Early termination (including any compensation) risk

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Description (What is the Risk)

The risk of a project being terminated before the expiry of time and the monetary consequences of such termination.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

The level of compensation payable on early termination will depend on the reasons for termination and typically for:

(1) Contracting Authority default - the Private Partner would get senior debt, junior debt, equity and a level of equity return;

(2) Non-default termination - the Private Partner would get senior debt and equity repaid (less receipts); and

(3) Private Partner default - (a) Where the project cannot be retendered (due to political sensitivity or a lack of interested parties) the Private Partner would typically be entitled to an amount equal to the adjusted estimated fair value of future payments, less the costs of providing the services under the project/concession agreement. (b) Where the project can be retendered, the Private Partner would be entitled to the amount that a new private partner would pay for the remaining term of the concession, less any costs incurred by the Contracting Authority during the retendering process.

It is common under Colombian PPP projects structure, that due to Private Partner default the contract liquidation balance sheet turn out negative. This is due to the fact that fines and penalty clauses are applied when the Private Partner is in default and are usually discounted when an administrative lapsing occurs. In addition to this, it is not common that the Contracting Authority recognizes early termination payments to the Private Partner regarding future income loss, when the early termination is caused by a Private Partner default. Additionally, a key aspect under Colombian PPP project scheme is that early termination payments are not calculated based on the outstanding debt payment. Nevertheless, early termination payments are the general rule, and as such it includes the payment of all the works entered into by the Private Partner not yet paid by the Contracting Authority.

It is common for the senior debt and hedging termination costs to be paid by the Contracting Authority, and for rights of set-off below that figure to be restricted in every scenario other than Private Partner default. In this scenario compensation from the Contracting Authority will typically be in a range between 100% and 95% of the senior debt and hedging termination costs. While it may seem that project lenders are therefore not significantly exposed to a project default, they would not always have the right to call for a termination in these circumstances, and so they are still motivated to make the project work to recover their loan if the Contracting Authority chooses not to exercise its termination rights.

Mitigation Measures (What can be done to minimize the risk)

A key mitigant is to make sure the termination triggers are not hair triggers and that there are adequate well-defined routes for each party to remedy any alleged default.

Government Support Arrangements (What other government measures may be needed to be taken)

The lenders will require direct agreements/ with the Contracting Authority giving the lenders step-in rights in the case of the Contracting Authority calling a default termination or in the event of the Private Partner being in default under the loan documentation. The lenders would typically be given a grace period to gather information, manage the project company and seek a resolution or ultimately novate the project documents to a suitable substitute concessionaire.

Comparison with Emerging Market

Early termination compensation is well defined and political risk insurance is not typically obtained due to a lesser risk of the Contracting Authority defaulting on its payment obligations.

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Description (What is the Risk)

The risk of a project being terminated before the expiry of time and the monetary consequences of such termination.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

The level of compensation payable on early termination will depend on the reasons for termination and typically for:

(1) Contracting Authority default - the Private Partner would get senior debt, equity and a level of equity return;

(2) Non-default termination - the Private Partner would get senior debt and equity repaid (less receipts); and

(3) Private Partner default - the Private Partner would typically get a payment that is a function of the input cost of the project (construction value / book value) or the outstanding senior debt.

In many emerging markets it is common for the senior debt and hedging termination costs to be paid by the Contracting Authority, and for rights of set-off below that figure to be restricted in every scenario other than Private Partner default. In this scenario compensation from the Contracting Authority will typically be in a range between 100% and 95% of the senior debt and hedging termination costs. While it may seem that project lenders are therefore not significantly exposed to a project default, they would not always have the right to call for a termination in these circumstances, and so they are still motivated to make the project work to recover their loan if the Contracting Authority chooses not to exercise its termination rights.

Mitigation Measures (What can be done to minimize the risk)

A key mitigant is to make sure the termination triggers are not hair triggers and that there are adequate well-defined routes for each party to remedy any alleged default.

Government Support Arrangements (What other government measures may be needed to be taken)

The risk of the Contracting Authority not paying the compensation on termination may require a guarantee from a higher level of Government to guarantee the level of compensation payable on termination.

The lenders will require direct agreements with the Contracting Authority giving the lenders step-in rights in the case of the Contracting Authority calling a default termination or in the event of the Private Partner being in default under the loan documentation. The lenders would typically be given a grace period to gather information, manage the project company and seek a resolution or ultimately novate the project documents to a suitable substitute concessionaire.

Comparison with Developed Market

In emerging markets, there may also be sovereign guarantees which support the Contracting Authorities payment obligations or central bank undertakings to make foreign currency available.

Political risk insurance may be available and is likely to be sought to cover the risk of the Contracting Authority or Government guarantor defaulting on its payment obligation.

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