As described in the European PPP Expertise Centre’s Managing PPPs during their contract life [1], the Procuring Authority should carry out periodic PPP contract reviews. These reviews should aim to identify any changes required by a changing environment (e.g. a change in the Procuring Authority’s requirements) and to assess the Project Company’s overall performance under the PPP contract. For example, this may involve a full technical, financial and legal review taking place every five years, which may lead to a renegotiation being initiated by the Procuring Authority.

Several case studies highlighted the types of opportunities that may arise over the contract period, including increases in demand, availability of new technology and the availability of better financing rates.

Example – opportunities to be assessed

The original plan for expanding the Queen Alia International Airport Expansion project in Jordan had been to execute the project in two stages. Once it became clear that the first stage of expansion would not be sufficient to account for passenger growth, both parties agreed to change the design to allow the expanded terminal to be able to accommodate higher volumes than originally estimated. The incentives for both parties were in alignment, and the changes had a positive impact on the project.

For more information, see the Queen Alia International Airport Expansion Case Study.

[1] Available at www.eib.org/infocentre/publications/all/epec-managing-ppps-during-their-contract-life.htm

For any renegotiation, the starting point should be that the cost implications for the Procuring Authority of renegotiating are less than the financial outcome of doing nothing.

However, the assessment of a proposed renegotiation should be as comprehensive as possible, and should not be limited to the direct consequences of the change. For complex renegotiations, it may be in the interests of the Procuring Authority to carry out a forward-looking audit as well as a review of the relevant contracts. This will help to avoid any unforeseen effects on other contractual provisions that could adversely affect the Procuring Authority’s interests.

The Procuring Authority should distinguish between the realisation of a risk that was allocated to the Project Company, and a genuine change in circumstance that was not contemplated at commercial close. Ideally, the former should not trigger the need for a renegotiation. As a general principle, a renegotiation should not be used to address the following:

• Any event that was foreseeable at financial close
  
  
• Any event that would affect the Project Company in its ordinary course of business (e.g. a general change of law)
  
  
• Materialisation of a risk allocated to the Project Company or invalid assumptions made in its pricing or the scope of work required in relation to those risks
  
  
• Any distress arising directly or indirectly from the performance, action or inaction of the Project Company
  
  
• Any failure by the Project Company to secure financing for the project

Example – European Union environmental requirements

The parties to the Segarra Garrigues Irrigation project in Spain were forced to change the scope and design after the European Court of Justice ruled that it was not meeting its obligations to protect birdlife. These changes were renegotiated in 2013 and 2015 and the changes will mean that less water is available for irrigation once the scheme is fully operational, so a further renegotiation is likely to take place in the future.

For more details see the Segarra Garrigues Case Study.

In practice, it is not uncommon for the events described above to lead to renegotiation, as is detailed in Section 4.3 (Summary data analysis), where causes such as increased construction costs are shown to be common. However, this does not alter the fact that value for money will likely be diminished where these risks – which were priced into the original bid – are not borne by the Project Company.

This type of circumstance may leave the Procuring Authority in a difficult situation when assessing whether to renegotiate the contract. On the one hand, the Procuring Authority needs to ensure that public sector interests are protected, and the Procuring Authority is retaining the value for money forecast at financial close. On the other hand, it has a sometimes-conflicting interest to ensure that the underlying public services continue to be provided.

The Procuring Authority should weigh up not only the risks of agreeing a worse position for itself, but also of agreeing a better position if it is at the expense of the Project Company. It may be a short-term victory if the Procuring Authority ‘wins’ the renegotiation but finds the Project Company becomes insolvent and the project is back on the Procuring Authority’s books to manage.

This decision also requires careful consideration of the costs of alternatives, which should be informed by public sector benchmarking and assessment of market conditions. Benchmarking with respect to scope changes is detailed in Section 3.5 (Claims).

