Company or by a third party. If a claim involves a risk that is covered by an insurance policy, the insurers should be involved in the process as early as possible.
Claims should only progress if the risk was allocated to the Procuring Authority under the PPP contract to ensure the allocation of risk agreed between the parties is not altered.
A thorough understanding of the PPP contract is essential for mitigating the risk of claims and preparing for their receipt where a claim may be inevitable. For this reason, it is common for the Procuring Authority to establish a risk register which should provide a continuous assessment of the relevant risks in terms of their likelihood, severity and potential mitigation measures available.
The risk register should be revisited on a regular basis throughout the life of the project as the risk environment will likely change given the long timeframes involved. This involves assessing and reassessing on an ongoing basis both the likelihood and severity of impact should a risk materialise and assessing whether there are any actions that the Procuring Authority can take to prevent or mitigate those risks, given any new information that has been made available.
Monitoring project risks will mean the Procuring Authority is aware of potential claims and can start considering them and planning for them before they are received from the Project Company.
The Procuring Authority should consider the implications of changes in technology over the contract duration. For example, what happens when certain lifecycle items become obsolete due to technology changes or changes to services due to technological advancement? Changes in law can also affect the risk profile of a project. It is unusual for changes in law to happen overnight, perhaps with the exception of international sanctions. Where the prospect of a change in law or technology change appears reasonably likely, it is sensible for the Procuring Authority and the Project Company to discuss in advance how those changes will be addressed.
A key consideration that specifically related to scope changes is the potential impact that a scope change will have on the risk allocation agreed between the parties. This is of particular relevance where the scope change is significant and the terms of the PPP contract are required to be amended. Renegotiation is detailed in Chapter 4 (Renegotiation). As noted above, the allocation of project risks between parties is normally carefully developed, negotiated and agreed in the PPP contract and this allocation should be maintained through any scope changes.
Given the long-term nature of PPP contracts, it is not uncommon that there will be a need for a scope change at some stage. This can arise through changing priorities of the Procuring Authority, advancements in technology, required design enhancements or through broader economic changes in the country or region (including changes in demand). Scope changes can also occur as the result of inadequacies in the original scope or due to an opportunity to optimise design or construction works or services (such as costs savings available due to changed market conditions for steel or concrete).
Typically, each party has the right to initiate a scope change request, and an agreed scope change procedure typically prescribes the step-by-step arrangements for managing the requested scope changes and associated timelines for the parties to submit proposals and provide approvals. It is also not uncommon for the Procuring Authority to have the right to instruct an immediate minor scope change with pricing and time to be agreed at a later stage. The specific procedure will depend on the PPP contract and the underlying legal framework and should be well known to the Procuring Authority.
Where the Project Company has initiated a scope change request, the Procuring Authority will need to carefully analyse the Project Company’s rationale for the proposed scope change and all the implications of the Project Company’s request, including whether the evidence submitted to document the cost, time and risk implications is valid and robust and satisfies value for money tests.
Where the Procuring Authority has initiated a scope change, the Procuring Authority should have undertaken an initial assessment and have an understanding of the scope of the proposed change, its cost and time implications, and the overall impact on the risk profile, before the scope change request is passed to the Project Company.
Irrespective of whether a scope change is initiated by the Procuring Authority or the Project Company, a full assessment of its impacts will need to be undertaken by the Procuring Authority. There will generally be a cost and/or time impacts (although not always, and such cost/time implications may be positive for the Procuring Authority in cases where the scope is reduced). There may also be an overall impact on the risk profile. This impact assessment should be completed before any negotiation over the terms of the scope change begins and should include evaluations of the financial, technical, contractual and program implications of any scope change.
Any potential scope change assessment should consider in full the implications on: scope of works; cost implications; allocation of risk; impacts on the existing risk profile; changes to the existing capital expenditure; operational expenditure and lifecycle budgets; time implications; impacts on the payment mechanism and performance standards; impacts on the existing security packages (e.g. performance bonds and guarantees) provided by the Project Company, liability caps; and any potential impact on the value for money of the project.
Any added value that could be generated for the project as a result of a potential scope change should also be explored.
To assist its assessment, the Procuring Authority may be able to implement a form of benchmarking or market testing to ensure it is still receiving value for money for the changed scope. This is typically not a simple process, particularly given that alternative contractors are likely to charge a premium for taking on a project delivered by another contractor, and given that the intervention of another contractor may adversely affect the warranties and indemnities provided by the Project Company. In some jurisdictions, a schedule of rates will be included in the contract for certain scope changes, which can also be used in assessing scope changes.
