Some of the most heavily negotiated provisions in PPP contracts relate to termination, expiry, and project handover. In this context, "termination" means agreeing to the circumstances related to when a contract may be terminated ahead of its scheduled expiry; "expiry" means whether and (if yes) what payment must then be made by the Authority to the PPP; and "project handover" means agreeing to what condition the assets must be in when they are handed over to the Authority following termination.
The PPP contract should describe in detail the circumstances that allow a party to terminate the contract, and in particular, where the other party has defaulted on its obligations. For it to lead to termination, a breach of contract has to be fundamental in nature and should (where possible) be subject to cure periods. A detailed list of all the breaches that entitle termination should be set out in the PPP contract.
Termination occurs under three conditions.
- Default by the PPP company: Termination for PPP company default is the final stage of a process that starts when a project is failing to perform in accordance with the requirements of the PPP contract. The PPP contract should set out the various circumstances which could trigger such termination, usually including things such as failure to complete construction, persistent failure to meet performance standards, or insolvency of the PPP company. Lenders should be allowed to step in to rescue the PPP project and protect their loan. The authority should permit (and rely on) the lenders to take control of the PPP project in such circumstances. The lenders' right to step in is typically provided for in a direct agreement entered into among the Authority, the PPP company, and the lenders. The PPP contract will be terminated only if lenders choose not to step in, fail in the step-in, or choose to step out of the non-performing project. In these cases, it is reasonable to assume that the PPP company's equity will be lost and no compensation will therefore be payable.
- Default by the authority/voluntary termination: The PPP contract should ensure that the PPP company is not financially harmed if termination occurs as a result of default by the authority or voluntary decision by the Authority. In these circumstances, both the lenders and the equity investors should be fully compensated. While calculating the compensation due to the lenders is relatively easy (e.g., debt outstanding, unpaid interest and fees, and breakage costs as a result of the termination of the hedging agreement), defining the compensation owed to the equity investors can be more complex.
- Prolonged force majeure: PPP contracts normally provide for the possibility for either party to terminate in the case that a force majeure event precludes performance of the obligations for a prolonged period of time. The general principle adopted is that since neither party is at fault, the burden of termination should be shared. The compensation payable by the authority will therefore normally be higher than that owed in the event of PPP company default but lower than that due on authority default. The compensation would normally cover the outstanding debt (and the hedging breakage costs). It may sometimes also cover the value of the equity injected into the project (but exclude any return on that equity).
PPPs are usually structured so that the authority makes no payment to the PPP company when the PPP contract expires at the end of its scheduled term. Termination payments are, however, envisaged upon contract expiry in certain circumstances. A typical case is that of new assets constructed at some stage during the life of the PPP contract as a result of an extraordinary event (this may involve a lump-sum termination payment from the authority). Similarly, where PPP assets have a particularly long life compared to the term of the PPP contract, the payment of a residual asset value upon expiry may be contemplated.
The final task in managing a PPP contract is to manage the transition of assets and operations at the end of the contract term. The approach to this transition should be clearly defined in the contract. This includes defining how quality of the assets will be defined and assessed, whether a payment will be made on asset handover, and how the amount of any payment will be determined. Options include clearly specified handover requirements, or the involvement of independent assessors.
For example, the contract could include:
- indicators of the condition the assets must be in at contract expiry (e.g. expected useful life left for each type of asset, ability to meet certain performance tests);
- a third party assessment of the condition of the assets and of the works to be completed to meet the required standards (such assessment should be carried out by an independent expert sufficiently in advance of the expiry date);
- retentions made from the service fee over a defined period prior to expiry (the proceeds being held as a guarantee in a reserve account); and
- verification by an independent expert that the works required to meet the hand-back conditions have been completed satisfactorily (this could also trigger the release of the retention sums to the PPP company).