[Public Risk]
In a rehabilitation project, there may be no requirement for other land to be available apart from the site to be rehabilitated. However, this will depend on the scope of the project.

Although other land may not be required, the Contracting Authority will be typically be required to grant the Private Partner all land rights it requires to implement the project and to facilitate access to the distribution network, and so will need to ensure that it has these rights in order to grant them. (See Access to the site and associated infrastructure below.) 

If other land is identified as being needed, the Contracting Authority may bear the risk of acquiring the required land interests for the project, whether through compulsory acquisition/expropriation or other powers, because it has powers to do so which the Private Partner does not. It is also in the Contracting Authority’s interest because on expiry of the contract the asset will typically revert to public ownership and operation (and/or the contract will be subsequently re-tendered). The Contracting Authority is generally responsible for providing a “clean” accessible site, with no restrictive land title issues. See also Access to the site and associated infrastructure under Land availability, access and site risk.

[Circumstance Dependent Risk]
During the feasibility stage (see PPP Project Preparation and Delivery in the Introduction), the Contracting Authority should undertake detailed assessments as regards ownership of the relevant land and ensure that it has a complete understanding of the risks involved in acquiring/accessing the site and those that will affect the rehabilitation and operation of the distribution system. This includes assessing how much of the distribution network infrastructure is undergrounded and the associated risks. Such information should be disclosed to bidders as part of the bidding process. This includes consideration of matters such as rights of way, covenants affecting use or disposal and historic encroachment issues that may encumber the land, as well as how the Contracting Authority is addressing such issues and the extent to which bidders are required to price certain risks. Reinstatement requirements must also be considered. To the extent the Private Partner has relied on information provided and priced any such risks, it will share in those risks provided that the information relied on was accurate. Some Contracting Authorities will guarantee only correctness of data provided, not completeness or interpretation.

If the Contracting Authority needs to use its legislative powers to acquire land for any part of the site (e.g. through compulsory acquisition/expropriation), this may increase social risk and other opposition to the project (e.g. due to delay caused by court cases). See also Social risk.

Market Comparison Summary

In certain markets, land rights (in particular reliable utilities records, and land charges and third party rights to (access) land) may be less clear than in other markets where established land registries and utility records exist and risks can be mitigated with appropriate due diligence. Where reliable information is not available, this will increase the risk of delay, cost increases and disputes. This makes it more likely that the Contracting Authority will need to bear the associated risk as the Private Partner will not be able to bear them.

The rights of private landowners against compulsory acquisition/expropriation might be stronger in developed markets, so the Contracting Authority may need to allow more time to acquire any new land.

Rights to cross third party land may be required in order to access the existing pipe network.

Acquisition pre-signature: To the extent any land is needed as part of the rehabilitation project, the Contracting Authority should complete the process of land acquisition before the contract is awarded so that all issues and risks are known and managed. All relevant processes will need to be carried out in a timely manner. The timeframe will depend on the issues affecting the site and the applicable processes. The risk that all necessary processes have been satisfied will be the Contracting Authority’s risk.

Acquisition post-signature: If the Contracting Authority is not able to provide the land by contract award, it will bear the risk of providing it in accordance with a contractually agreed programme. Failure to obtain the land by a certain date may entitle the Private Partner to terminate the contract (see also MAGA risk).

Identification pre-signature: [Public risk]
If a permanent need for additional land is identified and agreed by the parties before contract signature then the associated risk is usually treated in the same way as the original land. Usually the Contracting Authority will bear the risk of acquiring/providing the additional land, unless the need for additional land is specific to a bidder (for example, due to a different design).

Identification post-signature: [Private risk]
If a permanent need for additional land is only identified after contract signature then this will be a Private Partner risk as the need should have been identified and factored in to the Private Partner’s bid. The Contracting Authority may however find it needs to provide assistance with acquisition where the land is essential, with costs being borne by the Private Partner.

Identification pre-signature: [Circumstance Dependent Risk]
Where temporary additional land needs (e.g. for materials or equipment storage during rehabilitation works) are identified in the procurement phase and are common to all bidders, then the associated risk is usually treated in the same way as the original land. Usually the Contracting Authority will bear the risk of acquiring/providing such land, unless the need for such land is specific to a bidder (for example, due to its construction methods and equipment) - in which case the risk should be allocated to that bidder and the cost factored into its bid price.

The Contracting Authority may however find it needs to provide assistance in some cases, with the cost being borne by the Private Partner.

Identification post-signature: [Private risk]
Where temporary additional land needs (e.g. for materials or equipment storage during rehabilitation) are identified, they should be a Private Partner risk as such need should have been identified and factored into the Private Partner’s bid. The Contracting Authority may however find it needs to provide assistance in some cases, with the cost being borne by the Private Partner.

Land rights issues involving indigenous groups will be the responsibility of the Contracting Authority. The Private Partner will bear the risk of complying with legislation and contractual obligations imposed on it in this regard.

The Private Partner’s obligations with regard to indigenous rights is well legislated for in some markets. In the absence of legislation, indigenous land rights issues and community engagement can be managed by the Contracting Authority through the adoption of internationally recognised social and environmental standards and practices for the project (e.g. compatible with the Equator Principles). This will be particularly relevant if international financing options are desirable. 

See also Social risk.

Market Comparison Summary

This issue is coming under increasing focus from multilateral agencies and other finance parties, as well as   civil society and human rights organisations. For example, the World Bank’s commitment to sustainable development is set out in its Environmental and Social Framework which includes standards that both it and its borrowers must meet in projects it is to finance. Many finance parties (including commercial finance parties) adhere to the Equator Principles, committing to ensure the projects they finance (and advise on) are developed in a manner that is both socially responsible and reflects sound environmental management practices (as described in the Equator Principles).

Examples of specific legislation are native title legislation in Australia and the equivalent First Nations law in Canada. These include a requirement to seek consent from the indigenous parties affected and to enter into indigenous land use agreements.

See Resettlement under Social risk.

General: [Shared Risk]
The risk that the land is not suitable is typically shared as the Contracting Authority may provide access to the existing network and be able to secure the availability of any new distribution areas, but the suitability of the allocated access may be dependent on the Private Partner’s design and rehabilitation plan. This will apply to both underground and overground suitability, to the extent the network is (or is planned to be) above or below ground. See also Design risk.

Underground: [Circumstance Dependent Risk]
In projects where most of the existing network is underground, data may be available.  However, if no or unreliable data is available and the risk cannot be transferred (or transferring the risk does not represent value for money), risk with regard to stability and suitability of the underground may sit with the Contracting Authority.  To the extent reliable data is available in the tender phase and can be relied upon by the Private Partner, the risk sits with the Private Partner. The importance of this risk may depend on the extent to which the Contracting Authority’s specification and Private Partner’s solution requires extension of the network into new areas. See also Site condition under Land availability, access and site risk.

Pre-signature: [Public Risk]
In most projects, there will be a benefit if planning consent for key permits and other key approvals can be obtained by the Contracting Authority before procurement – these may include key environmental consents. As the water distribution network already exists, fewer consents may be necessary than for a new build project. This will depend on the scope of the rehabilitation and consents to access the system to be rehabilitated may be required.

Post-signature: [Circumstance Dependent Risk]
If consents for key permits are not obtained before contract signature and the Contracting Authority wants to sign the contract, it will typically bear the risk of the consents being delayed or not obtained (subject to the Private Partner complying with any reasonable requirements) – this may be treated as a compensation event. Failure by the Contracting Authority to obtain the consents by a certain date is likely to entitle the Private Partner to terminate the contract. Permit risk may be complicated further if there are different levels of authorities involved, and interaction between levels of design and authorisations may impact the timeline. If the risk of non-availability is too great, this may deter some investors and financiers from engaging in or continuing in the bid process. See also MAGA risk, Design risk and Environmental risk.

Market Comparison Summary

Some markets (particularly regulated markets) may require certain licences and consents to be obtained, in order to rehabilitate and operate a water distribution system (e.g. in relation to water supply, construction and operation of the system and environmental permits).

In some jurisdictions, it may not be possible to obtain the requisite planning consents until such time as the Private Partner has been identified and/or detailed design is known.

Obtaining subsequent detailed planning consent and other approvals will be a Private Partner risk. However, the Contracting Authority will share this risk to the extent the relevant authority does not act properly or within approval process deadlines - this may be treated as a compensation event. See also Environmental risk and MAGA risk.

Obtaining access to relevant parts of the distribution network to carry out rehabilitation works may be difficult and costly depending where it is located – for example, if it is under or crosses other infrastructure (such as a road or other utility pipes) or under or across private property.

The Contracting Authority will typically be required to grant the Private Partner all land rights it requires to implement the project. Failure to provide access may be treated as a compensation event. See also MAGA risk.

The Private Partner will be responsible for assessing the adequacy of the land rights granted (including any associated easements and access rights in relation to third party land). The Contracting Authority will then be responsible for ensuring the Private Party has these rights, whether by way of legislation/statutory powers or through contract.

If the risk of non-availability of land access is too great, this may deter some investors and financiers from engaging in or continuing in the bid process.

Market Comparison Summary

Third party rights to (access) land may not be easily identifiable in some jurisdictions, increasing risk of delay, cost increases and disputes. This makes it more likely that the Contracting Authority will need to bear the associated risks.

Construction phase/operation phase: Risk allocation with respect to site security will depend on the political climate, opposition to the project, nature of the risk and the stage of the project. Parties should aim to have a complete understanding of the risks involved in physically securing the site and those that will affect the rehabilitation and operation of the distribution system.

Ordinarily the Private Partner will be responsible for day to day site security. However, the Contracting Authority may need to use statutory means to properly secure the site for the Private Partner (such as police involvement or eviction) and in some circumstances may be required to provide additional site security / assistance during operations to manage this risk. Failure may be treated as a compensation or MAGA event. See also Force majeure risk, MAGA risk, Social risk and Vandalism under Construction risk and Operating risk.

Market Comparison Summary

For example, where there is public opposition to the distribution system (for example, on environmental grounds), there may be protestor action, or there may be issues safeguarding the equipment and installation.

Costs or delays caused by relocation of /access to utilities: [Private Risk]
To the extent reliable data is available and shared during the tender process, the Private Partner can bear and price the corresponding risk of any costs or delays caused by statutory undertakers and utility providers in carrying out diversions or relocations. Costs and delays caused by re-location or diversion of existing utilities which are due to the Private Partner’s design or construction plan are usually allocated to the Private Partner. For connections to existing infrastructure, see Project management and interface with other works/facilities under Construction risk.

[Circumstance Dependent Risk]
The Contracting Authority will bear risk if no reliable information is available. It will also bear risk to the extent data provided by it and relied upon by the Private Partner in its bid proves inaccurate.

Lack of data on existing utilities location can make it difficult for the Private Partner to assess (and price) the cost and time needed for relocation which can impact on the rehabilitation timetable and ultimately on meeting relevant operation commencement dates. If the Private Partner bears this risk, the Contracting Authority may need to share the risk by capping the Private Partner’s liability or by having a cost sharing mechanism.     

Where existing utilities will remain in place at or in the vicinity of the site, the Private Party may be required (or wish) to enter into crossing agreements or proximity agreements with the owners of the relevant utilities

MARKET COMPARISON SUMMARY

In some markets or challenging locations, there may be little data on location of utilities (sewage, oil, gas, optical fibre etc) and the Private Partner may be unable to accept all or part of this risk.

Costs or delays caused by utility provider: [Circumstance Dependent Risk]
Costs and delays caused by a utility provider could arise in both phases and the risk will be allocated according to the relevant circumstances, market and ownership of the utility. The risk could be shared or allocated to the Contracting Authority.

MARKET COMPARISON SUMMARY

In markets where the utility provider is a private entity, this risk is likely to be treated as a relief event (and the utility company will bear the risk) - this is common in mature markets. In less mature markets, particularly where the utility provider is a state-owned entity, the risk is likely to be allocated to the Contracting Authority as a compensation or MAGA event.

Surveyed: [Circumstance Dependent Risk]
The Contracting Authority usually undertakes detailed geotechnical and ground/soil surveys during the feasibility stage (if not already publicly available) and discloses such information as part of the bidding process. Sharing the surveys will save bidders’ costs (all which would otherwise feed through to the Contacting Authority in the contract price). To the extent reliable data is available and shared during the tender process, the Private Partner can bear and price the corresponding risk of such conditions causing cost and delay.

The Contracting Authority will bear risk to the extent data provided by it and relied upon by the Private Partner in its bid proves inaccurate. Some Contracting Authorities will guarantee only accuracy, not completeness or interpretation of the data.

MARKET COMPARISON SUMMARY

In a mature market, the Contracting Authority normally hands over the site to the Private Partner in an “as-is” condition on the basis of the surveys provided. The Private Partner can rely on the surveys but otherwise bears the risk.

In some markets, the bidders carry out the surveys during the tender process – this may be the best solution in some circumstances, but may also limit competition unless bidders are compensated for these costs.

Unsurveyed: [Circumstance Dependent Risk]
Where it is not possible to fully survey site condition prior to award (e.g. in high density urban areas or underground), the risk for unsurveyable land will be allocated to the Contracting Authority (e.g. as a compensation event). The risk may be shared by the Private Partner (e.g. as a relief event) in some circumstances, for example where the risks were within the knowledge of the Private Partner when it priced its bid or an experienced contractor would have considered their existence as being possible. The impact on the project and the cost of remediation works for certain existing site conditions can be significant so the ultimate risk allocation will depend on the project specifics.

MARKET COMPARISON SUMMARY

In some markets there may be less historic data available to the parties to assess risk. It may however be easier to perform comprehensive surveys in a less urban area.

Cultural / Archaeological finds: [Circumstance Dependent Risk]
Discovery of artefacts can cause delays and costs as there may be legal or other requirements in relation to reporting them and permitting archaeological study. The risk allocation will depend on the nature of the project, the extent to which the risk was known to and priced by the Private Partner, the reliability of data provided by the Contracting Authority and whether the project location is considered high risk. One approach is to share the risk such that the Private Partner bears the risk in respect of designated areas (such as a low risk area) and the Contracting Authority bears the risk outside such areas (such as a high risk area). Another approach is for the Private Partner to be obliged to coordinate work, but for the Contracting Authority to appoint specialised contractors and to bear cost/delay and interface risk.

MARKET COMPARISON SUMMARY

In markets where reasonable surveys/assessment can be made and the risk priced, discovery of finds is often treated as a relief event.

Unexploded bombs, land mines and other munitions: [Circumstance Dependent Risk]
Discovery of munitions can cause delays and costs as they will need to be defused and removed. The risk allocation will depend on the nature of the project, the extent to which the risk was known to and priced by the Private Partner, the reliability of data provided by the Contracting Authority and whether the project location is considered high risk.

MARKET COMPARISON SUMMARY

In markets where reasonable surveys/assessment can be made and the risk priced, discovery of munitions risk is often treated as a relief event. In some countries, the risk of unexploded land mines can be high and specific surveying and cost provisions may need to be agreed.

