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

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 return; 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 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. While it may seem that project lenders are therefore not significantly exposed to a project default, they would not typically 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/tri-partite 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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