Force majeure risk

Water Desalination Water Desalination

Description (What is the Risk)

The risk that unexpected events occur that are beyond the control of the parties and delay or prohibit performance.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

Force majeure is a shared risk and there will be a fairly well developed list of events that entitle the Private Partner to relief.

Typical events could include:

- natural force majeure events, which typically can be insured (e.g. lightening, fire, earthquake, tsunami, flood, cyclone, or other natural calamity/act of God, epidemic or plague, accidents or explosions etc), and

- other force majeure events which typically cannot be insured (often described as 'political force majeure' events) (e.g. war within the jurisdiction, strikes / protest, terrorism, riots etc).

The Private Partner will generally be entitled to an extension of time (but sometimes only over an agreed threshold) and additional costs only in the event of a political force majeure, but an extension of time only in the event of a natural force majeure.

Force majeure events occurring during construction will also cause a delay in revenue commencement. The ability of the Private Partner to bear this risk for events of 'political force majeure' will be limited, and the Contracting Authority will typically have to bear the risk after a certain period of time or level of loss has been exceeded.

During the operation period, the impact of the force majeure will depend on whether the force majeure is 'natural' or 'political'. In the event of natural force majeure, the Private Partner would be entitled to the tariff to the extent of its availability. In the event of a political force majeure event, the Private Partner would be entitled to the tariff on the basis of the availability of the plant as tested by the last availability test.

In the event of a prolonged force majeure event, the Contracting Authority would generally have the right to terminate. The Private Partner would generally expect to receive more equity return than for termination for a 'natural' force majeure event.

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

Project insurance (physical damage and loss of revenue coverage) is the key mitigant for force majeure risks that cause physical damage.

On availability based projects, the risk of disruption as a result of no-fault events could be mitigated by relaxing the performance thresholds (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 some jurisdictions the project may be subject to abatement but not excused from non-performance/breach.

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

Generally speaking, where parties are unable to agree on a way forward following a force majeure event, an amount of compensation should continue to be payable by the Contracting Authority to the Private Partner in order to service the Private Partner's debt obligations during the course of the event. Where the project is terminated, in some jurisdictions the Contracting Authority may be required to fully compensate the Private Partner for debt owed to the lenders. Whether the debt will be kept whole in such a scenario, will be a key area of focus for prospective lenders as part of their initial credit assessments.

Comparison with Emerging Market

On developed market transactions, the Contracting Authority typically compensates the Private Partner, only for its outstanding debt (but not for its expected rate of return) for termination arising from a 'natural' force majeure.

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Description (What is the Risk)

The risk that unexpected events occur that are beyond the control of the parties and delay or prohibit performance.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

Force majeure is a shared risk and there will be a fairly well developed list of events that entitle the Private Partner to relief.

Typical events could include:

- natural force majeure events, which typically can be insured (e.g. lightening, fire, earthquake, tsunami, flood, cyclone, or other natural calamity/act of God, epidemic or plague, accidents or explosions etc), and

- other force majeure events which typically cannot be insured (often described as 'political force majeure' events) (e.g. war within the jurisdiction, strikes / protest, terrorism, riots etc).

The Private Partner will generally be entitled to an extension of time (but sometimes only over an agreed threshold) and additional costs only in the event of a political force majeure, but an extension of time only in the event of a natural force majeure.

Force majeure events occurring during construction will also cause a delay in revenue commencement. The ability of the Private Partner to bear this risk for events of 'political force majeure' will be limited, and the Contracting Authority will typically have to bear the risk after a certain period of time or level of loss has been exceeded.

During the operation period, the impact of the force majeure will depend on whether the force majeure is 'natural' or 'political'. In the event of natural force majeure, the Private Partner would be entitled to start receiving the tariff to the extent of its availability. In the event of a political force majeure event, the Private Partner would be entitled to start receiving the tariff on the basis of the availability of the plant as tested by the last availability test.

In the event of a prolonged force majeure event, the Contracting Authority would generally have the right to terminate. The Private Partner would generally expect to receive more equity return than for termination for a 'natural' force majeure event.

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

Project insurance (physical damage and loss of revenue coverage) is the key mitigant for force majeure risks that cause physical damage.

On availability based projects, the risk of disruption as a result of no-fault events could be mitigated by relaxing the performance thresholds (e.g. requiring a lower level of availability without incurring performance penalties).

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

See comments on the risk of uninsurability for a Desalination Plant projects in emerging markets.

Comparison with Developed Market

On emerging market transactions, the Contracting Authority often does not provide any compensation for termination arising from a 'natural' force majeure, on the grounds that this should be insured. In the event of prolonged force majeure, the Contracting Authority will be entitled to terminate.

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