Pre-existing environmental pollution: [Circumstance Dependent Risk]
Pre-existing pollution is typically the Contracting Authority’s risk except to the extent it was known to and priced by the Private Partner. The impact of rehabilitating the water distribution system on communities must be carefully assessed and managed by the parties as contamination of a water distribution system will affect the morbidity and mortality rates of users.

Remediation works for certain existing environmental conditions can be expensive so the ultimate risk allocation will depend on the project specifics and the surveys provided to the Private Partner. Existing environmental conditions which cannot be adequately catered for or priced may to be retained by the Contracting Authority.

See also Environmental risk and Change in law risk.

Where the project is to rehabilitate existing assets, where practical, they should be fully surveyed (and potentially warranted) by the Contracting Authority. To the extent reliable data relating to the condition of existing assets is shared by the Contracting Authority during the tender process and can be relied upon during implementation, the Private Partner can price the risk of using them, including the interface with other aspects of the project and latent defect risks. The Private Partner will then bear the corresponding risk. The Contracting Authority will bear risk to the extent such data proves inaccurate or insufficient, and to the extent of any warranties it provides. Some Contracting Authorities will guarantee only accuracy, not completeness or interpretation. This is a key risk in a water distribution rehabilitation project as the condition of the system to be rehabilitated may be challenging for the Private Partner to fully assess and price. There may need to be a mechanism for the Contracting Authority to support rehabilitation and maintenance costs to a certain level if the project is likely to be financially unviable for the Private Partner otherwise.

See also Suitability of design under Design risk, Project management and interface with other works/facilities under Construction risk and Maintenance standards under Operating risk.

Market Comparison Summary

Some water projects have proved financially unviable for the private sector due to the state of disrepair and high maintenance costs of the existing distribution network.

[Public Risk] [Shared Risk]
Ultimately, the policy relating to the social impact of the provision of infrastructure is for the government. The Contracting Authority will bear this risk except to the extent the Private Partner is responsible for implementing any social management measures.

During the feasibility stage, the Contracting Authority should have considered the impact on habitat, (social) infrastructure and communities generally, as well as on adjacent properties and industries - both in terms of the rehabilitation and ongoing operation and maintenance of the distribution system. It may need to carry out social impact studies and aim to minimise any negative impact of the project. Contamination of a water distribution system will affect the morbidity and mortality rates of users, and increases to water bills may cause social unrest so operational and social risks are closely related.

Private sector involvement in the delivery of water can face strong public resistance where there is a perception that water should be provided by the public sector and tariffs not necessarily charged or enforced. Consultation may reduce the risk of opposition if outcomes are incorporated in the strategy and tender requirements. The approach, compensation schemes and what is acceptable should be addressed in the bid requirements and the contract. Investors and lenders may expect to see a plan addressing social impact, including the execution of any necessary contractual arrangements.

Where the distribution system is to be underground, the social/environmental impact can be lessened by requiring the Private Partner to reinstate the environment above the pipeline once completed and to allow reuse of the affected land to the extent possible and safe (e.g. for grazing or nomadic use).

All the way through construction and operations, active stakeholder engagement by the Contracting Authority will be critical to avoid litigation, achieve key milestones on time and ensure it is delivering infrastructure that serves its public purpose. Both the Private Partner and the Contracting Authority should develop sound environmental and social risk management plans before construction begins. Depending on the nature of the project, the Contracting Authority may need to retain the risk of unavoidable interference with affected parties and mitigate this through measures such as relocation (see also Resettlement under Social risk) and continued efforts to manage the social and political impact of the project on and around the site (possibly including a compensation regime for affected businesses adjacent to the distribution system (or new pump stations) and/or including social infrastructure development in the project, e.g. extending the water system to nearby villages).

[Circumstance Dependent Risk]
The Private Partner will bear the risk of non-compliance with any contractual social risk obligations as well as social risk obligations set out in the underlying legal system, although even where social risk obligations are passed onto the Private Partner, the consequences of such risks occurring may come back to the Contracting Authority. For this reason, the Contracting Authority should critically analyse just what social risk obligations should be passed onto the Private Partner and what should be retained.

Where there is public opposition, there may be protestor action in both construction and operating phases, and/or issues safeguarding the site equipment and installation. See also Site security and Access to the site under Land availability, access and site risk, and Vandalism under Construction risk and Operating risk.

The Contracting Authority may choose to adopt internationally recognised social and environmental standards and practices for the project to manage social risk, especially if international financing options are desirable.

For a detailed analysis on how governments can better address aspects related to social inclusion in the delivery of infrastructure, see the GI Hub’s practical guidance on Inclusive Infrastructure and Social Equity.

Market Comparison Summary

This issue is coming under increasing focus from multilateral agencies, development finance institutions and other international finance parties, as well as civil society and human rights organisations. Finance parties (including commercial finance parties) will look very closely at how these risks are managed at both private and public sector level.

Many finance parties adhere to the Equator Principles, committing to ensure the projects they finance (and advise on) are developed in a manner that is both socially responsible and reflects sound environmental management practices (as described in the Equator Principles). The World Bank’s commitment to sustainable development is set out in its Environmental and Social Framework which includes standards that both it and its borrowers must meet in projects it is to finance.

In civil law jurisdictions the obligation upon the Contracting Authority to act “in the general interest” and to justify and document decisions may strengthen the stakeholder process. This is because the level of transparency and justification required should ensure that stakeholder views are properly taken into account and the risk of arbitrary decisions (and consequent challenges) reduced.

[Public Risk]
Depending on the nature of the project, the Contracting Authority may need to retain the risk of unavoidable interference with affected parties and mitigate this through measures such as relocation, although this may be mitigated by specific siting of the infrastructure. This may include the removal of formal and/or informal housing or businesses and resettlement of communities in another location, potentially also with compensation. In a rehabilitation project, this may be less of a risk but will depend on the scope of the project and whether the existing site has become used/occupied for other purposes prior to rehabilitation.

[Circumstance Dependent Risk]
The Private Partner is responsible for implementing any social risk management measures contractually agreed - these should be clearly specified by the Contracting Authority in the procurement phase to enable the Private Partner to price the cost and associated risks.

As with land use rights involving indigenous groups, any other social impact risks involving such groups will usually be the responsibility of the Contracting Authority but the Private Partner will bear the risk of complying with relevant legislation and contractual obligations.

In the absence of legislation, indigenous rights issues and community engagement may be managed by the Contracting Authority through the adoption of internationally recognised social and environmental standards and practices for the project, particularly if international financing options are desirable. See also Heritage/indigenous land rights under Land availability, access and site risk.

Market Comparison Summary

The Private Partner’s obligations with regards to indigenous rights is well legislated for in some markets and in other markets there may be more reliance on internationally recognised standards. See also Heritage/indigenous land rights under Land availability, access and site risk.

The Private Partner assumes the risk of labour disputes and strike action adversely affecting the project except to the extent such action falls into the category of political risk – the Contracting Authority may bear the risk (if a MAGA event) or share the risk (as a force majeure or relief event) for strikes and other widespread events of labour unrest. For example, nationwide and sector strikes are usually Contracting Authority risks, but strikes at the Private Partner’s facilities will be a Private Partner risk. See also Force majeure risk and MAGA risk.

Market Comparison Summary

In less politically stable jurisdictions the Contracting Authority may have to accept more risk for strikes than in some jurisdictions. In markets where the risk of strikes is low, the Private Partner may be comfortable accepting this risk as a relief event.

See Site condition and Existing asset condition under Land availability, access and site risk.

Pre-signature: In most projects, there will be a benefit if planning consent for key permits and other key approvals can be obtained by the Contracting Authority before procurement - these may include key environmental consents

In many major projects, the environmental authorisations are a key component of the project and may take significant time to be prepared and approved. In some cases, these authorisations are initiated (such as preparing the environmental impact assessment) and prepared by the Contracting Authority ahead of the procurement process. At a specified point in time, the Private Partner will take over the risks related to obtaining detailed environmental licences or permits related to the project. Responsibility for obtaining any permits related to works or work method usually sits with the Private Partner.

Post-signature: Except as specifically identified otherwise, the Private Partner typically bears the risk of obtaining all environmental licences, detailed permits and environmental authorisations required for the project after contract signature. However, the Contracting Authority will share this risk to the extent the relevant authority does not act properly or within approval process deadlines - this may be treated as a compensation event or MAGA event. See also MAGA risk.

In some countries, there may be different levels of governmental approval required. Local authorities may interpret certain requirements in their own way after the contract price has been submitted and impose unexpected conditions on the Private Partner. This could adversely affect the project’s financial model. The parties should ensure that the contract sets out clearly how any such interpretation or unexpected requirement is addressed to avoid disputes as to which party bears the consequences. See also Key Planning Consents under Land availability, access and site risk, Change in law risk and Compliance with environmental consents and laws under Environmental risk.

Market Comparison Summary

Environmental scrutiny is increasing around the world. The Contracting Authority and the Private Partner must develop sound environmental and social risk management plans before construction begins. 

The risk of delay in obtaining approvals may be greater in some jurisdictions, particularly where different levels of government are involved. Delays in obtaining environmental permits have caused significant construction delays in some sectors (for example, in some projects in South America) and the timeframe required should not be underestimated. If adequate relief is not given to the Private Partner, this may deter the private sector from participating in new projects in the same sector or jurisdiction.

International finance parties, multilateral agencies and development finance institutions are particularly sensitive about environmental and social risks. Many finance parties adhere to the Equator Principles, committing to ensure the projects they finance (and advise on) are developed in a manner that is both socially responsible and reflects sound environmental management practices (which are described in the Equator Principles).

Finance parties will look very closely at how these risks are managed at both private and public sector level and this scrutiny is helpful to mitigate the risks posed by these issues. See also Communities and businesses under Social risk.

The Private Partner bears the risk of complying with all environmental licences, detailed permits and environmental authorisations required for the project as well as applicable environmental laws.

The parties should ensure that change in law provisions adequately address changes in (mandatory) environmental standards and laws to avoid disputes as to which party bears the consequences of any requirements imposed after contract signature. See also Change in law risk.

In the absence of legislation, environmental obligations can be managed by the Contracting Authority through the adoption of internationally recognised standards and practices for the project, particularly if international financing options are desirable. See also Communities and businesses under Social risk.

The Private Partner bears the risk of environmental events caused by the project to the extent due to its failure to comply with applicable licences, laws and contractual obligations. This includes conditions affecting both the project itself and third parties. Water leakage from distribution pipes is a particular risk in water distribution projects, with consequent risk of contamination of the water being distributed.

The Contracting Authority may want to satisfy itself as to the overall robustness and suitability of environmental plans proposed by the Private Partner, to ensure that such plans will be adequate to appropriately manage the risks of the project, but the Contracting Authority should not take on any risk in doing so.

Outside both parties’ responsibility: [Shared Risk]
The risk of environmental events external to the project occurring which adversely affect the project (or, as a result, third parties) should be treated according to the nature and cause. They may be a form of shared risk, such as a relief event or force majeure event (e.g. if an earthquake damages key elements of the distribution network so that it cannot operate for a period).

Within Contracting Authority’s responsibility: [Public Risk]
Within Contracting Authority’s responsibility: If environmental events are within the responsibility of the Contracting Authority or government they may be treated as a compensation event or MAGA event if they damage the distribution system (or a new substation) or lead to legal action against the project by third parties). See also MAGA risk and Climate change event under Environmental risk.

Market practice is developing with greater focus on events caused by climate change and the Contracting Authority should consider the risk and impact of climate risk events on the infrastructure (both one-off external weather events and more gradual effects, such as rising sea levels or temperatures and droughts). Water supply in a water distribution project is likely to be a particularly sensitive issue due to unpredictable weather patterns and drought. It may be appropriate to treat certain events as force majeure events if they occur beyond certain thresholds (e.g. temperatures outside certain ranges). Design resilience is also an important mitigating factor, for example, for projects with seasonal weather such as monsoon or where earthquakes are common.

An alternative may be to consider a separate contractual mechanism to address these types of risks over the long term life of the contract. As with other variations required by the Contracting Authority, any changes to the project scope to mitigate climate change effects are likely to need to be funded by the Contracting Authority where the Private Partner cannot foresee such developments and has no means of passing on the cost (and no other agreement as to cost sharing is in place). As it is likely to be more costly to retrofit measures, it is essential that the Contracting Authority consider this risk during the feasibility phase, and that both parties continue to consider this issue further during the tender process. The scope for passing on costs through user tariff increases will depend on the project circumstances.

See also Force majeure risk and Operational risk.

Market Comparison Summary

If clear requirements are not included, this may lead to different bidders taking this risk into account in different ways. To avoid speculation and disputes, post-contract award, these issues should be clearly set out in the tender documents and negotiated throughout the tender process.

Generally the Contracting Authority should aim to transfer design risk to the Private Partner but the extent to which this is possible will depend on how involved the Contracting Authority wants or needs to be in specifying design requirements in the tender documentation. Alternative approaches are described below.

Output specification: [Private Risk]
Where possible, the Contracting Authority usually aims to set a broad output driven specification in the tender documents, requiring the Private Partner to design and rehabilitate the project in a way which satisfies the performance specifications and ensures compliance with applicable legal requirements, good industry practice standards and, where applicable, minimum quality standards.  This allows for private sector innovation and efficiency gains in the design. With this approach, the Private Partner will have principal responsibility for adequacy of the design of the system and its compliance with the output / performance specification. A design review process during the contract will allow for increased dialogue and cooperation between the Contracting Authority and the Private Partner, but defined design standards (which may be statutorily imposed) may render such a process less important than on other projects care should be taken to ensure that the mutual review process does not reduce or limit the Private Partner’s overall liability.

In limiting how prescriptive it is in the performance specification, the Contracting Authority may wish to request a degree of cooperation and feedback during the bidding phase to ensure that the bidding consortia’s expectations in terms of an appropriate risk allocation for design responsibility are taken into account when finalizing the performance specification. If the Contracting Authority provides bidders with a basic design, bidders will typically be responsible for any errors, if they assume this basic design in developing their detailed design. An alternative is to provide (more) detailed design, but to contractually oblige the bidders to comment on and subsequently accept the (amended) design.

[Circumstance Dependent Risk]
The Contracting Authority should bear the risk of technical information provided by it proving inaccurate to the extent the Private Partner was allowed to rely on it for design purposes (e.g. inaccurate site condition or existing asset surveys).

See also Changes to design under Design risk.

Prescriptive specification: [Public Risk]
A prescriptive specification can ensure the Contracting Authority receives bids on a particular (and similar) basis. However, the disadvantage of this approach is that it will restrict private sector innovation and efficiency gains in the design and may not result in best value for money. The Contracting Authority may also retain some design risk in certain aspects of the system or related works, if it is more prescriptive in the performance specification. For example, if the performance specification is too prescriptive, the Private Partner’s ability to warrant the fitness for purpose of its design solution may be impacted and the Contracting Authority will to that extent share in the design risk. The prescriptiveness of the performance specification is likely to be dependent on the depth of the feasibility study.

