Transcript Document 7204720

Meeting the Challenge of Public Private Partnerships and
Project Infrastructure Construction
Roger D. Stark
Partner, K&L Gates
1601 K Street N.W.
Washington DC 20006-1600
[email protected]
202/778-9435
DC-#1010156 v1
Cynthia M. Weed
Partner, K&L Gates
925 Fourth Avenue, Suite 2900
Seattle, WA 98104-1158
[email protected]
206.370.7801
OVERVIEW
2
Summary of Presentation
 Background on P3, public finance and key
paradigms
 Project finance/public finance Structures
 Legal constraints on P3s
 Elements of successful P3s
 Conclusions
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Background on P3s, Public Finance
and Key Paradigms
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What are P3s?
Public-private partnerships (P3s) :
 Combine private sector capital with public
sector commitments (and, sometimes,
capital)
 Procure plant and equipment, improve
public services and/or improve the
management of public sector assets
 Focus on public service results, and
thereby offer a more cost-effective
approach to public sector risk management
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What are P3s? (cont’d)
 Infrastructure Project Need
 Will be used in whole or in part by the general public
or a public agency
 Public Participant – State or state agency/local
government
 Private Participant – joint venture/domestic/foreign
 Is it a partnership?
 Not in the traditional legal sense
 More likely a joint venture or in the alternative a lease
or franchise arrangement
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Combination of public and private finance components
 A formula for success – due to the unique
contributions available from each participant
 Governmental power
 Eminent domain
 Taxing power
 Access to tax-exempt financing
 Private strengths
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Construction expertise
Equity investor
Private procurement
Private management
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Key Elements of a P3
 Contracts awarded based on “value for money,” not
lowest bid
 Capital or capital-equivalents provided by public
and private parties
 Reliable, long-term commitments
 Flexibility in structuring contractual arrangements to
best suit the economic, operational and policy goals
of the parties
 Assets with relatively high residual value
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Key Elements of a P3 (cont’d)
 Government support in the form of credit
commitment, concession or other facilitation
 Private capital contributed to the venture earns
returns that may vary based on project risks, project
performance and/or government regulation
 Documentation that commits the government and
the private entities to various project rights and
obligations
 A sustainable “win/win” relationship between
government and private parties
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Vocabulary/Perceptions/Reality
 Private participants financing goal
 Return on investment
 Public participants financing goal
 Obtain asset at lowest cost
 Avoidance of debt limits
 Avoidance of public procurement requirements
 Reality is that the cost or the risks involved have the
potential to reduce or eliminate the perceived
benefits to each side
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“Traditional” Finance Paradigms
 In the corporate world, capital is raised through
equity as well as debt offerings
 In the public sector, capital is raised primarily
through the issuance of long term debt – bonds – in
order to accomplish specific projects. Most public
sector debt has an amortization term of 20-30
years; most debt is amortizing – often on a level
payment basis
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Recent Developments
 Increased Budget Constraints at the
Federal, State and local level
 Mistrust of merchant projects/market
projections
 Degradation of municipal credit quality
 Heightened attention to regulatory and
political risks
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Structural Paradigms
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Municipal Finance
 General Obligation Municipal Bonds (tax
exempt, indenture trustee)
 “Private Activity” Revenue Bonds
 Lease Purchase
 Certificates of Participation (“nonappropriation risk,” “essential services”)
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Tax-Exempt Financing
 Debt issued at lower interest rates, because the
recipient does not include the interest in federal
gross income
 The structure of the debt is limited primarily by state
law. Debt may be fixed rate, variable rate, auction
rate, credit enhanced, un-credit enhanced, senior or
subordinate lien
 Bond insurance used to be a major factor in project
financing and public private partnerships
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Tax-exempt lease purchases
 Public partner enters into a long term agreement:
 Providing for payments over time
 (if the lease is securitized, payments will generally be
semiannual, with annual principal payments)
 Public participant has management of and control
over the asset during the term of the lease
 At the end of the lease term, public partner may
acquire title to the property
 Title may be in the form of a condominium ownership
interest
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Conduit Financing
 The public partner may participate as an issuer of debt solely to
provide access to tax exempt financing
 Public partner does not provide any direct financial support (i.e.
taxes, revenues other than project revenues) to the project
Bonds
Government Issuer
Trust agreement
Proceeds to pay cost
Project
Revenues from project
Bond proceeds
Bond Repayments
Trustee
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Investors
Conduit Financing
 Risks
 Construction Risk
 Revenue Risk
 Acts of God
 Mitigating Factors
 Private Partner Guarantee
 Bond insurer (used to be)
 Contingent Guaranties
 Letter of credit
 Surety Bonds
 Government contingent guaranty
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Partnership Financing

The public partner may participate not only as an issuer, but also with a source
of governmental revenues – governmentally imposed
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Special excise taxes
Customer facility charges
Incremental tax revenues
Utility revenues (special revenues)
Bonds
Government Issuer
Govt. revenues
Bond proceeds
Trust agreement
Proceeds to pay cost
Project
Bond Repayments
Trustee
Revenues from project
(may be secondary or absent)
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Investors
Partnership Financing
 Risks
 Security of Govt. Revenue Source (how critical)
 Mitigating Factors
 Back up Guaranty from govt. entity
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Project Finance
 Firm, long-term revenues
 Mitigation of market and regulatory risks
 Fixed price, on-time, at-spec EPC to
mitigate construction risks
 O&M Agreement to mitigate operating risks
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63-20 Financing Option
What it is: A mechanism created under federal tax
law (Rev.Rul. 63-20; Rev. Proc. 82-26) that permits
nonprofit corporations to issue tax-exempt debt
How it works: Nonprofit corporation established
under state law issues tax exempt bonds; proceeds
used for a desired project; the nonprofit corporation
is obligated to repay the debt from identified and
pledged sources
Applications: Unlimited, but particularly helpful in the
P3 context
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Privatization Models
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Concession of public services
Build/Own/Transfer
Sale/Leaseback
“Contracting Out”
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UK Private Finance Initiative (“PFI”)
 Project Company/“OpCo”/D&B Contractor
 Project Agreement defines
construction/operation results and pushes
various commercial and financial risks down to
private sector participants
 “Private consortia, usually involving large
construction firms, are contracted to design,
build, and in some cases manage new projects.