The success of the project may be the main goal of the Procuring Authority and so, if the Project Company proves that the feasibility of the project depends on the revision of the contract, a renegotiation will be more likely to be considered as appropriate. In some examples, changes appear to have been accepted by the Procuring Authority to ensure the project remains viable. However, where changes are accepted to ensure the viability of a project, this might send the wrong signal into the market, in particular, if it changes the risk allocation.

The outcomes of renegotiations in the collected data suggest that several projects were facing financial challenges and that the outcomes were agreed to preserve the public interest in the project.

One option which is perhaps dismissed too lightly is termination, either because the project will fail automatically through insolvency if not renegotiated, or because the Procuring Authority has a right to terminate.

Termination may be seen as a taboo subject, in particular due to the political fallout of such a step and the perception that the Procuring Authority has failed to deliver the outcome it promised, even though, in such a situation, it may be that the contract has done exactly what was intended. In most default termination scenarios, it can be expected that the private sector will have taken a significant financial hit – loss of equity and likely a loss of a material part of the senior debt.

A Procuring Authority should not accept a less favourable outcome than simply terminating the PPP contract and making the termination payment. Termination of the PPP contract is detailed in Chapter 7 (Default and termination).

Example – Project Company difficulties in obtaining finance

The Project Company in one of the case studies in Brazil is facing financial difficulties with lower than expected toll revenue, and challenges in raising the required debt finance. The Procuring Authority is considering extending the period in which investment can be completed, as well as whether to take an alternative approach:

• Terminate the PPP contract and retender the project
  
  
• Replace the equity investors with new equity investors capable of raising the required debt finance
  
  
• Require the existing equity investors to commit additional equity

For more information, see the Brazil Toll Road Case Study.

When faced with a renegotiation, the Procuring Authority should ensure that it has adequate capacity and information to carry out the negotiations. This requires a good understanding of the contractual arrangements, and adequate reporting and measurement systems for tracking the progress of the project.

PPP contracts are complex arrangements and external advisors will typically be needed to make the correct decisions. Engaging external advisors is detailed in Chapter 2 (Contract management team set-up and training). Resourcing and preparation for the renegotiation needs to be on a similar level as the original negotiations in the tender process. The Project Company will often employ specialists, bringing experience from a wide range of projects for these purposes, and the Procuring Authority should aim to match that level of experience.

The Procuring Authority’s analysis should involve a prudent combination of advice: commercial, financial, legal and technical. Each stakeholder or advisor may bring a different perspective to the proposed renegotiation and the Procuring Authority’s position (and confidence to negotiate) will typically improve dramatically when a combined analysis of this nature is carried out.

A key consideration is the potential impact that a renegotiation will have on the risk allocation agreed between the parties at financial close. The allocation of project risks between parties is normally carefully developed, negotiated and agreed in the PPP contract and the aim should be for this allocation to be maintained through any renegotiation, though it may have to be adjusted if there are significant changes. For guidance on typical risk allocation arrangements between the Procuring Authority and the Project Company, see the GI Hub’s PPP Risk Allocation Tool. [1]

This decision also requires a careful cost assessment of the proposed renegotiated solution, which should be informed by public sector benchmarking and assessment of market conditions. Benchmarking with respect to scope changes is detailed in Section 3.5 (Claims). The termination payment can also act as the reference price in a renegotiation.

Renegotiations in PPP contracts that are poorly carried out can be very costly for the Procuring Authority (with adverse impacts on taxpayers), for end users of the services, for other government institutions, or all the above, as they have the potential to drastically change what was agreed to at financial close.

In some jurisdictions, advisors are available at the bidding stage to assist with negotiation (e.g. through a project preparation facility). However, such funds for advisors are typically no longer available when circumstances arise that require a renegotiation. This can cause issues particularly where the Project Company is well resourced for the renegotiation. This is an area where development banks can take a role in particular markets.

[1] Available at http://ppp-risk.gihub.org. 