Some jurisdictions allow only limited room for individual design, since all key aspects and many details are already fixed in the official planning approval decision. If the Private Partner wants to deviate from these requirements it must conduct formal amendment procedures, which in practice have such process and risk impact that bidders are not willing to take the risk that comes with initiating such amendment procedures. See also Changes to design under Design risk.

MARKET COMPARISON SUMMARY

In more developed PPP markets, the Contracting Authority typically drafts a broad output specification, unless permit or other regulatory requirements oblige it to provide more detailed and descriptive specifications.

Projects in some less established PPP markets may be particularly dependent on availability of reliable resources necessary for construction and operation, which has implications for the Private Partner’s ability to meet the reliability requirements in the performance specification and take full design risk.

The quality of the information provided by the Contracting Authority and the Private Partner’s limited ability to verify such data can hinder the Private Partner’s ability to unconditionally take full design risk in some markets. Attempts to transfer the risk in such circumstances may also lead the Private Partner to price in expensive risk premiums that do not represent value for money for the Contracting Authority.

Existing infrastructure: [Circumstance Dependent Risk]
As the project involves an existing water distribution system, the Private Partner’s ability to warrant the fitness for purpose of its design solution must be considered – it may not be able to warrant defects in the existing infrastructure which may impact the project’s performance and the Contracting Authority may have to bear this risk.

The Contracting Authority will retain the design risk to the extent that the design is dependent on interconnections for which the Contracting Authority retains responsibility, such as the raw water supply connection points and raw water quantity and quality, and on the stated condition of the existing assets.

The Private Partner will bear the risk of obtaining design approvals as it will have principal responsibility for preparing the detailed design and obtaining relevant approvals from the appropriate state or other body. However, if the Private Partner has complied with all relevant conditions and time frames, the Contracting Authority will share this risk to the extent the relevant authority does not act properly or within approval process deadlines - this may be treated as a compensation event. See also MAGA risk.

Where specific solutions or consultants are imposed by the Contracting Authority (e.g. technical), some risk may remain with the Contracting Authority.

The risk of changes to design after contract signature is allocated according to the reason for the change. If the original design is deficient, this will be a Private Partner risk, subject to the aspects which are the Contracting Authority’s risk (as outlined in Approval of designs and Suitability of design under Design risk). If changes are required by the Contracting Authority, this would as a rule be a Contracting Authority risk (with the consequent time and cost implications borne by the Contracting Authority on the same principles as for compensation events). See also Variations risk.

Contractual amendment procedures can in practice have such process and risk impact that the Private Partner may not be willing to take the risk that comes with initiating such amendment procedures.

Requesting design changes or alternative or more detailed design development during the procurement stage will delay the procurement timetable and cause bidders to incur additional costs. The lack of certainty and potential cost may deter bidders and, depending on the change in requirements, may result in the procurement process needing to be re-run to comply with procurement laws or risk later challenge.

Construction cost increases (i.e. costs exceeding the rehabilitation costs assumed in the project’s financial model as at financial close) can have a variety of causes, such as mistakes in rehabilitation cost estimates, increased cost of materials, actions of the Contracting Authority or government, variations, as well as delays in – or mitigating potential delays in – the rehabilitation programme. In a rehabilitation project, the discovery of existing assets being in a worse state of repair than anticipated can significantly increase costs.

The Private Partner typically assumes the risk of cost increases to the extent these are not caused by force majeure, compensation events (such as in relation to unsurveyed site or existing asset conditions) or MAGA events, and are not addressed through other bespoke provisions (e.g. Contracting Authority variations, Change in law or provisions specifically addressing exchange rate risk during construction - see also Variations risk, Change in law risk and Exchange rate fluctuation risk under Financial markets risk) or hardship doctrines (see Glossary definition) in underlying law. The Private Partner will mitigate the risks it bears by passing them through as far as possible to its sub-contractors (for example, the construction sub-contractor) and in a concession model there may be scope for passing on some of the cost via an increased tariff (although the ability to do this may be limited). The Private Partner’s financial model will typically include contingency pricing for cost overruns (as will the sub-contractor’s assumptions). See also Force majeure risk and MAGA risk.

Market Comparison Summary

In certain markets, risk is considered manageable by the Private Partner through robust pass through of obligations to credible and experienced sub-contractors and by allowing appropriate timetable and budget contingency. The Private Partner can mitigate the risk of sub-contractor non-performance by obtaining appropriate security from the sub-contractors (for example, parent company guarantees and/or performance bonds). The Contracting Authority may sometimes seek additional security itself to ensure such costs can be met - see Taking performance security under Public Sector Risk Mitigation.

Enforcement of construction budgets may be easier in markets where the Private Partner will typically have more experience and reliable access to resources.

Where projects involve large elements of undergrounding, this element of construction risk will be more carefully assessed by the Private Partner.

Delays in delivering the rehabilitated infrastructure by the relevant works completion date as at financial close can have a variety of causes, such as unavailability of construction materials, delays in shipping, variations and mistakes in programme scheduling, as well as weather events, civil unrest or industrial action and actions of the Contracting Authority or government.

The Private Partner typically assumes the risk of delays to the extent they are not caused by relief, force majeure, compensation or MAGA events, and are not addressed through other bespoke provisions (e.g. in respect of Contracting Authority variations or change in law). See also Force majeure risk, MAGA risk, Variations risk and Change in law risk.

Given the nature of an existing water distribution network, it is likely that the Private Partner will be operating the asset at the same time as carrying out its rehabilitation programme. Rehabilitation works will be programmed to ensure critical components are completed in a timely way and if there are significant components of the project that need to be completed or areas to be rehabilitated, the Contracting Authority may want to tie the Private Partner to particular milestone dates or a particular programming schedule.

Works will need to be evidenced as complete and water distribution projects require detailed commissioning and testing regimes to ensure that the system meets the output, water quality, efficiency and environmental requirements set under the contract and applicable legislation. To the extent the system has been suspended during the rehabilitation works (or for example where there have been contamination issues that have had to be remedied under the rehabilitation project), the Private Partner will be expected to demonstrate readiness for connection with the water supply and that the relevant parts of the water distribution network meet the minimum performance levels before being permitted to enter into operation.

The consequences for the Private Partner of delays to the relevant works programme/completion dates are loss of expected revenue (from the Contracting Authority or users, as applicable to the project model) which is due to start from the relevant date and ongoing rehabilitation and financing costs. In extreme cases, there is also a risk of potential termination for failing to meet the “longstop date” (a final later date by which the Private Partner must complete the project works/commence operation to avoid the Contracting Authority being entitled to terminate).

The Private Partner will pass through the risks it bears as far as possible to its sub-contractors (and may require the sub-contractors to pay it agreed damages to compensate for the delay to and loss of its overall project income and act as an incentive for timely completion).

The Contracting Authority may also consider imposing agreed delay damages on the Private Partner to compensate it for delay to the start of the operating phase. However, imposing such agreed damages will typically result in the Private Partner building additional contingency time and cost into the project’s rehabilitation plan and the Private Partner should already be sufficiently incentivised to meet the relevant works completion date on time so that its revenue streams can commence.   

Some jurisdictions require certain criteria to be met in contractual provisions imposing delay damages if they are to be legally enforceable. Broadly speaking, if the damages exceed the Contracting Authority’s likely real losses they may be seen instead as a disproportionate penalty and the provisions may be unenforceable.

Market Comparison Summary

Enforcement of construction deadlines may be easier in markets where the Private Partner will typically have more experience and reliable access to resources.

Some projects in less mature markets have faced significant construction issues and the Contracting Authority will need to be prepared to enforce its rights to manage the consequences of a failure by the Private Partner to meet the construction milestones.

In less mature markets, the management of completion risk in some sectors is typically addressed by having either: (i) a scheduled completion date (with attached agreed damages for delay) followed by a fixed period for operation; or (ii) a scheduled construction period forming part of the overall contract term which is itself fixed, subject to extensions for certain events such as force majeure. With the latter scenario, the Contracting Authority may attempt to additionally impose agreed delay damages on the Private Partner. The difference between the two structures is that the former preserves the project’s revenue generating operation phase and the Contracting Authority relies on the agreed delay damages to incentivise timely completion of the works and operation commencement. In the latter case, the incentive to complete the works and meet the scheduled operation commencement date is that any delay at the Private Partner’s risk will reduce the revenue-generating operating phase. This approach would need to be adapted to factor in the likely concurrent operation and rehabilitation programme in a water distribution rehabilitation project.

Project management: [Private Risk]
Typically, the Private Partner assumes project management risk. The Private Partner is best placed to integrate the complex rehabilitation works, water supply connection and ongoing and long-term operation and maintenance of the project to ensure reliable service. This may be managed through a single project joint venture / consortium or by the Private Partner managing a series of works, supply and operation/commissioning contracts. The Private Partner will be expected to demonstrate the distribution system’s readiness for connection with the water supply before distribution re-commences (to the extent it has been suspended during the rehabilitation works).

Interface with other works/facilities: [Circumstance Dependent Risk]
Interdependence with other projects may also affect contract obligations and risk allocation. If some or all of the project is dependent either on the Contracting Authority carrying out particular works or making available an existing facility, or on related infrastructure work being completed by a third party, that interface risk will be the Contracting Authority’s risk. If the operation commencement date will be delayed due to such works not being carried out on time or the Contracting Authority otherwise failing to meet its obligations, this will be a compensation event or MAGA event. For example, the project may be relying on the Contracting Authority procuring new water treatment plants or upgraded connections to the water supply or pump stations. See also MAGA risk.

If additional interconnection facilities are required for the project (such as new water supply or upgraded connections to the water supply or pump stations), construction of these additional facilities may also be included within the Private Partner’s scope of responsibility, transferring the risk of delays and cost increases in the construction to the Private Partner.  Ownership and responsibility for operation and maintenance of these additional facilities may be transferred to the Contracting Authority on completion of construction and commissioning, subject to the Private Partner’s defect rectification obligations during the prescribed warranty period.

See also Utilities and installations, Suitability of design under Design risk, Maintenance standards under Operating risk, Demand risk and MAGA risk.

Market Comparison Summary

In some markets the Private Partner may be allocated the risk of third party work being properly and timely completed, particularly if the Private Partner has the opportunity to enter into interface arrangements with the third party. These interface agreements will result in the interface risk being shared between the Private Partner and the third party.

Meeting relevant quality standards will be a Private Partner risk, but where standards or codes are revised after the bid submission date this risk allocation will depend on whether the changes are mandatory and whether the Private Partner has priced the risk of such changes into its bid. The Contracting Authority may consider increasing the contract price to account for increased costs of compliance or the Private Partner may be excused from compliance with the new standard if it is not mandatory. This may be dealt with through the change in law provisions. See also Change in law risk.

Responsibility for health and safety compliance on the construction site is typically a Private Partner responsibility. The Private Partner typically bears the risk of complying with health and safety laws/requirements and indemnifies the Contracting Authority in respect of any breach of such requirements. Subject to applicable law, the Private Partner’s liability may be mitigated to the extent the health and safety incident was caused or contributed to by the Contracting Authority or other government entity and/or the affected party.

Some projects require an annual safety review which enables the parties to assess relevant performance and safety management. Otherwise, the engagement of an experienced contractor with a strong safety record is also a mitigant.

Market Comparison Summary

In some jurisdictions with developed construction legislation, the Private Partner’s responsibilities in the construction phase will be set out in law with strict liability for certain incidents. There may be specific bodies which will sanction it for breaches of applicable health and safety legal obligations. A breach of applicable health and safety obligations may give rise to criminal liability for one or both parties (and/or their personnel), including the risk of fines.

Except where arising due to a breach or fault by the Contracting Authority, the Private Partner will usually bear the risk of personal injury, death and property damage to either the Contracting Authority (and its employees and other personnel) or third parties arising due to the rehabilitation works. The Private Partner will usually indemnify the Contracting Authority against any liabilities it incurs as a result of such personal injury, death and property damage.

The Private Partner should take out appropriate insurance to cover its potential liabilities, but typically the Contracting Authority will set certain minimum requirements under the PPP contract (see also Unavailability of insurance under Financial markets risk).

Market Comparison Summary

In certain jurisdictions, it may be appropriate for the Contracting Authority to bear certain risks relating to what are ultimately state responsibilities or other factors outside of the Private Partner’s control, for example a failure or lack of intervention by emergency services.

In allocating this risk, it should be borne in mind that in many jurisdictions by law it is not possible to exclude (or cap) a party’s liability in respect of death and personal injury.

The Private Partner should be required to design and rehabilitate the project in accordance with good industry practice, and bears the risk and responsibility for completing the project free of defects. Defects are typically categorised as (i) visible and (ii) latent/hidden defects and are treated differently under the contract. The risk of visible defects is sometimes covered by an interim acceptance at completion of the works (and may result in a one off payment of agreed damages). As latent defects may not be noticeable for some years, the Private Partner is typically liable for such defects for a number of years following completion and the Contracting Authority may request a performance bond from the Private Partner to support this obligation (which the Private Partner will require from the relevant construction sub-contractor).

The Contracting Authority may retain latent defects risk in existing structures. See also Existing asset condition under Land availability, access and site risk and Maintenance standards under Operating risk.

Market Comparison Summary

Defects liability periods and responsibilities vary between legal systems and jurisdictions and may be set contractually or in some cases by law. Market practice also varies between sectors. Some jurisdictions impose strict liability for defects and may compulsorily require corresponding insurance. In the Middle East, for example, decennial liability may apply as a matter of law for ten years from completion of certain (commonly civil) works.

The Private Partner takes the risk of obtaining all relevant licences for the rehabilitation and operation of the distribution system and for intellectual property infringement except to the extent that the Contracting Authority imposes certain design or other technology solutions on the Private Partner, in which case the corresponding risk may be shared or borne by the Contracting Authority.

The Private Partner must ensure that all required licences are able to be transferred to the Contracting Authority (or its nominee) at the end of the contract to enable it to continue rehabilitation and/or operation/maintenance.

See Industrial action under Social Risk.

Vandalism is not typically a risk in water distribution projects but maybe a Private Partner risk, sometimes with a threshold/cap above which the Contracting Authority will bear/ share the risk. This will depend on the nature of the risk and the extent to which the Private Partner can effectively have an impact on/mitigate risk, design choice, use of materials, site access and security during rehabilitation, etc. See also Site Security under Land availability, access and site risk and Social risk.

Market Comparison Summary

Vandalism may be more of a risk in certain political climates and malicious damage may be a concern depending also on the location and accessibility of the system.

Contracting Authority change: [Public Risk]
The Contracting Authority typically bears the risk and cost of variations implemented following its request. The contract will specify the extent to which it is entitled to require changes and the reasonable grounds on which the Private Partner may refuse. The Contracting Authority will also bear the risk of ensuring it can meet its cost liabilities.

