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 Contracting Authority can face the following risks on expiry or termination of the concession period:

(a) uncertainty about the type and timing of transfer of the assets (either back to the Contracting Authority or to a replacement Private Partner);

(b) re-delivery of poor condition or out-of-specification assets;

(c) receiving inadequate compensation for non-performance and early termination (if applicable);

(d) inability to obtain the benefit of supply/manufacturer warranties; and

(e) other related political and public relations issues.

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 may be entitled to claim compensation for its losses;

(2) Non-default termination - if the Contracting Authority chooses to terminate, the Private Partner may be entitled to claim compensation for its losses; and

(3) Private Partner default - no compensation payable unless set out in the regulatory regime.

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

The primary mitigant is that termination rights will be limited in a regulated gas market context and the parties will rely upon the regulator and the protections built into the regime.

The Contracting Authority should ensure that there is no uncertainty about the Private Partner's obligations at the end of the concession period (due to expiry or termination).

These matters can be addressed in the concession agreement and should deal with redelivery obligations, compensation (either on a net book value or present market value basis), access to warranties and guarantees and transfer of operation and maintenance know-how.

In some developed markets there may be step-in rights granted to Lenders although this is rare in the context of regulated gas markets.

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

In most circumstances these will be limited. In most circumstances these will be limited.

Comparison with Emerging Market

In most developed markets the gas market regulations will not include detailed termination compensation provisions and the Private Partner and the Contracting Authority will rely upon the relevant laws and general investment protection.

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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 Contracting Authority can face the following risks on expiry or termination of the concession period:

(a) uncertainty about the type and timing of transfer of the assets (either back to the Contracting Authority or to a replacement Private Partner);

(b) re-delivery of poor condition or out-of-specification assets;

(c) receiving inadequate compensation for non-performance and early termination (if applicable);

(d) inability to obtain the benefit of supply/manufacturer warranties; and

(e) other related political and public relations issues.

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, termination costs, equity and expected equity returns; equity may be limited to a certain number of years from the date of termination;

(2) Non-default termination - the Private Partner would get senior debt, termination costs, equity and (in some cases) a portion of expected equity returns; and

(3) Private Partner default - the Private Partner would seek to get senior debt and termination costs.

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

The Contracting Authority should ensure that there is no uncertainty about the Private Partner's obligations at the end of the concession period (due to expiry or termination).

These matters can be addressed in the concession agreement and should deal with redelivery obligations, compensation (either on a net book value or present market value basis), access to warranties and guarantees and transfer of operation and maintenance know-how.

A further 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 covenant risk of the Contracting Authority 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 Authority's payment obligations.

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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