During a recent visit to Japan, the Finance Minister emphasised that building infrastructure and attracting investments will be the key focus areas for India to emerge as a developed nation in the next 25 years. Public Private Partnership (PPP) projects will form a sizable chunk of these investments. Since 1990, 1168 PPP projects across 11 sectors, such as roads, ports and airports, with an aggregate investment of over USD 295 billion, have achieved financial closure in India. To implement the PPP model, the relevant governmental authority usually enters into model concession agreements with 'concessionaires', which are private participants in PPP projects. Concession agreements are standardized contracts issued by the Government, consisting the terms and conditions governing the projects. While the PPP model has flourished and concession agreements have been upgraded from time to time, some of its most critical aspects continue to face hurdles – such as termination payment.
Termination payment is monetary compensation that the Government is required to pay the concessionaire to cover for the debt provided by banks and financial institutions, if the concession agreement stands terminated, regardless of which party is at fault for such termination. Hypothetically, if a concession agreement for construction of a national highway is terminated, the NHAI would have to make termination payment to the concessionaire, irrespective of whether such termination was a result of default by the concessionaire or by the NHAI.
Courts of law have recognized that termination payments are intended to safeguard the interests of financial institutions which lend money to concessionaires to undertake projects. If not for termination payments, lenders would be reluctant to fund such projects because financing for such projects is non-recourse funding, with the concessionaire usually repaying its debt by utilizing the revenues generated from the project. If the project remains incomplete or is terminated, the concessionaire will have negligible resources to repay its lenders. Tangible assets of the concessionaire, which are charged in favour of lenders, are rarely sufficient to repay the entire debt. In sectors such as roads or ports, the project land itself, being property of the Government, cannot be sold off by the lenders to recover their dues. Failure to recover these mammoth sums of money would in turn deplete public funds, causing stress on the financial ecosystem. Thus, security and certainty of receiving termination payment makes PPP projects bankable despite the non-recourse nature of such fundings.
However, having undergone the test of time, it appears that such security and certainty itself has come into question. A demand for termination payment is usually disputed by governmental authorities, on account of challenges to the termination of the project itself, invariably resulting in arbitration and litigation. The delay not only hampers the re-development of the project, but also leaves the concessionaire and the lenders empty-handed for years, with the interest-meter of lenders ticking for inordinate periods.
In an attempt to smoothen the termination payment process, the Committee of Public Undertakings (2022-23) has recently suggested in a report to the Parliament that the onus of making termination payments in the road sector should be outsourced to insurance companies. In this arrangement, the NHAI will subscribe to an insurance premium, and in an event of termination, the insurer will directly make the termination payment to the concessionaire. The suggestion may address the delays (being the primary concern of the lenders) by automation of these payments without any subjectivity. Additionally, this would also minimize claims of conflict of interest arising because of the NHAI's authority to terminate projects while also being empowered to release termination payments to concessionaires on account of such termination. However, implementing this in practise will pose several challenges.
With no similar insurance product currently in the market, insurance companies will have to be sufficiently incentivized to undertake such high-liability insurance. A recent example of NHAI making termination payment related to the Khed-Sinnar Expressway, where the NHAI was reported to have paid over Rs. 891 Crore to the concessionaire. Outside the road sector, the Delhi Metro Rail Corporation is presently meddled in a dispute involving a claim of over Rs. 8000 Crores as termination payment. Moreover, this will entail huge premiums to be paid by NHAI, which will eventually be factored in the project cost, making it less viable commercially. While it perhaps does not have the same tenets, learnings from India's first-ever surety bond insurance, introduced by Bajaj Allianz and recently announced by the MoRTH, may come handy in addressing some of these issues.
It is also important to consider that in certain road projects, the amount of termination payment is required to be calculated based on project costs provided by the concessionaire, which is generally higher than the NHAI's estimated project costs. A CAG report from last year highlighted that NHAI calculates termination payment based on its own estimates and does not undertake a thorough review of the concessionaire's project cost, which is not the correct method to arrive at termination payment. Variance in calculation may continue to be grounds for dispute, which will not be resolved by merely involving a third-party insurer. It will also be important to have an automatic trigger for termination payment by the insurer within the maximum time allowed under the concession agreement, as want of express approval before release of each payment may lead all stakeholders back to square one.
Another suggestion to consider is introducing a tripartite arrangement among the NHAI, the concessionaire and the lender. The lender is not a party to the concession agreement, leaving it with no privity of contract with NHAI. While it is hoped that a tripartite arrangement will help protect lender interests, this is not the first time a tripartite arrangement has been proposed in PPP projects. Model tripartite agreements have previously been issued to allow infrastructure debt funds to refinance road projects (and also port projects), with lukewarm success in terms of the intended outcome. However, the present suggestion is intended for the primary lenders and for the nascent stages of the project.
The proposed tripartite agreement must ensure that lenders have recourse for termination payment directly against the NHAI, as ambiguity on this front may leave room for disputes. A neutral dispute resolution mechanism, which is arguably amiss in concession agreements, should also be included. While this tripartite agreement should not conflict with the concession agreement, a careful examination of each aspect is necessary to ensure that the mechanism also achieves its objective of protecting lender interests and public money.
An extensive assessment of these suggestions is crucial to assess their applicability in other PPP sectors. In a nutshell, the attempt to address concerns around termination payments while praiseworthy and much needed, requires careful consideration of the core issues, without which it will remain a half-baked solution.
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.