Private Partner change: [Circumstance Dependent Risk]
The Private Partner will bear the risk and cost of variations implemented following its request, unless the parties have agreed a sharing mechanic as part of their discussions of the change. A sharing mechanic may be appropriate where the Contracting Authority wants to incentivise the Private Partner to introduce innovative or environmentally-friendly solutions.

If the Contracting Authority is liable for costs, it should mitigate its risk by requiring a transparent costing review process, which it can due diligence. This is likely to be particularly a concern during the construction phase. As with any potential liabilities under the PPP contract, the Contracting Authority will want to consider how best it can fund such payments, e.g. through financing the variation directly itself, requiring the Private Partner to procure committed but undrawn funding at financial close or to establish a reserve to fund future variations, each of which will come at a cost and may affect value for money, or requiring the Private Partner to procure financing at the time of implementation of the variation.  Where financing is procured by the Private Partner, whether at financial close or at the time of implementation, the Private Partner’s revenues will need to be adjusted to fund repayment of the financing. The risk and cost associated with changes arising due to other provisions will be addressed according to those provisions.

See also Changes to design under Design risk, Cost increases and Works completion delays under Construction Risk, Increased operating costs and affected performance under Operating risk, Climate change event under Environmental risk, Disruptive technology risk and Change in law risk.

Market Comparison Summary

Some jurisdictions have detailed change protocol templates to follow for variations to ensure that costing is fair and transparent.

Due to the impact changes can have on rehabilitation or operation (e.g. in terms of timing, cost and delivery), there may be restrictions placed on the ability to request changes of certain types or in certain phases. The Contracting Authority’s ability to request and meet any changes costs will also be a concern, particularly where it has a weak credit.

Some contracts may contain a variation clause to provide for both parties to propose variations to the minimum functional specification, in particular where this may deliver public health and water efficiency benefits.

Increased costs and delays in the operating phase can have a variety of causes, ranging from mistakes in maintenance cost estimates or variations to extreme weather events. Aside from adjustments for inflation, the Private Partner broadly assumes the risk of events which inhibit performance and/or give rise to cost increases beyond modelled costs, to the extent these are not relief, force majeure, compensation or MAGA events, and are not addressed through other bespoke provisions (e.g. in respect of Contracting Authority variations or changes in law) or hardship doctrines (see Glossary definition) in underlying law. See also Variations risk, Change in law risk, Force majeure risk and MAGA risk.

[Private Risk]
The Private Partner bears the risk of meeting the performance specification under the contract (i.e. by ensuring that the works and the operational performance of the water distribution network are of the necessary quality and level and that it is ready to take and distribute water when required). In an availability based payment structure the Private Partner’s payment may be subject to abatement if availability criteria and performance-based standards are not met. For example, availability criteria may be linked to the system being able to distribute certain water quality, flow and volume measured against pre-determined schedules or standards. Performance monitoring also enables the Contracting Authority to monitor service levels generally and potentially to receive early warning of matters requiring improvement or remediation.

[Public Risk]
Where certain availability criteria (or performance indicators) cannot be met due to actions by the Contracting Authority (or other government entities) or unforeseen circumstances, the Private Partner may be entitled to relief (e.g. if caused by a relief, force majeure, MAGA or compensation event). For example, if civil unrest damages the distribution system this may be a MAGA event. The Contracting Authority will generally retain the risk associated with outages (and related maintenance) caused by other water network infrastructure which interconnects with the distribution system. See also Force majeure risk and MAGA risk.

The Contracting Authority is responsible for enforcing the performance regime and for ensuring that the performance specifications are attainable and properly tailored to what the Private Partner can deliver based on relevant market data and policy objectives and domestic and international water standards. The appropriateness of the metrics can be assessed by reference to standards of similar services provided by the Contracting Authority (or other government body), value for money, the nature of the project and the relevant markets.

In the concession model, poor performance by the Private Partner may adversely affect revenues and may similarly be penalised under the concession terms. The Private Partner may be entitled to compensation to the extent this is the fault of the Contracting Authority. See also Demand risk.

Market Comparison Summary

In mature markets, the Contracting Authority should have access to various data sources to develop realistic and attainable performance specifications and models. 

For other markets, particularly in the case of market first projects, the preparation of attainable standards by the Contracting Authority is complicated by the lack of relevant market data. The Contracting Authority should set standards which are achievable in the relevant market, taking into account, for example, applicable driving and vehicle maintenance standards. These may vary across different markets.

In less mature markets, the Private Partner may require the Contracting Authority to reduce the performance requirements during the settling in period and possibly readjust the performance metrics once the performance of the distribution system has stabilized. This can mitigate the risk of long-term performance failure.

In the concession model where the end user pays a tariff for the water it consumes, the Private Partner is likely to be limited in its ability to pass through any costs to the end consumer due to the fixing of water tariffs in the contract or through regulation.

The main input or resource required for a water distribution project is water. This is usually within the ownership or control of the Contracting Authority and, accordingly, it generally bears principle responsibility for the quantity and quality of the water supplied at the delivery point. Water supply is likely to be a particularly sensitive issue in some jurisdictions due to unpredictable weather patterns and drought and may also be an issue where the Contracting Authority has not implemented reliable access to water supply resources/infrastructure.

The other main input or resource required for a water distribution network is power for pumping. The Contracting Authority typically bears the principle responsibility to ensure an uninterrupted supply of power to the facility. The price of the power is often a pass-through cost.  The Private Partner will generally bear the risk of all other resources to operate the project, such as labour supply.

The Private Partner may be incentivised to increase efficiencies in energy consumption throughout the term by a mechanism to share the savings.

Where the Contracting Authority is unable to meet its contracted thresholds for the quantity and/or quality of water, or is unable to secure the supply of the resources it is responsible for (such as a continuous energy supply), this may be treated as a relief or compensation event (or MAGA event).

The Private Partner bears the principal risk and responsibility of ensuring an uninterrupted supply of other resources for the project (such as maintenance equipment and materials) and to manage the costs of those resources. It will need to consider this when structuring its supply arrangements.

In some markets, there may be specific instances where resource risk needs to be shared (e.g. in relation to reliance on local source materials) where resources may be affected by labour disputes, embargos or other political risks. These may be treated as relief, force majeure, compensation or MAGA events. See also Force majeure risk and MAGA risk.

Market Comparison Summary

Certain markets are generally more susceptible to market volatility and major cost variations.

Mature markets generally do not experience market volatility to the extent of less mature markets, and resource availability is less of a concern.

The Private Partner takes the risk of obtaining all relevant licences for the rehabilitation and operation of the distribution system and for intellectual property infringement except to the extent that the Contracting Authority imposes certain design or other technology solutions on the Private Partner, in which case the corresponding risk may be shared or borne by the Contracting Authority. 

The Private Partner must ensure that all required licences are able to be transferred to the Contracting Authority (or its nominee) at the end of the contract to enable it to continue rehabilitation and/or operation/maintenance.

The risk allocation for health and safety will, in part, depend upon operating responsibility for the asset. The Private Partner will typically bear this risk in respect of its operational responsibility, as well as in respect of maintenance/repair works and other health and safety aspects related to its project responsibilities. Subject to applicable law, the Private Partner’s liability may be mitigated to the extent the health and safety incident was caused or contributed to by the Contracting Authority and/or a third party. See also Liability for death, personal injury, property damage and third party liability. 

Market Comparison Summary

In some jurisdictions with developed construction and working practices legislation, certain of the Private Partner’s responsibilities will be set out in law with strict liability for certain incidents. There may be specific bodies which will sanction it for breaches of applicable health and safety legal obligations, for example, in relation to maintenance work being carried out in the operating phase. A breach of applicable health and safety obligations may give rise to criminal liability for one or both parties (and/or their personnel), including the risk of fines.

The risk allocation for these liabilities will depend upon operating responsibility for the asset. Except where arising due to a breach or fault by the Contracting Authority, the Private Partner will usually bear the risk of personal injury, death and property damage to either the Contracting Authority (and its employees and other personnel) or third parties arising out of the Private Partner’s activities under the contract. The Private Partner will usually indemnify the Contracting Authority against any liabilities it incurs as a result of such personal injury, death and property damage. For example, water leakage damage due to defective pipes is a main third party liability risk, as well as water contamination.

The Private Partner should take out appropriate insurance to cover its potential liabilities and typically the Contracting Authority will set certain minimum insurance requirements under the PPP contract (see also Unavailability of insurance under Financial markets risk). See also Liability for death, personal injury, property damage and third party liability under Construction risk.

Market Comparison Summary

In certain jurisdictions, it may be appropriate for the Contracting Authority to bear certain risks relating to what are ultimately state responsibilities or other factors outside of the Private Partner’s control, for example a failure or lack of intervention by emergency services.

In allocating this risk, it should be borne in mind that in many jurisdictions by law it is not possible to exclude (or cap) a party’s liability in respect of death and personal injury.

[Private  Risk]
The Private Partner will bear the principal risk of meeting the appropriate standards regarding maintenance as set out in the contractual performance specification, so that the water distribution network remains available and robust and is handed back in the expected condition on early termination or expiry of the agreement. In the availability model this will mean ensuring that the network also meets the contractual levels of quality, availability and volume of output required to achieve a full availability payment. This includes day-to-day routine maintenance as well as lifecycle maintenance, replacement of particular assets. Failure to maintain the distribution system as required to meet the availability criteria under the PPP contract will lead to the Private Partner earning lower availability payments under the PPP contract. The PPP contract may also contain additional incentive mechanisms through which failures to maintain the distribution system in accordance with the performance specification may lead to payment deductions. Material and/or prolonged failure to maintain the distribution system would be a breach of the PPP contract potentially entitling the Contracting Authority to terminate the PPP contract.

In the concession model, poor maintenance by the Private Partner may adversely affect revenues, for example, if the network suffers leakages and cannot deliver water to end users. The Private Partner may also be penalised under the concession terms for maintenance failures and the resulting handback condition of the assets. See also Condition at handback risk.

In practice, estimating life cycle works may be challenging. It requires experience and, to the extent available, the Contracting Authority may be able to provide data on life cycle cost. As maintenance standards are often set at a higher level in PPP projects than in existing (non-PPP) projects, such data is likely to require a multiplier. Life cycle funding/reserving mechanisms may mitigate life cycle risk but are also difficult to design adequately and Contracting Authorities should bear in mind that these can have an impact on risk allocation/value for money.

The involvement of the Private Partner in the operation, maintenance and rehabilitation of the project, and the linking to payment entitlement, can provide several benefits. It should incentivize greater care and diligence by the Private Partner in both the rehabilitation and operating phases, and increase the useful life of the infrastructure.

The Contracting Authority may establish a facilities management committee to oversee the Private Partner’s performance of the maintenance and rehabilitation services, along with a formal mechanism to discuss and resolve performance related issues. Generally speaking, the Contracting Authority should avoid undue interference with the Private Partner’s provision of maintenance and rehabilitation services so as not to dilute the risk transfer benefits.

If the system is part of an existing interconnected distribution system, the Contracting Authority may be required to guarantee and manage maintenance which is dependent on that system.

MARKET COMPARISON SUMMARY

In mature markets, the Private Partner generally assumes the overall risk of periodic and preventative maintenance, emergency maintenance work, work stemming from design or construction errors, rehabilitation work, and in certain instances, work stemming from implementing technological or structural changes. See also Disruptive technology risk.

Throughput higher than forecast: [Circumstance Dependent Risk]
If distribution volume is much heavier than forecast and beyond the capacity specification required by the Contracting Authority, it may need to agree a mechanism to pay compensation in respect of increased maintenance costs or agree a system upgrade variation, noting that increased throughput will also typically increase the revenue available in a concession model project. See also Demand risk.

Existing (or other) assets interfacing with the project: [Public Risk] [Private Risk]

To the extent existing assets are being integrated into the project system by the Private Partner as part of the rehabilitation works, the maintenance risk should be allocated to the Private Partner to the extent the condition of the existing assets is known and future maintenance work can be assessed properly by an experienced contractor. This is a key risk in water distribution rehabilitation projects.

In some cases, where existing asset condition cannot be assessed, the Contracting Authority may need to retain the maintenance or latent defect risk (and fit for purpose standards may need to be appropriately adjusted).

Existing (or other) assets interfacing with the project: The Contracting Authority will bear risk if it is required to guarantee and proactively manage the maintenance of an existing (or other) asset that integrates with and is key to the water distribution project. See also Access to the site and associated infrastructure under Land availability, access and site risk.

MARKET COMPARISON SUMMARY

Some water projects have proved financially unviable for the private sector due to the state of disrepair and high maintenance costs.

See Access to the site and associated infrastructure under Land availability, access and site risk, Project management and interface with other works/facilities under Construction risk, Maintenance standards under Operating risk and Demand risk.

See Industrial action under Social Risk.

Vandalism is not typically a risk in water distribution projects but may be a shared risk, for example with a threshold/cap above which the Contracting Authority will bear/ share the risk. This will depend on the nature of the risk and the extent to which the Private Partner can effectively have an impact on/mitigate risk, design choice, use of materials and restrict access to certain areas etc. See also Site security under Land availability, access and site risk and Social risk.

Market Comparison Summary

Vandalism, and the breaking of pipes to make illegal connections to the network, may be more of a risk in certain political climates and in certain geographical areas and malicious damage may be a concern depending also on the location and accessibility of the system.

In the availability model, demand risk is not applicable as the Private Partner will typically be paid for having made the distribution system available to a particular standard/capacity which is not reliant upon demand for water or whether the network is actually used.

Demand: In the concession model the end user pays a tariff for the water it consumes and the Private Partner bears demand risk. As this will determine its primary revenue the Private Partner should ensure it has commissioned and analyzed demand forecasts for water in the area potentially served by the distribution network.

Tariff-fixing: The water tariff will be set under the concession terms or by regulation. If the Contracting Authority or other government entity is required to take action to set the tariff, a failure to do so in a reasonable manner should be treated as a compensation event or MAGA event if it has an adverse financial effect on the Private Partner. This could include failing to increase the tariff or increasing the tariff to a level which adversely affects user demand. Due to political and affordability reasons, water tariffs can be set at levels which make the project financially unviable - in this instance government support will be needed.

Higher demand than anticipated: If distribution volume is much heavier than forecast and beyond the capacity specification required by the Contracting Authority, it may need to agree a tariff increase (and possibly revenue support) in respect of increased maintenance costs or system upgrade, noting that increased throughput will also typically increase the revenue available in a concession model project.

Lower demand than anticipated: If distribution volume is much lower than forecast, this will impact the Private Partner’s revenues. This may be caused by the tariff level, although with water being an essential resource, inaccurate forecasting may also be the cause. To mitigate this risk, both parties ensure that appropriate demand analysis has been carried out in assessing the project. Failure by the Contracting Authority to comply with any contractual obligations or measures which adversely affects demand would typically be treated as a compensation event or MAGA event.