Example – use of benchmarking
On the Central Berkshire Waste project in the UK some waste and haulage services were subject to benchmarking. The contractor would compare its costs with the market price of equivalent services. The price would then be adjusted accordingly, unless the Procuring Authority chose to proceed to market testing, which is effectively re-tendering of the contractor’s scope. Any subsequent increase or decrease in the cost of the works or service would then be reflected by an adjustment to the unitary payment available to the Project Company. While benchmarking may be carried out by the Project Company, it is essentially a joint exercise, as the Procuring Authority must be satisfied that it is receiving value for money. A team comprising representatives from both parties can be set up to oversee this type of benchmarking exercise.
For more information, see the Central Berkshire Waste Case Study
The allocation of risk associated with a material scope change can also be the subject of prolonged commercial negotiations and the Procuring Authority may need to hire external advisors for significant or complex scope changes. Questions over what constitutes a change and what falls within the scope of the Project Company’s pre-existing obligations also have the potential to lead to disagreements.
The Procuring Authority should have full visibility on its procedural obligations with respect to claims and scope changes and the timelines for performing these obligations as agreed in the PPP contract. When a claim is received by the Procuring Authority it is important to be aware of the agreed procedures to ensure compliance.
The Procuring Authority should also be clear which activities are on the critical path and which are conditions precedent for other major activities as the timelines will typically be integrated into the Project Company’s program. Failure to respond to claims according to the agreed procedures may render the Procuring Authority in breach of the PPP contract and liable for additional claims. This is particularly the case where there are deeming provisions (where a claim may be deemed to be accepted when no response has been received from the Procuring Authority within a defined time).
It is advisable for Procuring Authorities to establish efficient internal procedures to ensure that claims are processed in a timely manner as required by the PPP contract. In many instances, template documentation can be prepared to assist with the initial stages of responding to common claims, which can be created with the assistance of legal advice.
The research indicates that it is not uncommon for scope change procedures to be overlooked or not followed properly. This can result in significant problems, including increased tension in the relationship with the Project Company and increased risk of disagreements in the absence of a clear process.
Notwithstanding the need to follow the procedures set out in the PPP contract, there are times when these procedures may turn out to be unworkable, in particular where time periods to generate information, review and respond may be impracticable. For example, in a situation where additional external resources need to be mobilised to assess matters. In these circumstances the risk of increased tension between the parties is also higher. A solution to this issue is for the parties to formally waive their strict contractual requirements and to agree to a less formal and more workable processes. Waiving rights under a contract should only be undertaken after receiving legal advice, to ensure an appropriate waiver is effected (i.e. that the Procuring Authority is waiving only what it is intending to waive and not waiving the Project Company’s obligations to comply with the relevant procedure in the future). An amendment to the PPP contract may also be appropriate. Renegotiation is detailed in Chapter 4 (Renegotiation).
One option for dealing with scope changes which can smooth their implementation is to carry out a ‘soft’ opening. A soft opening involves issuing a scope change notice informally, allowing the change to be considered a number of weeks in advance of issuing a formal notice. Care needs to be taken to avoid inadvertently triggering the formal scope change mechanism. Unless express contractual provisions exist permitting a ‘soft’ opening, legal advice should be sought in relation to this process.
Examples – taking a flexible approach to variations
The Central Berkshire Waste project in the UK introduced a system whereby one party submits an informal notice of change one month before the formal notice is issued. This gives each party the opportunity to review and adapt to its implementation before it is formalised.
On the InterCity Express Programme project, also in the UK, challenges from associated infrastructure works meant that the Procuring Authority had to take a flexible approach to dealing with variations.
For more information, see the Central Berkshire Waste and InterCity Express Programme Case Studies.
Once the Procuring Authority has assessed the merits of a claim and it has satisfied itself that the claim has merits, it should aim to accept the claim as quickly as possible. Whenever possible, the relationship between the parties should not be affected by a drawn-out claim, nor should the parties spend unnecessary amounts of money in disagreement or dispute about a claim that should be accepted by the Procuring Authority. Management of disputes is detailed in Chapter 5 (Disputes).
The management of scope changes needs to be undertaken efficiently to minimise adverse impacts on the project while at the same time preserving value for money. It is important to classify scope changes and develop a framework to ensure minor changes can be dealt with efficiently while significant changes (e.g. addition of a new airport runway) undergo a robust review to ensure value for money.
Where the parties cannot agree to the merits of a claim or the consequences (including compensation payable or additional time) the parties should work together to come to a solution.
Example – Working in partnership to avoid disputes
The Brabo I Light Rail project in Belgium was connected to the wider network of Antwerp, resulting in increased usage and maintenance requirements of some sections of the project. The Project Company and Procuring Authority worked together to estimate the additional costs, avoiding any disagreements.