Renegotiation can increase the chance of a dispute or challenge. This is particularly the case in developing markets with weaker institutional frameworks that lack the following features:

• A defined and transparent process and framework for renegotiation
  
  
• Transparency of the renegotiation process
  
  
• Established guidelines for levels of compensation
  
  
• A transparent framework for conflict resolution in the renegotiation process

The final decision on a renegotiation should be based on full disclosure of long-term costs, risks and potential benefits. The case for a renegotiation should be made explicit and recorded so that the decisions are made in a rational and defensible manner. Evidence should demonstrate that project distress is material and likely to result in default under the PPP contract or other serious adverse implications should it continue. The evidence should demonstrate that the distress is likely to cause adverse outcomes for the public sector and/or users of the service. Information management is detailed in Section 3.4 (Information management).

As renegotiation can have significant financial (direct and contingent) implications for the Procuring Authority, some form of fiscal oversight similar to the one used in the original PPP contract approval mechanism will typically be required. Regulatory frameworks typically separate responsibility for the approval of amendments from the Procuring Authority personnel who manage the renegotiation.

Oversight measures include procurement laws (to address instances where the risk allocation changes significantly and other bidders could have been more successful under the new structure) and state aid laws (to address instances where an unjustified benefit is granted to the Project Company).

Some specific examples of oversight include relevant thresholds on the project capital value, such as regulation in Chile, which prescribes a limit of 20% of approved capital value for renegotiations before Ministry of Finance approval is required; and a similar threshold in South Africa, which requires any ‘material’ amendment to be approved by its National Treasury. The applicable law may also distinguish between renegotiations and scope changes, and provide different thresholds.

There may also be merit in the establishment of independent technical panels capable of assessing the merits of a renegotiation. An independent panel demonstrates government commitment to a structured process that is likely to improve market certainty and reduce opportunistic calls for renegotiation. For example, in the Philippines an Investment Coordination Committee evaluates the monetary implications of major projects.

Though the Project Company will typically be the key party involved in renegotiating with the Procuring Authority, other private partners will also have interests and likely veto rights with respect to material PPP contract amendments. Such parties include lenders and key contractors in certain circumstances. The contractual review to assess a renegotiation should therefore include a review of any relevant direct deeds the Procuring Authority has entered into with the lenders and/or key contractors (such as the construction contractor). For example, where the Project Company is required to incur additional capital expenditure, that expenditure will need to be financed.

It is prudent to assess whether a renegotiation on any particular project may be symptomatic of a sector-wide or industry-wide issue. If any systemic factors can be identified, then a more robust (policy) change should be considered for future PPPs.

It is typical that more complex provisions, particularly in respect of remuneration and compensation, bear a greater likelihood of being the subject of renegotiations. Therefore, it is important that details of these provisions are shared between similarly structured projects and are incorporated into the preparation of new projects.

Similarly, if the risk allocation agreed between the parties at financial close is adjusted as part of a renegotiation, it should be assessed whether that adjustment should be incorporated into the preparation of new projects. For guidance on typical risk allocation arrangements between the Procuring Authority and the Project Company, see the GI Hub’s PPP Risk Allocation Tool. [1]   

Example – Reviews in India and Brazil

PPPs in India were suffering from several systemic challenges, including delays in land acquisition, difficulties in the shifting of utilities and right of way issues, often culminating in disputes. On the private sector side, inadequate due diligence and aggressive bidding led to project failures. As a result, the Indian Finance Ministry appointed a committee to review PPPs with a focus on the assessment of challenges associated with contract renegotiations, the adequacy of risk allocation, contract drafting and institutional capacity. Several recommendations were made for improvement.

Lessons from previous PPP contracts have informed new contracts in the Brazilian electricity sector. The Procuring Authority (the national energy regulator, ANEEL) observed that difficulties in obtaining environmental permits often led to extensive delays and occasional project terminations. Consequently, ANEEL altered the bidding process to introduce a step to assess the feasibility of a proposed project from an environmental perspective, thus reducing the risk of environmental permitting causing delays

[1] Available at http://ppp-risk.gihub.org.