Revenue risk: As water is an essential commodity, even where demand risk may not be a concern, revenue risk may an issue, i.e. the ability to collect and enforce tariff payments from end users. Enforcing payment can be difficult depending on user demographic and expectation, such as opposition to private sector involvement in water delivery and to levying of payments and collection enforcement. This can be exacerbated by a perceived lack of political will to support enforcement and by unpopular tariff increases. See Environmental risk and Social risk.

Government support measures: If tariff or revenues levels are too low to make the project financially viable, the Contracting Authority may need to provide additional support in the form of a subsidy or minimum revenue guarantee or a reduction in any concession fee potentially payable. This could be an upfront subsidy towards capital expenditure or a guarantee that if revenue falls below a specified level, the Contracting Authority will pay the Private Partner an amount to ensure it receives a minimum revenue. The threshold for the guarantee should be set at a level which incentivizes the Private Partner to increase user demand and pursue revenue collection and not to rely solely on the guarantee anddiscourage users and reduce maintenance costs.

Market Comparison Summary

In the concession model the end user pays a tariff for the water it consumes. the Private Partner is likely to be limited in its ability to pass through any costs to the end consumer due to the fixing of water tariffs in the contract or through regulation. Risks that impact on demand will also be closely assessed.

Construction phase: [Circumstance Dependent Risk]
The risk of construction costs increasing due to inflation is typically borne by the Private Partner who will generally price in this risk in markets where such risk can be projected and quantified. Where this is not possible the Contracting Authority is likely to be asked to bear some risk.

Operation phase: [Public Risk]
Inflation risk in the operating phase is typically borne by the Contracting Authority (on availability-based projects). The Private Partner will look to be kept neutral in respect of both international and local inflationary costs through an appropriate inflation uplift. There is always a time lag in how quickly the indexation price increase is available to the Private Partner.

On availability-based projects, this is achieved by the availability payment typically including both a fixed component (where debt has been hedged) and a variable component which includes an escalation factor that accounts for rises in costs.

Market Comparison Summary

The fluctuation of inflationary costs is a greater risk in less mature markets than it is in other markets and the Private Partner’s expectation will be that this risk is borne and managed by the Contracting Authority during the contract term.

The variable component of the availability payment is typically defined by the consumer price index in mature markets. In other markets, the selected indexation method will need to reflect variable financing costs and variable inputs such as staff and materials.  It will be more crucial in less mature markets to find appropriate indicators which mirror the project needs rather than a general consumer price index.

Rate change between bid and financial close: The Contracting Authority may expect the Private Partner to bear the risk of an exchange rate fluctuation for a specific time period (e.g. 90 days) between submission of bid and financial close. Where there is a prolonged period between bid submission and financial close, the Contracting Authority may need to bear the risk.

Where exchange rates are volatile or long term currency swap markets are illiquid, the Private Partner may have limited ability to accept the risk of exchange rate fluctuation and will seek to transfer the exchange rate risk to the host country by requiring that some or all of the contract price is linked to a foreign currency, such as USD.

MARKET COMPARISON SUMMARY

Although not recommended, there can be a significant period between prices submitted at bid stage and financial close. This may be more typical in less experienced markets and will make it difficult for the Private Partner to bear the risk of a change in exchange rate.

Exchange rate risk can be substantial in markets where exchange rates are more volatile or long term debt or swap markets are more illiquid (such as in countries with less developed capital markets.

Rate changes during project: Allocation of exchange rate fluctuation risk over the life of a project will depend on the relevant project jurisdiction and the nature of the project costs. In most PPPs, the Private Partner will bid and be paid by the Contracting Authority (or end users) in the domestic currency of that country. It may, however, incur costs in a foreign currency and such costs are translated into the bid price in the domestic currency on the basis of a particular exchange rate. In some PPPs, the Private Partner (and its lenders) may seek to transfer the exchange rate risk to the host country by requiring that some or all of the contract price is linked to a foreign currency, such as USD.

Construction phase: Exchange rate risk can arise where some or all of the rehabilitation costs are denominated in a currency different to the domestic currency. For example, where construction of the asset requires equipment that is manufactured overseas, adverse exchange rate movement may result in such equipment becoming more expensive than anticipated when converting domestic currency. This may use up the contingency the Private Partner has provided for in its financial arrangements (and priced into its bid) and/or require the Private Partner to take on additional borrowing in the construction phase to finance these costs.

Operating phase: As with rehabilitation costs, a similar risk may arise if the Private Partner incurs operating costs in a currency different to the currency of the PPP contract payments.

In addition, exchange rate risk can arise if the debt used to finance rehabilitation is denominated in a currency different to the domestic currency of the price paid under the PPP contract or tariffs collected. Adverse exchange rate movements during the operating phase where the debt is being repaid will result in debt repayment in the foreign currency requiring a larger proportion of the Private Partner’s revenue. This may result in the Private Partner having insufficient funds to service its debt and/or may eat into its projected equity return.

MARKET COMPARISON SUMMARY

Exchange rate risks are more substantial in markets where exchange rates are more volatile or long term debt or swap markets are more illiquid (such as in countries with less developed capital markets). In more mature markets, the risk of currency fluctuations is typically not substantial enough to require the Contracting Authority to provide support and exchange rates risks are addressed solely through the Private Partner’s own hedging arrangements. Where the exchange rates are more volatile, access to long term hedging may be either unavailable or too expensive.  

The likelihood of debt being dominated in a foreign currency is more likely in markets where financing by multilateral or international banks may be required (e.g. in less mature markets where there is limited depth in the local debt capital markets).

See also Strength of Contracting Authority payment covenant under Early Termination risk.

Mitigation: The Private Partner typically looks to mitigate exchange risk through hedging arrangements, to the extent possible or necessary in the relevant market. These should ensure the costs the Private Partner incurs are effectively fixed instead of fluctuating, and protects it against adverse rate movements. The cost of such hedging will be part of the contract price bid. Devaluation of a local currency beyond a certain threshold may also trigger a non-default termination, or a “cap and collar” subsidy arrangement from the Contracting Authority.

MARKET COMPARISON SUMMARY

Some cost risk can be managed on concession model projects by passing the risk through to the user by way of water tariff adjustments, but the ability to do this may be limited.

Rate change between bid and financial close: [Circumstance Dependent Risk]
The Contracting Authority normally expects the Private Partner to bear the risk of a change in the reference interest rate between submission of bid and financial close for a specific time period (e.g. 90 days). Any rate changes after this time period will be a Contracting Authority risk.

MARKET COMPARISON SUMMARY

Although not recommended, there can be a significant period between prices submitted at bid stage and financial close. This may be more typical in less experienced markets and will make it difficult for the Private Partner to bear the risk of an adverse change in interest rate.

Rate changes during project: [Private Risk]
The Private Partner will typically bear the risk of interest rate fluctuations over the life of the project but this will depend on the specific project and its jurisdiction. The Private Partner will seek to mitigate this risk through hedging arrangements, to the extent possible or necessary in the relevant market. These should ensure the interest rate the Private Partner is required to pay is effectively fixed instead of fluctuating, and protects it against adverse rate movements. The cost of such hedging will be part of the contract price bid.

MARKET COMPARISON SUMMARY

In mature markets, the risk of interest rate fluctuations is not substantial enough to require the Contracting Authority to provide support and is typically addressed solely through the Private Partner's own hedging arrangements.

In other (less stable) markets this may not be possible due to interest rate volatility or lack of long term hedging availability and in some circumstances it may be more appropriate for the Contracting Authority to retain interest rate risk if it can bear the risk more efficiently than the private sector.

[Shared Risk]
The responsibility for placing required insurances and the cost of doing so is typically borne by the Private Partner. However, PPP contracts typically also include provisions to address the risk of insurance becoming unavailable or only available at a cost which exceeds a level at which the Private Partner is able to price in reasonable contingency. This only applies if the uninsurability is due to factors unrelated to the Private Partner. Where neither party can better control the risk of insurance coverage becoming unavailable or more expensive, this is typically a shared risk. How this is addressed will depend on the specific project and jurisdiction. For the purposes of PPP projects, insurance is generally deemed unavailable to the extent (a) it is no longer available in the international insurance market from reputable insurers of good standing or (b) the premiums are prohibitively high (not just more expensive) such that contractors in the project jurisdiction are commonly not insuring such risk in the international market.

As part of the feasibility study the Contracting Authority should consider what insurances are necessary and available at a reasonable premium and whether insurance might become unavailable (or too expensive) for the project given the location and other relevant factors. This is essential for assessing risk allocation for relevant events (e.g. force majeure risk allocation) and for the Private Partner to price its risks.

More costly premium: [Shared Risk]
Where the cost of the required insurance increases significantly (without becoming prohibitive), the risk is typically shared by the parties by either having an agreed cost escalation mechanism up to a ceiling or a percentage sharing arrangement. This allows the Contracting Authority to quantify the contingency that has been priced for this risk.

Unavailability: [Shared Risk]
A standard approach in mature markets to manage unavailability of insurance is that where required insurances become unavailable, the contract typically requires the parties to try to agree a solution to manage the uninsurable risk and the Private Partner is relieved from breach of its obligation to take out the required insurance to the extent the unavailability is not due to its actions. If a solution is not agreed, the Contracting Authority is typically given the option to either terminate the project or to proceed with the project as “insurer of last resort” (i.e. to effectively self-insure and/or put in place its own insurance cover and pay out in the event the risk eventuates). If the Contracting Authority chooses to assume responsibility for the uninsurable risk, it may require the Private Partner to regularly approach the insurance market to try to obtain the relevant insurance and the contract price should be adjusted to reflect that the Private Partner is no longer paying the corresponding insurance premium.

Occurrence of uninsurable event: [Shared Risk]
With the mature market standard approach, if an uninsurable event occurs, the Contracting Authority may (a) terminate the contract (typically on a force majeure basis plus corresponding third party liability payments) or (b) pay the Private Partner the equivalent of insurance proceeds and continue the project. The approach to termination compensation reflects the general acceptance that uninsurability is neither party’s fault and should be a shared risk.

Unavailability due to fault: [Circumstance Dependent Risk]
Risk allocation will be affected by the reason for unavailability. As highlighted above, the provisions should only apply to the extent the Private Partner is not responsible for the insurance unavailability. Equally, if the unavailability is caused by the Contracting Authority’s actions, the Private Partner may want to negotiate a right to terminate if a fundamental risk becomes uninsurable.

Market Comparison Summary

The standard approach as regards unavailability is common in mature markets. In some less mature markets, if insurance becomes unavailable, the Private Partner is typically relieved of its obligation to take out the required insurance but, unlike the mature market position, the Contracting Authority does not become insurer of last resort and the Private Partner bears the risk of the uninsured risk occurring. If the uninsured risk is fundamental to the project (e.g. physical damage cover for major project components) and the parties are unable to agree on suitable arrangements, then the Private Partner may need an exit route (e.g. the ability to terminate the project on the same terms as if the unavailability of the insurance were an event of force majeure).

In negotiating an insurer of last resort position, the Private Partner and, in particular, its lenders, will carefully assess the Contracting Authority’s credit and its ability to meet liabilities if an uninsurable event occurs. This is a reason why this position may be more likely in economically stable markets. In less stable markets the parties may negotiate more over whether a particular insurance should be an obligation in the first place and how the risk (and its occurrence) might be managed (e.g. through the force majeure provisions).

In less mature markets, wider reference criteria may be needed in defining unavailability (e.g. to address a situation where the pool of benchmark contractors is insufficient to draw a meaningful comparison).

Projects in some locations may find it more difficult to get insurance for certain events under commercially viable conditions. In this case the parties will need to find a solution to unavailability at the start of the contract.

There are two key risks associated with refinancing (the changing or replacing of the existing terms on which the Private Partner’s debt obligations have been incurred): (i) the risk that a project will be unable to raise the required capital to refinance a project at a given point in time; and (ii) the risk that a refinancing of debt will create additional project risks (e.g. in terms of potential increased liabilities for the Contracting Authority and increased financial instability of the Private Partner).

The risk of failing to raise required capital will arise in projects where the Private Partner (a) needs to seek a rescue refinancing to reschedule its borrowings if it is struggling financially, or (b) needs to replace short term (known as mini perm) financing which may have been the only financing option available to (or desirable for) the project initially. This is typically a Private Partner risk. Mitigation measures can include, in the case of mini perm financing, raising debt capital that has a repayment schedule that is matched to the PPP contract and project revenues available over the period of the PPP contract or by structuring the debt in several tranches of different tenors so that refinancing risks are smaller but arise more frequently.      

MARKET COMPARISON SUMMARY

Refinancing risks will ultimately depend on the depth and liquidity of the relevant capital markets. In more developed capital markets, the risk of failing to raise required capital is unlikely to be a significant risk as long-term finance is available from the outset.

Mini perm financing is more common in countries where the capital markets are less developed and there is a lack of a market for long term debt instruments.

However, banks globally already face greater regulatory pressure which affects the loan tenor they can offer, and it is possible they will face increased constraints even in developed markets which may lead to shorter initial debt tenors and increased refinancing needs. 

Refinancings may also occur where the Private Partner wants to take advantage of better financing terms available in the market (e.g. where the market recovers after a global financial crisis or after construction completion when the project is perceived to be less risky by funders). 

The risk of a refinancing creating additional project risks will be a risk for both the Private Partner and the Contracting Authority. The Contracting Authority needs to ensure that a refinancing does not adversely affect it (e.g. by increasing the level of its potential liability for termination compensation above what would have been the case under the original financing documents/financial model or increasing the risk of such liability falling due if the financial stability of the Private Partner is affected). To mitigate this risk, the contract should specify that the Contracting Authority’s consent to refinancing is required in specified carefully drafted circumstances.

Where the result of a refinancing is that the Private Partner's debt costs are reduced, resulting in greater profit and in turn a higher equity return (typically known as "refinancing gain”), it may be appropriate for the gain to be shared between the parties (e.g. to the extent it increases the original forecast equity return in the financial model). The Contracting Authority may expect to share a percentage of the refinancing gain (e.g. 50%) where public funds (or user payments) are being used to pay for or support the PPP project or to the extent concession fees and any support measures are tied to financing costs. To ensure it does not miss out on an anticipated share of any refinancing gain, the Contracting Authority should ensure that all relevant definitions are carefully drafted. The way the Contracting Authority receives its share of the gain will depend on the nature of the refinancing and discussions at the time. Options include: (a) a lump sum upon the refinancing to the extent the Private Partner receives such amounts at the time of the refinancing; (b) a lump sum or periodic sums at the time of receipt of the relevant payments, or the receipt of the projected benefit; (c) a reduced availability payment; or (d) by a combination of the above (in accordance with the applicable payment model).

For a more detailed analysis of typical refinancing provisions and sample drafting, see the World Bank’s Guidance on PPP Contractual Provisions 2019 Edition.

MARKET COMPARISON SUMMARY

It has become increasingly acknowledged in mature PPP markets that it would not be fair for the Private Partner to enjoy the entire benefit of a refinancing gain where it is not entirely responsible for the availability of improved financing terms (e.g. where the market recovers after a global financial crisis).