For more information, see the Brabo I Light Rail Case Study
It is also important that the Procuring Authority understands the impact that cash flow risk may have on the Project Company’s or its contractor’s behaviour in dealing with claims. From a Project Company’s perspective, there is a strong preference for having claims assessed as quickly as possible, even at the risk that only part of its claim is successful. Conversely, where a claims process is delayed (and particularly where similar claims continue to be made and not assessed) the Project Company may become entrenched in its position. This highlights the importance of dealing with claims and opening a direct line of communication as quickly as possible. Project Company cash flow risks are detailed in Chapter 6 (Insolvency), which details guidance on the financial status of Project Companies prior to insolvency.
Having effective governance structures in place to process and approve claims quickly will be key. Guidance on governance is detailed in Section 2.1 (Contract management team set-up) and Section 3.2 (Performance monitoring) (with respect to other government stakeholders that are not the Procuring Authority, such as a ministry of finance or equivalent government agency).
The Procuring Authority should work with other government agencies to mitigate against the occurrence of a MAGA event, as detailed in Subsection 3.5.1 (Background). This will require closely managing relationships with other government agencies.
There can also be a threshold value for scope changes which the Procuring Authority can implement without seeking approval from the relevant authority in the government. For example, in the Philippines that threshold is 10% of the total capital value. For any scope changes below the threshold value, the Procuring Authority is required to report the scope change to the financing authority but no approval is required from the financing authority. Approval is required for any scope changes above the threshold. Other jurisdictions may define a material scope change which requires approval from the relevant ministry of finance or equivalent agency.
Managing relationships with other government agencies is one of the topics detailed in Section 3.3 (Stakeholder management).
The procurement regulations and other applicable laws of a particular jurisdiction may also impact on what the Procuring Authority can do in terms of providing additional funding to compensate for a claim made by the Project Company. For example, the concept of ‘state aid’ in the EU restricts what a public sector body can provide to a private organisation such as a Project Company and this has to be assessed carefully.
Where the settlement of a claim or approval of a scope change requires additional funding, securing the budget for implementing the scope change should be considered at an early stage of the process. An inability to settle a claim quickly can mean that the claim inadvertently progresses to a dispute. This risk should be mitigated by properly communicating with and working other relevant government agencies, including a ministry of finance or equivalent agency.
The Procuring Authority should aim to limit the introduction of too many scope changes soon after financial close, as this might affect value for money forecast at financial close and alter the risk allocation agreed in the PPP contract. For example, such actions may be symptomatic of shortcomings in the design, such as its incompleteness.
The key issue associated with significant scope changes is that it is no longer obvious that the Project Company offers the most cost-effective solution for the scope change in the absence of competition. This is because the scope change may be being processed through what is an agreement negotiated bilaterally between the parties, without competition, and the project’s value for money becomes less clear. Some jurisdictions require a freeze on design changes made after financial close for an initial duration.
Minor changes during the course of operations are considered normal, as they may entail little or no costs cost but can capture changes in circumstances during the contract’s lifecycle.
Significant claims and scope changes are of key concern to project lenders and the Project Company’s loan documents will likely contain restrictions on what scope changes are permitted and when lender consent is required. The threshold for when consent is required is typically low. The lenders want to be involved where there is a significant change to the scope and risk profile of the project, whether or not lenders are required to finance the scope change. Any change to the risk profile agreed at financial close may have an impact on the cash available to pay debt service obligations to the lenders and could lead to a default under the finance documents. The Procuring Authority should be aware of this to ensure it is considering the interests of the lenders in assessing a potential scope change and give the lenders the time required to complete their due diligence and associated assessments, and give their approvals.
Example – Lender approval requirement
There were a range of changes that had to be implemented on the InterCity Express Programme project in the UK and the associated commercial negotiations were complex and time consuming. Lender approval needed to be secured and this led to the extensive use of external advisors. Nevertheless, the parties were able to work collaboratively to overcome these challenges.
For more information, see the Intercity Express Programme Case Study.
It may be difficult to assess how the Procuring Authority should move forward if the lenders ultimately decide that they are not willing to proceed as the new risk profile is outside parameters they are comfortable with and they believe that the Project Company has a legitimate right to reject the proposed scope change. In the case of a major proposed change, this objection may only come at the end of a costly and time-sensitive preparation process. In such circumstances, the Procuring Authority may have limited options. One option would be for the Procuring Authority to agree up front with the Project Company the parameters that the scope change will take and for the Project Company to agree to forgo its right to reject the scope change if it stays within these boundaries. Another possibility might be to undertake it through a seperate contractual process outside of the existing contract regime. A more extreme and less common route is for the Procuring Authority to buy out the debt, on the basis that, after the change is implemented, the Procuring Authority will transfer the debt, once the project has reached a new equilibrium.
View our list of previous questions and answers or submit a question to our PPP Contract Management team.