As public infrastructure in the U.S. continues to age, public-private partnerships have become an increasingly popular procurement vehicle for state and local governments. In the right circumstances, a P3 may be a valuable tool to assist the public sector in delivering critical transportation and other public infrastructure projects--perhaps years, if not decades, ahead of schedule.
While early project delivery is attractive to the construction industry, the risk profiles and allocations of a P3 often differ significantly from a traditionally-procured project. Understanding the contractual framework and principal risk items is essential to any construction firm interested in dipping its toe into the P3 waters.
Each P3 procurement is driven by the rules established by the public owner, which vary from project to project. Nonetheless, many involve a similar contractual framework. Included in a typical P3 are three primary, project-specific contracts that are of paramount importance to parties focused on design and construction:
- the P3 or "concession" agreement;
- the design-build contract; and
- the interface agreement.
Through the P3 agreement (between the public owner and the developer's special-purpose project company), the owner "concedes" the project for an extended term to the project company. The developer is responsible for securing all or a portion of the project's financing, generally through a combination of debt and equity. Under the design-build-finance-operate-maintain (DBFOM) model, the project's revenue streams (e.g., tolls, fare box collections or lease payments) are used to service the debt and provide a return on equity.
In a typical P3 procurement involving new construction, the owner first issues to shortlisted proposers a draft RFP (which includes a draft of the P3 agreement). Proposers are then offered an opportunity to submit questions and comments on the terms and risk allocations of the agreement. This is followed by a proprietary one-on-one meeting between the owner and each proposal team. Subsequently, the owner often issues a revised draft of the RFP, followed by an additional round of questions and comments from the proposers and proprietary meetings. Before a final RFP is issued, the owner and proposal teams exchange thoughts on a wide array of risk allocations, including terms relating to project financing, technical issues, and long-term operations and maintenance.
Throughout this process, much attention is paid to terms relating to design and construction. These issues are central to the viability of the project and, obviously, of greatest importance to a proposal team's contractors and designers. The following are a sampling of the issues regularly addressed as part of these exchanges, many of which are not unique to the P3 realm:
- Utility adjustments. Existing utilities (above and below ground) running along roadways, bridge decks, etc. may have to be relocated during project construction to accommodate the new structures. Responsibility for the relocations and interfacing with utility companies is commonly addressed in the P3 agreement, with the public owner often seeking to push a large portion of this risk to the developer.
- Relief events. Relief events are circumstances that entitle the developer to seek additional compensation, a time extension or other relief from the public owner. Relief events typically encompass owner-caused delays and impacts, discovery of unusual geotechnical conditions, and certain changes in law, among others. The P3 agreement should be clear on which events entitle the developer to relief as well as the procedures for submitting and prosecuting a claim.
- Substantial completion (and service availability). The P3 agreement will specify the criteria for the project to achieve substantial completion, making it available for safe, effective and efficient use by the public. Similar terms for final completion are also addressed, along with deadlines for these and other design- and construction-related milestones.
- Defaults, cure periods, and termination. Like other construction agreements, the P3 agreement will contain default and termination provisions. These terms establish the circumstances under which each party may be considered in default, any related cure periods, and termination provisions (including termination for convenience by the owner).
As discussions with the owner progress, a developer will usually engage with its design-builder to craft the terms of their relationship. These negotiations place intense focus on risk allocations, establishing both the central terms of the eventual agreement between these two parties if the team is awarded the P3 agreement, and the basis for developing a design-build price. Often referred to as a drop-down agreement (because the design- and construction-related terms of the P3 agreement largely "drop down" to the design-builder), this agreement involves an entire set of additional risk allocations.
Though investment interest in new public infrastructure includes firms with some ability to manage construction risks (e.g., a development arm of a construction firm), a large segment of P3 equity comes from unaffiliated investors seeking to flow down as much risk as possible to their design-build teammate. While each project and circumstance is different, issues typically negotiated between a developer and design-builder include the following:
- Remedies for non-payment. If the developer fails to make timely or full payments, the design-builder will want to have remedies in place. One example is the design-builder's ability to suspend work. Though this and other remedies may be addressed in the design-build contract, it is important to recognize that the developer's lenders will want to have a say in this, typically through a "direct agreement" between the design-builder and the lenders' agent.
- Submittals, communications with owner, and approvals. In a traditional procurement, the design-builder contracts directly with the public owner. But in a P3, the developer stands between the owner and the design-builder (at least contractually speaking). The developer and design-builder should have a clear understanding with respect to the design-builder's ability to deal with the owner directly, along with the consequences of any delays or procedural missteps by either party.
- Relief events (beyond those included in the P3 agreement). Negotiations tend to focus on time and compensation relief associated with developer-caused events. To the extent the design-builder is afforded relief beyond what is included in the P3 agreement, the risk remains with the developer unless it is able to transfer it to an insurer or some other third party.
- Liquidated damages for delay. Project financing requirements often influence the terms of the design-build contract, and liquidated damages provisions are no exception. Liquidated damages are sometimes applicable to a missed completion deadline on a "no excuses" basis with only narrow (but heavily negotiated) exceptions. The design-builder should have a firm handle on trigger points for any liquidated damages, along with amounts, available time relief and potential impacts on the design-builder's pricing contingencies.
- Responsibilities for achieving project completion. Obviously, much responsibility for completing the project lies with the design-builder. However, to the extent the developer or other contractors are involved in achieving elements of substantial or final completion, the agreement should address each parties' obligations along with the consequences of its failure to deliver.
A developer will usually have a separate drop-down agreement with an operations and maintenance contractor, which, as the name suggests, will operate and maintain the P3 project for the life of the concession. While the design-builder and O&M contractor have distinct roles, the overall team benefits from their cooperation and regular interaction.
With an eye toward minimizing life cycle costs, the O&M contractor will want to have input on design. Additionally, the O&M contractor will need to access the project during the design-build phase, particularly as substantial completion nears. For example, on rail and mass transit projects, the O&M contractor must train its staff and test the system to ensure it can meet the operational standards of the P3 agreement. Similarly, the design-builder will need to enter portions of the completed project (or even close down a portion temporarily) to address punch list and warranty items.
This is where an "interface" agreement--among the developer, design-builder and O&M contractor--comes into play. This agreement typically addresses cooperation in design development, project testing, and overlapping work activities. It also allocates liability for design modifications that place an unanticipated burden on one of the parties.
A public-private partnership may be the right vehicle to advance an infrastructure project on an accelerated basis. But before a construction firm dives too deeply into a P3 pursuit, it should:
- understand the basic contractual structure affecting key design and construction aspects; and
- identify project risks and work to modify terms that are inconsistent with the firm's appetite for risk and its overall strategic objectives.
Originally published by Construction Executive.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.