In emerging markets, particularly for demand risk projects, there may be limited scope for the Contracting Authority to negotiate refinancing gain sharing if such gain is a key incentive for potential bidders. Refinancing provisions may not be included. This is more likely in untested “riskier” markets where the prospect of refinancing gain is a key driver to bidders’ participation (as has been the case, for example, in the Philippines). As with more mature markets, the potential for sharing refinancing gain should increase as the PPP market becomes more established and perceived risks decrease.

The Private Partner essentially bears the risk of failing to have the requisite technical or financial capability to deliver the project in accordance with the contract. However, as the consequences of such failures can lead to interruption in service and inconvenience to the Contracting Authority and users, as well as potential termination liabilities for the Contracting Authority, the Contracting Authority must carry out a thorough evaluation of each bidder to ensure that it selects the right partner to deliver the project, with whom it can develop the necessary long term partnership and meet any aspirations it may have as regards community engagement and local employment and skills development. See also Risk Allocation in PPP contracts in the Introduction.

The Private Partner is responsible for its sub-contractors and bears any associated risks, unless the Contracting Authority imposes mandatory sub-contractors, in which case it may need to bear, or share, certain sub-contractor-related risks. However, the sub-contractors should form part of the Contracting Authority’s evaluation of each bid for the reasons highlighted in relation to the Private Partner.

Complying with any contractual restrictions on change in ownership will be a Private Partner risk. The Contracting Authority wants to ensure that the Private Partner to whom the project is awarded remains involved and that any restrictions on, for example, foreign ownership of critical infrastructure are not circumvented. As the project is awarded on the basis of the Private Partner’s technical expertise and financial resources, it will also want to ensure key parties such as parent company sponsors (and sub-contractors) remain involved.

The Contracting Authority will typically prohibit any change in the Private Partner’s shareholding for a period (e.g. by a lock-in for the construction period or until a couple of years into the operating phase (i.e. post energization) and thereafter may impose a regime restricting change in control without consent or where pre-agreed criteria cannot be met.

The Contracting Authority’s desire for certainty of involvement of key participants will need to be balanced with the private sector’s requirements for flexibility in future business plans. This is particularly in respect of the equity investor markets and the added benefits of allowing capital to be ‘recycled’ for future projects.

Market Comparison Summary

In less mature markets, there is typically more restriction on the Private Partner’s ability to restructure or change ownership. Overly restrictive provisions may deter investment, so this needs to be assessed in terms of the benefits to the Contracting Authority of both ensuring sufficient competition in the bid phase, and enabling parties to recycle their investment into other projects in the jurisdiction. Once the project is operational, for example, it may be reasonable for financial investors seeking regular returns to invest in place of certain of the initial (e.g. construction party) sponsors.

The risk associated with Contracting Authority step-in depends on the grounds for stepping in and whether due to the Private Partner’s fault or not. Step-in circumstances include emergencies involving the emergency services, intervention to protect against social and environmental risks and fulfilling a legal duty to provide essential services of continuity of service. For example, the Contracting Authority may have the legal and/or contractual right to step into the project to remedy chronic or emergency situations, including water quality and public health issues. The scope and terms of the Contracting Authority step in is a key bankability point due to the potential impact on the parties' liability and can be a key risk in water projects in some markets.

Private Partner fault: [Private Risk]
If step in is due to Private Partner fault or an event it is responsible for, the Private Partner essentially bears the risk of costs incurred by the Contracting Authority (and itself). In some jurisdictions this liability may be capped. The Private Partner is usually given relief from performance of its affected obligations and may receive some payment in respect of its obligations.

No Private Partner fault: [Public Risk]
In this situation, the Contracting Authority bears the risk and will be responsible for its own costs. The Private Partner will be given relief from performance of its affected obligations and be entitled to extensions of time and relief on the basis of a compensation event (except to the extent the cause falls under another provision (such as force majeure) in which case that provision will apply). It will be entitled to full payment subject to certain deductions and may also require a cost indemnity from the Contracting Authority.

In each case, risk should be allocated in respect of later issues around interface between solutions implemented during step in and the Private Partner's planned delivery solution, as well as any other risks that are allocated to the Private Partner.

For a more detailed analysis of typical Contracting Authority step-in provisions and sample drafting, see the World Bank’s Guidance on PPP Contractual Provisions 2019 Edition.

Market Comparison Summary

In some sectors in some jurisdictions (e.g. France), step-in is only contemplated in a breach situation and the Private Partner typically bears all cost up to a certain percentage (e.g. 15%) of project costs. A termination right may arise if the situation subsists for a certain period (e.g. 6 - 12 months). In some jurisdictions, the Private Partner may receive full payment as if it was performing the service in full or partial payment to reflect the affected obligations. In each case this will be subject to deductions and could result in zero payment.

In some jurisdictions (e.g. in some EU countries and Australia), the Contracting Authority may not accept any liability when stepping in due to a Private Partner breach or event which is the responsibility of the Private Partner, except in the case of gross negligence in an emergency step in, fraud or bad faith.

The scope and terms of step-in will be particularly relevant for Private Partners in jurisdictions which are less predictable or have underdeveloped or less stable legal or regulatory frameworks as the Private Partner will be concerned to limit the Contracting Authority's potential effect on the delivery of the PPP project. It may only want to agree to such rights in projects in sectors and jurisdictions where the Contracting Authority is committed to ensuring continuous delivery of the essential public service and has demonstrable experience in such delivery.

The Contracting Authority should bear the risk of any change to its ownership/status which adversely affects the project, for example, where its financial covenant and credit are adversely impacted. The Private Partner will typically have a right to terminate if certain criteria are not met and be entitled to compensation.

Market Comparison Summary

In stable markets, this risk may not be specifically addressed in the contract if satisfactory statutory or constitutional protections are available to the Private Partner. In less stable and untested markets, more specific provisions may be required, particularly where the Contracting Authority is not a central government entity.

Private Partner/Contracting Authority disputes: [Shared Risk]
The risk of disputes is a shared risk and the consequences will depend on the outcome of the dispute. To minimise the risk of uncertain and costly outcomes, the contract should expressly include a clear governing law (typically the domestic law of the Contracting Authority’s jurisdiction) and choice of dispute resolution forum (courts or arbitration). Efficient and fair dispute resolution processes should be included which provide for an escalated procedure where matters cannot be resolved between the parties’ senior management, resolution of technical disputes by an independent expert, and recourse to the chosen forum. If the contract does not contain appropriate procedures this is likely to deter potential bidders and their lenders as efficient dispute resolution is a key bankability issue. A failure by the Contracting Authority to follow contractually agreed processes may also have an adverse effect on private sector interest in other PPP projects in that jurisdiction.

There may be investment treaties applicable to the PPP arrangements with foreign parties, but these are no substitute for proper dispute resolution provisions in the contract itself.  The Contracting Authority may be expected to waive any privileges and sovereign immunities which it enjoys before local and foreign courts (such as immunity from any suits by the Private Partner).

Transparency and public access to information about disputes may be an important factor in choice of forum. In some jurisdictions the legal process is public which contrasts with arbitration which is generally a confidential and private process. Where additional agreements govern the relationship between the parties themselves, consolidation of related disputes and the joinder of related parties may be appropriate. To reduce the risk of concurrent processes, the agreements should include similar dispute resolution clauses agreeing to this.

The Private Partner should be obliged to continue with performance of the contract while the dispute is resolved and, if so, will bear the risk of failing to do so.

For a more detailed analysis of typical governing law and dispute resolution provisions and sample drafting, see the World Bank’s Guidance on PPP Contractual Provisions 2019 Edition.

MARKET COMPARISON SUMMARY

Contracting Authorities will typically select domestic law and local courts as the forum for disputes. This is for a variety of reasons including familiarity and compatibility with any concession/PPP legislation. It also minimizes the risk that local users and other stakeholders will bring claims in a different court.

In jurisdictions with a less established and experienced legal system, the Private Partner is likely to want an established dispute resolution forum (such as a recognised arbitration centre for the particular region), rather than to rely on local courts. There may be circumstances where this option needs to be considered by the Contracting Authority as a necessary compromise in order to ensure the project is bankable. For the same reason, there may be certain cases where the Contracting Authority will consider having a foreign law as the governing law of the contract.

Choice of forum may be restricted in some jurisdictions due to local law requirements (e.g. prohibiting referral of disputes to a foreign court or international arbitration, or being subject to a "foreign" law). This is particularly common in certain civil law countries where solely specific administrative courts are able to judge public authority decisions and/or contracts. Additionally, there may be local law limitations (under constitutional arrangements, public policy or otherwise) on contractually agreeing to waive sovereign immunity. There may also be reputational and political issues if a Contracting Authority is seen to exempt public sector projects from the jurisdiction of domestic courts.

Sub-contractor disputes: [Private Risk]
The Private Partner is responsible for disputes with its sub-contractors. The Contracting Authority should avoid the risk of getting involved in expensive and time-consuming peripheral disputes with other parties. However, it may want to consider allowing certain disputes it has with the Private Partner to be joined with disputes on the same matter between the Private Partner and its sub-contractor where the forum for resolving the dispute is appropriate. Any assessment of the need for joinder provisions is likely to be fact-dependent.

[Private Risk]
Responsibility for disruptive technology risk depends on the project circumstances. The Private Partner’s obligation is to meet the output specification. If it fails to do so due to obsolescence of equipment or materials it is likely to suffer payment or revenue deductions and, above a particular threshold, may be at risk of termination. In this case it bears the risk of potentially having to replace relevant technological solutions (e.g. if the solution it has chosen is no longer supported).

However, if it is performing above that threshold, the Contracting Authority cannot require it to replace technology simply because more efficient technological solutions are available unless there is an agreed contractual mechanism for doing so.

[Circumstance Dependent Risk]
In planning the project, the Contracting Authority will want to take into account that disruptive technology may impact its long term need for the asset. It may consider imposing obligations on the Private Partner to adopt and/or integrate with new technologies or to allow for other foreseeable developments, such as smart metering of water consumption by end users.

It may be appropriate additionally to agree a specific cost sharing mechanic under which the Contracting Authority can request technological upgrades with appropriate cost sharing according to the reason for the request (e.g. if the replacement solution will improve health and safety or have social/environmental benefits). The same considerations apply if the Private Partner wants to make a technological change which is not strictly necessary and it may be appropriate for the Contracting Authority to consider incentivising the Private Partner to propose changes which will be of public or environmental benefit.

The Private Partner will seek to mitigate potential exposure through agreed cost and improvement parameters, beyond which it will be treated as a Contracting Authority variation of the contract and entitle the Private Partner to relief in accordance with the contractual variation mechanic. See also Variations risk.

It is important to take into account that some disruptive technologies may have both upside and downside effects on a project, as well as efficiency or social and environmental benefits. It may therefore be appropriate to consider mitigating mechanisms in any contractual solution. For example, the introduction of smart metering may have efficiency benefits but will add implementation and maintenance costs.

In many jurisdictions changes can be made only in accordance with pre-agreed contractual mechanisms, to avoid third party challenges on the basis that the amendments are so substantial that the existing contract should be retendered.

Market Comparison Summary

Disruptive technology risk is becoming under increasing focus in all markets. This is particularly the case in relation to technological changes relating to environmental protection and this area may require its own treatment in the contract (e.g. through specific treatment under the contractual variations mechanism and/or through other specific contractual obligations).

Where contracts impose an obligation on the Private Partner to seek continuous improvement in specified areas (e.g. monitoring and metering) or to operate in accordance with good or best industry practice, this may result in some element of technological advance.

[Shared Risk]
Force majeure is typically treated as a shared risk where neither party is better placed than the other to manage the risk or its consequences.

Scope: Force majeure is an event (or combination of events) outside the reasonable control of the contracting parties which prevents one or both parties from performing all or a material part of their contractual obligations. In some - typically civil law jurisdictions – the definition may require the event to be unforeseeable or not reasonably avoidable. Many jurisdictions have a concept of force majeure under general law and, particularly in civil law jurisdictions, this can limit the freedom of the parties to derogate from the scope of the legal concept and agree something different in the contract. However, most PPP contracts include specific force majeure provisions, whether they are civil law or common law governed, as this provides contractual certainty. The contract should be clear to what extent underlying law applies.

Approach: Depending on the jurisdiction, the definition of force majeure may be an open-ended catch-all definition, an exhaustive list of specific events, or a combination of both.

The open-ended catch-all definition is often seen in civil law-governed contracts and may also be more appropriate in markets which are less developed or stable and where there is little precedent or certainty. A non–exhaustive list of events may also be included. Qualifying events may be “natural force majeure” events (such as natural disasters and severe weather events, and possibly climate change events) and certain “political force majeure” events (such as strikes, war, government action etc.).

The exhaustive limited list approach is more common in developed and stable markets where the Private Partner has more certainty as regards the risk of events occurring and how it can manage them. It may be comfortable that events which might be force majeure in a less mature market (e.g. some types of industrial action) may instead be treated as relief events in a developed and predictable market. Under this approach, force majeure events are typically (but not necessarily exclusively) events which are uninsurable. Typical events include (i) war, armed conflict, terrorism or acts of foreign enemies; (ii) nuclear or radioactive contamination; (iii) chemical or biological contamination; and (iv) discovery of any species-at-risk, fossils, or historic or archaeological artefacts. As market practice develops, certain climate change events might also be included. See also Site Condition under Land availability, access and site risk and Climate Change event under Environmental risk.

For a more detailed analysis of typical force majeure provisions and sample drafting, see the World Bank’s Guidance on PPP Contractual Provisions 2019 Edition.     

Risk qualification: The Contracting Authority should consider whether it can limit its risk by carefully defining the events which qualify as force majeure, and/or qualifying or excluding them as appropriate.  For example, in some projects earthquakes may only qualify as force majeure if they are above a specified seismic intensity. Alternatively, an event may only qualify if it has subsisted for a particular length of time. In some projects, risk is allocated to the Private Partner and/or shared for the first few months, and subsequently becomes a shared risk or Contracting Authority risk (with entitlement to terminate if the force majeure event continues for more than a defined time period (e.g. 6 - 12 months)). Using an open-ended definition of force majeure widens the risk shared by the Contracting Authority, but may be appropriate in some markets.

The availability of insurance for certain events will be one of the main criteria in determining the extent which an event should qualify as force majeure and/or how the consequences should be addressed. Certain risks may be more likely to constitute a force majeure event if they occur in one phase than another (e.g. events in the construction phase affecting materials supply).

MARKET COMPARISON SUMMARY

The scope of force majeure will depend on the particular project and jurisdiction. In France, for example, the affected party is relieved from its obligations if force majeure prevents performance and French jurisprudence has defined the characteristics of a force majeure event as (i) beyond the control of the parties, (ii) unforeseeable and (iii) impossible to overcome.

In less mature markets, the list of specific events is likely to be wider than in more mature markets and include natural risk events, which typically can be insured (e.g. fire / flooding / storm etc), and force majeure events which typically cannot be insured (e.g. strikes / protest, terror threats / hoaxes, emergency services action etc). The extent to which the risk will be shared or allocated to one of the parties will depend on its nature and on the particular jurisdiction.

Contracting Authority political risk: [Public Risk]
In some markets, certain political risk events may need to be allocated in full to the Contracting Authority because the Private Partner cannot reasonably be expected to bear any of the risk and/or because the Private Partner may price in such a high contingency in respect of the risk that it makes the contract unaffordable. Where the Contracting Authority bears the full risk of these risks, this may be addressed under the force majeure provisions but with “political force majeure” receiving different treatment to the shared risk force majeure events. Alternatively, these political risks may be treated in a separate provision under the heading of “material adverse government action” or similar (which may also include other forms of event for which the Contracting Authority is deemed solely responsible). See also MAGA risk.

MARKET COMPARISON SUMMARY

In certain markets, it may be necessary to differentiate how similar types of risk events are treated, depending on where they occur. For example, in more politically volatile jurisdictions, war events might be wholly a Contracting Authority risk where they occur within the country, but a shared risk otherwise. See also MAGA risk.

The basic principle of force majeure is that the risk is shared and each party bears its own losses. However, there may be circumstances where it is appropriate for the Contracting Authority to provide relief to the Private Partner, provided the Private Partner has made reasonable efforts to mitigate the force majeure effects and to the extent it was not responsible for the event. In addition to granting the Private Partner relief from breach of its affected obligations, certain time or cost relief may be granted (sometimes where a particular threshold of costs or time delay has been reached). This will depend on the phase in which the event occurs and should be considered at the time, together with the impact of the event on the Contracting Authority and the options available to it.

Termination following prolonged force majeure (e.g. 6 - 12 months) may also be available. If the Private Partner has the ability to terminate the PPP contract on the basis of a prolonged force majeure event, the Contracting Authority may want to include an option to require the PPP contract to continue, provided that the Private Partner is adequately compensated. This approach is more likely to be encountered in a more established PPP market.

Rehabilitation phase: The consequences for the Private Partner of a force majeure event in the rehabilitation phase are that it may be unable to meet all or part of its contractual obligations, in particular key dates (such as the operation commencement date); may suffer delayed and/or lost revenue; and may incur additional financing and other costs (e.g. in relation to mitigating the event), both during and after the force majeure event. As well as relief from breach of the affected obligations, the Contracting Authority may decide to grant certain cost relief (either while the force majeure event subsists or through the operating phase if the contract continues) on the basis that the Private Partner has limited means to absorb additional costs and it may be in both parties’ interests to avoid the Private Partner going insolvent. For example, it may elect to make a compensation payment at the time or, if the contract continues, grant extensions of time and/or an extended operating period so that the Private Partner has the opportunity to recoup lost revenue and costs. Alternatively, availability payments could be increased

Operating phase: The consequences for the Private Partner of a force majeure event in the operating phase are that it may be unable to meet all or part of its contractual obligations (including failing to deliver the service); may suffer delayed or lost revenue; may incur additional financing and other costs; and may possibly be unable to service its debt repayment obligations. Again, in addition to relief from breach of its affected obligations, the Private Partner may be granted grant certain cost relief on the same principles as described in the construction phase. In an availability payment model, it may also grant payment deductions relief or relaxed performance standards (e.g. paying the Private Partner for actual water availability during the force majeure event and relieving it from any penalties for consequent inability to perform in developed markets and requiring a lower level of availability without incurring performance penalties in emerging markets).

Insurance: Project insurance (physical damage and loss of revenue coverage) will be a key mitigant in respect of physical damage, to the extent it is available, and an important consideration in respect of compensation and how to continue the project. Design resilience is also an important mitigating factor, for example, for projects with seasonal weather such as storms/hurricanes/excessive snowfall or where earthquakes are common.

Market Comparison Summary

The approach to cost and deductions relief varies across jurisdictions. In developed markets (particularly some civil law jurisdictions) Contracting Authorities may be more willing to make compensation payments during a force majeure event. In some jurisdictions, the contract will expressly identify only specific force majeure risks for which the Contracting Authority will grant financial relief (e.g. raw materials price volatility).

It may not be as common in less mature markets for cost compensation to be paid during force majeure unless caused by an event deemed to be a political risk for which the Contracting Authority is wholly responsible (e.g. a MAGA event). See also MAGA risk.

Force majeure relief should be distinguished from relief available under any hardship doctrines (see Glossary definition) existing under the underlying law of the project jurisdiction.

In projects where a MAGA provision is appropriate, the Contracting Authority bears the risk of specific “political” actions having a material adverse effect on the Private Partner’s ability to perform its contractual obligations, or on its rights or financial status. The Contracting Authority is responsible for costs and delays and is typically at risk of termination for prolonged MAGA events. Although not all jurisdictions use the term “MAGA”, many have equivalent provisions under different terminology.

MAGA events typically include: deliberate acts of state such as outright nationalisation or expropriation in relation to the PPP project; a moratorium on international payments and foreign exchange restrictions; certain governmental acts (such as not granting essential approvals where the Private Partner is not at fault); and politically-inspired events such as national strikes. Change in law is also a form of MAGA. Although some of these events may not seem as obviously within the Contracting Authority’s control itself as others (e.g. if they relate to other arms of government), market practice is that they are accepted by the Contracting Authority. This is because passing them to the Private Partner may result in it being unable to enter into the contract or pricing in such contingency that the contract is unaffordable. The list of events will depend on the individual project circumstances and the position agreed on force majeure events, and the Contracting Authority can limit its risk by qualifying relevant events by reference to a clearly defined materiality threshold.

The process and consequences of MAGA are broadly similar to force majeure as regards the parties trying to find a solution and how the Private Partner may be compensated. The key difference is that the underlying principle behind MAGA relief is to put the Private Partner back into the position it would have been in had the MAGA event not occurred. The parties may terminate for prolonged MAGA, with compensation payable on a similar basis to Contracting Authority default termination. The Contracting Authority may be able to reduce its liability in some cases if it can negotiate different treatment for MAGA events which are not as clearly within its own control and influence.

For a more detailed analysis of typical MAGA provisions and sample drafting, see the World Bank’s Guidance on PPP Contractual Provisions 2019 Edition. See also MAGA/Change in law termination under Early Termination risk.

Market Comparison Summary

MAGA type clauses are more likely in less predictable and stable markets where the Private Partner (and its lenders) may require a clear regime to address specific government-related actions for which the Contracting Authority is responsible. This may be because of an actual or perceived likelihood of certain MAGA events occurring (e.g. war or civil unrest), or a lack of track record of PPP contracts being run successfully free from political interference over long periods of time and across political cycles.

In mature politically stable markets, the Private Partner (and its lenders) are often comfortable that the type of MAGA risks likely to arise are limited. Instead of being detailed in a specific Contracting Authority risk clause, they can be addressed through the shared risk force majeure provisions and compensation event type provisions (and the general right to terminate for Contracting Authority default in limited circumstances).

Investors and lenders may be able to obtain political risk insurance in respect of some of these types of risks. This is more common in politically young or unstable markets.

Some jurisdictions are more politically volatile internally than others and certain political risks will be treated differently. For example, war events may be treated as MAGA if they occur within the country, and shared risk force majeure if outside it.

[Private Risk]
Compliance with applicable law and mandatory regulation is each party’s risk. The Private Partner is typically subject to an express contractual obligation and will be in breach if it does not comply with applicable law, subject to change in law relief. The contract must be clear what laws and other mandatory regulations and industry codes the Private Partner is obliged to comply with. This is essential not only so the Private Partner can price its compliance, but also in order to determine what constitutes a change in law so that change in law risk can be allocated effectively.

[Circumstance Dependent Risk]
Compliance by third parties is likely to be a Contracting Authority risk where it has failed to enforce compliance and there is an adverse effect on the project (e.g. where load limits exceed permitted levels and increased maintenance costs are incurred). See also Maintenance Standards under Operating risk.

Market Comparison Summary

[Public Risk]
The Contracting Authority primarily bears the risk of unexpected changes in law which were not in the public domain before a specified cut-off date in the bid phase and which cause the Private Partner’s performance of its contractual obligations to be wholly or partly impossible, delayed or more expensive than anticipated (or impact its investors). This is because the Private Partner has contracted to provide the specific water distribution project at a specified price based on a known legal environment and typically has limited means of offsetting adverse consequences of unexpected law changes. As change in law may also benefit the Private Partner, change in law clauses are often reciprocal, to ensure the Contracting Authority benefits from the "positive" financial consequences of a legislative change.

[Circumstance Dependent Risk]
The Contracting Authority’s risk can be mitigated by ensuring that the contract clearly defines what constitutes a change, the relevant cut-off date and what constitutes being in the public domain. This will vary according to the nature of the project and jurisdiction concerned.

There are various approaches to risk allocation as briefly summarised below and the degree of risk sharing will depend on the type of change and the approach suitable to the maturity and stability of the relevant legal market. Any risk that is transferred to the Private Partner is likely to be reflected by contingency pricing in its bid which may result in the Contracting Authority paying for something that never happens. The Contracting Authority should be mindful of how it will fund changes in law which are at its risk should they arise.

For a more detailed analysis of typical change in law provisions and sample drafting, see the World Bank’s Guidance on PPP Contractual Provisions 2019 Edition.

Approach (a) Contracting Authority risk: [Public Risk]
The basic approach is that the Contracting Authority bears all the risk of change in law and provides full relief to the Private Partner.

Approach (b) Limited risk sharing: [Public Risk] [Shared Risk]
A more nuanced approach is for the Private Partner to accept a certain annual monetary threshold up to which it accepts any unexpected change in law risk and above that threshold the Contracting Authority bears the risk/cost. This enables the Private Partner to price the risk it bears.

Approach (c) Advanced risk sharing: [Shared Risk]
With this approach the Private Partner is kept whole in respect of unexpected changes in law which are: (i) discriminatory (e.g. to the project or the Private Partner); or (ii) specific (e.g. to the water distribution sector or to investors in water distribution businesses); or (iii) require capital expenditure after rehabilitation completion (i.e. in the operating period). (Applicable law may protect the Private Partner from unexpected changes in the rehabilitation period if the relevant legal regime provides that changes in law affecting capital expenditure during construction do not apply retrospectively.) With this more detailed approach the Private Partner bears (some of) the general business risk that applies to all businesses (including operational expenditure or taxation affecting the market equally) and can absorb this in part through the indexation provisions typically contained in the pricing mechanism.

Bespoke mechanisms: [Shared Risk]
It may be appropriate to have bespoke mechanisms for certain changes in law, such as those relating to climate change and environmental protection – market practice is still developing in this regard. See also Climate change event under Environmental risk.

Consequences: [Public Risk]
The Private Partner should always be entitled to relief from breach of contract where a mandatory change in law occurs which conflicts with an existing obligation or would make compliance illegal (and/or impossible). The contract typically contains a mechanism by which the Contracting Authority is deemed to request a corresponding contractual variation of the relevant obligation.

The nature of the cost relief given to the Private Partner will be as described for a compensation event. Alternatively, the Private Partner may be entitled to a right to terminate (typically on a Contracting Authority default basis).

Stabilization provisions: [Public Risk]
Some projects may also provide for a stabilization clause that entrenches certain legal positions (such as the current tax regime) against any future changes in law. This may require a level of parliamentary ratification of the project contract. The stabilization method is generally not favoured by governments or non-governmental organisations (e.g. because the concept of Private Partner immunity from changes in environmental protection laws is unsatisfactory) and the Contracting Authority should instead seek contractual mechanisms to address such matters.

Market Comparison Summary

Change in law risk may be treated as a MAGA event if the treatment agreed for this form of political risk is the same as for other MAGA events. Generally speaking, where a detailed approach to risk allocation is involved and where the consequences do not lead to termination, change in law is best dealt with separately – this is more typical is established markets. See also MAGA risk.

In defining a change it may be appropriate for the definition to include any modification in the interpretation or application of any applicable law. This is particularly likely in common law jurisdictions.

As highlighted by the different approaches, in mature legally stable markets the Private Partner will likely have less protection than in jurisdictions where changes in law are less predictable and/or more likely due to underdeveloped or less stable legal or regulatory frameworks.

Approach (a) is often seen in developing markets with less established legal environments as it may be the only way that private finance can be raised and should also enable the Private Partner to offer a more competitive price.

Approach (b) has also been seen in more developed markets and some emerging markets.

Approach (c) is seen in more experienced PPP markets. While it will involve some contingency pricing, this approach is considered generally more beneficial to the Contracting Authority, but may not be bankable in every jurisdiction and should be contemplated on a case-by-case basis. Even in markets using this approach there will be instances where this risk allocation is not fully achievable due to the nature of the PPP project and the extent to which the applicable legal and regulatory regime is settled.

Past models (including in the UK) used to require the Private Partner to assume, and price for, a specified level of general change in law capex risk during the operational period, before compensation would be paid. The UK Government ultimately decided that this allocation did not represent value for money and reversed this position. Some countries which adopted the UK model had already taken this approach.

Although a Contracting Authority may bear all change in law risk at the start of a PPP program, once a track record and/or legal environment is established in its jurisdiction which gives the private sector greater confidence in the stability and predictability of the regime, Contracting Authorities procuring new PPP projects may be able to explore some risk transfer to the Private Partner.

A termination right as a consequence of change in law is not considered necessary in all jurisdictions. In civil law jurisdictions it is common for the Private Partner to have a specific right to terminate the contract where performance of the PPP contract would entail a breach of law that cannot be remedied by a Contracting Authority variation. This is not usually seen in common law jurisdictions with established legal frameworks as the Private Partner and its lenders are able to take a view that it is highly unlikely that a change in law would result in such drastic consequences without means of holding the government accountable.

In civil law jurisdictions, Private Partners may sometimes rely on underlying legal principles such as hardship doctrines (see Glossary definition) for relief. However, widespread market practice across civil and common law jurisdictions has shown that the private sector is unwilling to enter into PPP contracts on such a basis as both lenders and sponsors require express contractual certainty in relation to the potentially significant impact of changes in law.

Projects in the water sector involve a close interaction with consumers and public health regulation plays a paramount role. A change in the public health and water quality legislation may well be of general effect but may have a disproportionate effect on the water sector, and in particular, on distribution network to consumers. For this reason, the parties may seek to adopt definitions of discriminatory/specific change in law to include any general changes in law that have this disproportionate effect.

The allocation of risk for early termination depends on the termination grounds and these also determine the financial consequences of termination. The key risks relating to the contract being terminated early are that the Private Partner is deprived of its expected revenue stream to repay the debt it incurred developing the project and the project asset or service ceases to be delivered for the Contracting Authority. The complexity and variety of termination circumstances result in parties in all jurisdictions almost always seeking to include clear contractual mechanisms in the contract which set out comprehensively what circumstances may give rise to termination, who may terminate and what the consequences of termination will be for the Contracting Authority and the Private Partner, as well as for lenders or other key third parties. Without such certainty, bidders and potential lenders may be deterred from bidding.

The Contracting Authority should not be "unjustly enriched" by receiving an asset for which the Private Partner has not received the expected contractual price (or equivalent revenues). This is an underlying legal principle in most jurisdictions and should be taken into account in the drafting of applicable termination compensation provisions.

The Contracting Authority, besides making a payment, will need to consider the other risks associated with termination, such as the reputational risks, continuity of service delivery, completion of the works or maintaining the asset itself, or re-tendering the project (or a mix).

For a more detailed analysis of typical early termination and termination payment provisions and sample drafting, see the World Bank’s Guidance on PPP Contractual Provisions 2019 Edition.

Market Comparison Summary

The increasingly market standard approach in all jurisdictions is to include contractual termination provisions in the contract. However, in some civil and common law jurisdictions there may be underlying laws addressing certain termination rights and their consequences which apply without the PPP contract having to include termination provisions. While relying on underlying law rather than express contractual provisions is an approach less likely to be seen in common law jurisdictions, there can be certain exceptions as described, for example, under Contracting Authority default termination and Voluntary termination by Contracting Authority.

Furthermore, if the transaction is financed in a shariah-compliant manner (such as through an ijara (lease) structure) consideration must be given to how ownership will be transferred following the termination. This is typically achieved through a Purchase Undertaking or Sale Undertaking of the underlying assets.

In less developed PPP markets, it may not be easy to re-tender a project if there is no pool of alternative contractors to take on the project.

Termination right: The Contracting Authority bears the risk of termination for breaches which have a material adverse effect on the Private Partner or the project (e.g. expropriation in relation to the PPP project and failure to pay). The test is typically that the default event has made it impossible for the Private Partner to perform the contract or rendered the continued relationship untenable and any materiality threshold should be clearly defined. See also MAGA risk.

To mitigate the risk of termination, the Contracting Authority should ensure that grace periods are built in (e.g. for non-payment) so that it has the opportunity to rectify the default and reduce the risk of a termination right arising purely from, for example, administrative error.

Compensation: Although the exact approach depends on the relevant jurisdiction and the project model, the underlying principle is that the Private Partner should be fully compensated by the Contracting Authority as if the PPP contract had run its full course. In an availability model, the Private Partner would typically receive an amount in respect of senior debt (including where applicable hedge break costs), junior debt, equity investment and a level of equity return which from the Contracting Authority’s perspective should where possible reflect the actual performance level of the Private Partner. Redundancy and sub-contractor break costs will also be included. A concession model would follow similar principles.

The Contracting Authority should mitigate the amount it pays out by setting off deductions available to the Private Partner in respect of, for example, insurance proceeds, bank accounts, hedge break entitlements and surplus maintenance funds.

Market Comparison Summary

There are some common law jurisdictions (e.g. Australia) where the Private Partner is expected to rely on its common law rights to terminate for Contracting Authority default instead of having an express contractual right. This may be because termination for Contracting Authority default is such a fundamental step with enormous business and other ramifications for the Private Partner that the focus is instead on the enforceability of the contractual payment and time/cost compensation provisions applicable to breaches by the Contracting Authority. Similarly, in civil law jurisdictions the PPP Contract may be silent, and the Private Partner may need to apply to an administrative court to request contract termination (as was the case in earlier PPP contracts in France). Relying on underlying law is likely to deter bidders in markets where there is insufficient legal precedent and certainty.

Termination right: Some PPP contracts may contain specific MAGA provisions which entitle the parties to terminate the PPP contract if there is a protracted MAGA event. The type of political risk events addressed by a MAGA provision may include the type of Contracting Authority defaults outlined under Contracting Authority default termination and also change in law where there is no solution agreed to continue the contract. This could mean that a PPP contract (i) only has a MAGA provision, (ii) only has a Contracting Authority default provision, or (iii) has a combination of the two and/or separate provisions addressing specific political risk matters such as changes in law. See also MAGA risk and Change in law risk.

Compensation: The same principles will apply as outlined for Contracting Authority default termination but some jurisdictions may only allow the Contracting Authority to terminate for protracted MAGA-style events by implementing a voluntary termination. The Contracting Authority may be able to negotiate a reduced termination payment in respect of “no fault” MAGA events. See also MAGA risk and Voluntary termination by Contracting Authority under Early termination risk.

Market Comparison Summary

Markets which are politically and legally stable are less likely to have separate MAGA termination provisions as the Private Partner and its lenders will be comfortable relying on a Contracting Authority default termination provision, combined with a shared risk force majeure provision and other contractual provisions (e.g. compensation events) which provide time and/or money relief to the Private Partner in relevant circumstances of Contracting Authority responsibility.

Termination right: In return for having the right to terminate for convenience, the Contracting Authority bears the risk of this event. It should have fully considered and prepared for termination before deciding to exercise its right to terminate. The notice period should be the minimum sufficient for both parties to make appropriate arrangements in respect of the handback of the project and to facilitate compliance with handback obligations.

Compensation: The Private Partner's prime concern will be to ensure it is fully compensated for such early termination and able to comply with its handback obligations. The termination payment will be based on the same principles as for Contracting Authority default.

Market Comparison Summary

In some jurisdictions (more typically civil law) the Contracting Authority may be entitled to terminate the PPP contract on the grounds of public interest even without an express contractual right. This inalienable right is rarely invoked but the private sector (Private Partner, sub-contractors and lenders) will still require the PPP contract to cater for this low probability but high risk event as comprehensively as possible. The Contracting Authority may be required to substantiate the validity of the public interest ground (for instance, termination may not be permitted purely on financial grounds).

In some jurisdictions (e.g. France) it is not possible to contractually waive the right to unilaterally terminate in the public interest, but it is possible for parties to agree in advance the procedure and consequences of such termination. In practice, these are usually identical to voluntary termination, or even a Contracting Authority default scenario. This is because the Private Partner is not responsible for, nor capable of mitigating, a public policy-driven decision to terminate unilaterally.

Termination right: The risk of a force majeure termination arising is shared by the parties. Typically it will arise after 6-12 months of prolonged force majeure where the parties are unable to agree a solution to continue with the project.

Compensation: The Contracting Authority pays termination compensation to the Private Partner reflecting the principle that force majeure events are neither party's fault and the financial consequences should be shared. This is not "full" compensation as this would result in the Contracting Authority bearing all the financial pain. Typically outstanding senior debt (including where applicable hedge break costs), initial equity, redundancy payments and sub-contractor break costs will be paid, less any applicable deductions as on Contracting Authority default termination). The Private Partner will lose all its forecast equity return (i.e. its anticipated profit) but the payment will be sufficient to repay all of its outstanding senior debt which will help address bankability concerns as to whether the debt will be kept whole in this termination scenario. The equity element will serve as a buffer for lenders if the termination payment does not cover 100% of the outstanding debt.

Market Comparison Summary

In some (typically less developed) markets, the Contracting Authority may succeed in negotiating paying no termination compensation in respect of certain natural risks which are insurable (and would reasonably be expected to be insured against as good operating practice), or a reduced amount reflecting insurance payments received (or receivable) by the Private Partner. This to some extent reflects the practice in more developed markets where these type of events may instead be classified as relief events which entitle the Private Partner to time relief only (but no ultimate right of termination). This will of course depend on the risk assessment by the Private Partner and its lenders.

In less mature markets it is not uncommon for the senior debt to be guaranteed as a minimum in every termination scenario, and for rights of set-off below that figure to be restricted.

Termination right: The Private Partner bears the risk of termination by the Contracting Authority for serious failures by the Private Partner connected to delivering the PPP project. Termination events may be performance-related or relate more specifically to the financial status and corporate activity of the Private Partner. In order to mitigate the risk of termination, the contract should clearly define the default events and they should have reasonable in-built tolerance levels so that an appropriate threshold of poor performance has to be reached before termination rights arise. The opportunity to rectify should be given where feasible. 

The Contracting Authority can mitigate the risk of a termination payment arising as it has control over serving the termination notice that triggers it. It also has the ability to mitigate against the risk of Private Partner default even before the PPP contract is signed, by careful selection of the winning bidder. See also PPP Project Preparation and Delivery in the Introduction.

Compensation: The Private Partner will typically be entitled to a compensation amount equal to a pre-set percentage (around 80 - 100%) of the scheduled outstanding debt, minus applicable deductions, and no equity compensation. The aim of a lender “hair cut” of less than 100% debt is to incentivise lenders to conduct proper due diligence and exercise their monitoring and step-in rights to ensure the Private Partner delivers the project satisfactorily so that it avoids termination and can repay the whole of the lenders’ outstanding debt.

Alternatively, a market value retendering of the contract may take place (or be deemed to take place) and the compensation paid to the Private Partner will be the price tendered (or deemed tendered), less applicable deductions. A third alternative is for the Private Partner to receive a payment based on book value.

Market Comparison Summary

In some civil law jurisdictions, insolvency laws may have an impact on the right to terminate the PPP in the event of insolvency of the Private Partner (or its shareholders).

A debt based compensation method is the most common approach in emerging markets and availability-based PPP projects in jurisdictions such as France and is also seen in Germany. The market value retendering approach is more likely in a mature PPP market where there are likely to be a number of potentially interested purchasers in the relevant sector. Lenders to PPP projects in certain jurisdictions or in relation to certain assets may be reluctant to rely on a market based valuation method for fear of undervaluation or underpayment. This is particularly likely to be the case in emerging markets where there is a limited PPP track record and a limited market. Some European jurisdictions have followed a book value approach but this may not accurately reflect sums owed and is not as common.

In less mature markets it is not uncommon for a high percentage or the full senior debt to be guaranteed as a minimum in every termination scenario, and for rights of set-off below that figure to be restricted. The higher percentage haircut is seen in markets where the risks in respect of project failure and of the ability to rescue it are considered low (e.g. from a technical or resourcing perspective, or because the market is known), and the overall security package available to Lenders is otherwise sufficient to cover their debt. Lenders in such markets (e.g. in some projects in the US) may alternatively accept no compensation for the same reason but this is not common practice.

If available in the relevant jurisdiction, lenders will seek a direct/tri-partite agreement with the Contracting Authority. The purpose of this is to give lenders step-in rights if the Contracting Authority serves a default termination notice or if the Private Partner is in default under the loan documentation. The lenders would typically be given a grace period to gather information, manage the Private Partner and seek a resolution to rescue the project and the right to ultimately novate the project documents to a suitable substitute private partner.

The Contracting Authority bears the risk of making the relevant termination payment on time and in the amount required. To mitigate the risk of failure, it will need to assess whether it will be able to pay a lump sum if such a large payment is not budgeted for or does not have backing from its government treasury department. Payment over time may be preferable and the Contracting Authority should in any event try to negotiate a reasonable grace period long enough to raise the necessary funds. The Private Partner and its lenders will typically want to close off their exposure to a terminated PPP project and avoid Contracting Authority credit risk as soon as possible. It is likely that they will favour a lump sum payment, particularly on Contracting Authority default termination where the most likely cause of termination is failure to pay. In some cases, the Contracting Authority may be asked to provide credit support of its payment obligations.

Lenders may be reluctant to release security interests held over the PPP project assets until compensation payments have been made in full. This may make the transfer of relevant assets back to the Contracting Authority difficult. In certain circumstances, the Contracting Authority may be able to negotiate an interim solution at the time of the termination, such as an arrangement whereby it has a right to access the PPP project assets during the period from the termination date until all termination compensation is paid, so long as the Contracting Authority complies with the payment terms with respect to such compensation. This approach is unlikely to be agreed at contract signature and certain issues will need to be clearly addressed (such as liability for damage to the asset while in the Contracting Authority's use).

Market Comparison Summary

In jurisdictions where the Contracting Authority’s credit is weak or uncertain, additional credit support may be sought by the Private Partner and its lenders. This may be the case, for example, in less stable regimes or emerging markets or in projects where the Contracting Authority is not part of central government. Support may be available via multilateral or export credit agencies or central government or sovereign guarantees. Lenders and investors may seek political risk insurance to cover the risk of the Contracting Authority or any government guarantor defaulting on its payment obligation.

A key concern for lenders in some jurisdictions relates to the requirement for parliamentary approval of appropriations in respect of contingent liabilities under project contracts. In the Philippines, for example, the government requires a two-year grace period for the payment of termination compensation as this is the maximum period of time for the parliamentary appropriation process.

In less mature markets, issues of convertibility of currency and restrictions on repatriation of funds are also bankability issues upon termination.

Release of security interests may not be a relevant concern in some jurisdictions, such as France, where lenders would not typically take security over the project assets as this would only give them limited rights. They would more usually take security over the Private Partner itself.

The Private Partner bears the risk of the project assets and land being handed back to the Contracting Authority in accordance with the contract and meeting the required handback conditions. This is linked to maintenance of the assets during the contract and may be complex given the need to define relevant asset standards. The circumstances around handback will vary from one PPP contract to another and will depend on matters including: the Contracting Authority's intentions with regard to post PPP usage, the nature of the asset (e.g. the water distribution network and payment collection system may be usable for much longer than the initial PPP project duration), the stage at which the PPP contract comes to an end, whether termination occurs during construction or operation and any requirements under underlying laws in the relevant jurisdiction. To mitigate the risk of unexpected consequences, the contract should set out the requirements and process, including the Private Partner’s obligations to facilitate an effective handover, hand over relevant licences and documentation and cooperate with the Contracting Authority so that the asset can continue the service.

To mitigate the risk of the assets not being returned in the expected condition, the contract should include a mechanism for surveying conditions in advance of expiry and requiring relevant remediation. Typically the contract will provide for a retention fund to be established to fund remediation a certain period in advance of contract expiry, or for the Private Partner to provide some form of financial bond. Any funds remaining in existing lifecycle funds should be used/shared appropriately.

For a more detailed analysis of typical handback provisions and sample drafting, see the World Bank’s Guidance on PPP Contractual Provisions 2019 Edition.

Market Comparison Summary

In civil law jurisdictions, assets built on publicly owned land and/or used for a public service will often be subject to particular restrictions. For example, mandatory handback at termination may be embedded in underpinning administrative law principles or legislation and there may be mandatory access or rights of use for third parties. In some countries (such as France), ownership will sit with the Contracting Authority throughout the duration of the contract, with assets built on such land automatically becoming Contracting Authority property as soon as they are built and handed back for free at natural expiry. The PPP contract will set out the specific accompanying detail about asset condition and cooperation obligations, taking into account the underlying mandatory law provisions.

Typically, in a common law jurisdiction, the Private Partner will have been leased the PPP project land by the Contracting Authority (and may have been permitted to sub-lease it to the relevant sub-contractors). The headlease to the Private Partner is usually coterminous with the PPP contract, so the land will revert to the Contracting Authority at the same time as the PPP project asset. In civil law jurisdictions, the PPP project land may have been made available through an administrative contract such as a "land concession" or other precarious right of use and is land within the public domain.