Contracts typically last for 30 years, during
which time the building is leased by a public
authority.”
UK Dept. of Health Website:
http://www.dh.gov.uk/ProcurementAndProposals/PublicPrivat
ePartnership/PrivateFinanceInitiative/fs/en
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Sponsors
Guarantees or
Support
Funding Company
Collateral
Agent
Equity Investment
Shareholders Agreement
Paying
Agent
Passive Equity
Investors
Senior Lenders
Term Notes
-Banks
-Public
-Institutional
Investors
Bank Revolver/LC
Facility
Legal Counsel
Independent Engineer
Market Consultants
Insurance Consultant
Subordinated Lenders
Parent Guarantor
Warranties
Performance Guarantees
Insurers
EPC Contractor
Project Input Contract
Project Company
Fixed Price
EPC Contract
Equipment and
Material Suppliers
Parent Guarantor
Subcontractors
Supplier
Parent
Guarantor
Legal Counsel
Design Engineer
Offtake
Purchaser(s)
Investment
Banker
Revenue Modeler
O&M Provider
O&M Agreement
Offtake Agreements/
Concessions/Project Agreements
Accountants
Rating
Agency(ies)
Subsidiary Infrastructure
(e.g., rights-of-way)
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Typical PFI Structure
Lender’s Direct
Agreement
Procuring Authority
Project Agreement
Project Company’s
Shareholders
Project Company
Loan and
Security
Documents
Project Company’s
Lenders
Operating
Contractor
D&B
Contractor
Key:
= contract
= flow of money
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Risk Mitigation Paradigms
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Risk Mitigation (Lender Goals)
 Mitigation of Construction Risk
 Reliable cash flow/credit quality—off-take
and Concession Agreements (nonappropriation risk?)
 Mitigation of market risks
 Mitigation of political risk (“essential
service”?)
 Bilateral contracts that integrate market
requirements and mitigate market risks
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Documentary/Risk Mitigation Paradigms
 Off-take Agreements
 Service Contracts (aka “Project
Agreements”)
 Concession Agreements
 Construction (EPC/Design Build) and O&M
Agreements
 Credit Facility Documentation (“renting
money”)
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Key P3 Objectives
 Enhance capital sources for creating new and
improving existing infrastructure
 Promote efficiency in infrastructure development
and execution
 Leverage existing assets and future cash flows to
facilitate capital formation and respond to pressing
infrastructure needs
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P3 Risks
 Political, regulatory and change of law risk
 Additional costs of project oversight, documentation
and execution may exceed savings from efficiencies
 Market projections fail to pan out
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Transaction Risk Matrix
Allocation of Project Risks/Burdens
Financial Structure
Development
Construction
Financing
Permitting
Project
Operation
Municipal Finance
GC Entity
GC Entity
GC Entity
GC Entity
GC Entity
Project Finance
Sponsors
EPC contractor,
project entity,
sponsors
Project entity
and sponsors
Sponsors, EPC
Contractor
O&M
contractor,
project entity,
sponsors
Privatization
Transaction
Specific
Transaction
Specific
Transaction
Specific
Transaction
Specific
Transaction
Specific
PFI
Project
Company
Design/Build
Contractor
Project
Company
Project Company,
Design/Build
Contractor
Project
Company
GC Entity= Government controlled entity
Project Company= Privately controlled entity
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Design
Bid
Build
Private
Contract
Fee
Services
Design
Build
Long
Term
Lease
Agreement
Build
Operate
Transfer
(BOT)
PUBLIC Responsibility
Design
Build
Finance
Operate
(DBFO)
Build
Own
Operate
(BOO)
PRIVATE Responsibility
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Other
Innovative
PPPs
Legal Constraints on P3s
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Legal Constraints on Public Private Partnerships
 Legal constraints generally arise as a result of the
participation of a “public partner”
 Why? -- Unlike private enterprise, public agencies are
entirely creatures of state law. They have only those powers
that are granted by a state constitution and by the state
legislature.
 The power of a state legislature is plenary
 The state constitution is the citizens’ limitation on the powers of
a state legislature
 As a result, any party dealing with a public agency is required to
be aware (to an extent not contemplated in the private sector) of
the constraints of state and local law. Any exercise of power by
a local government beyond its express grant of authority (or that
necessarily implied) is void. Let the private party beware.
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Lending of Credit
 Most often (but not always) found in a State Constitution.
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In order to protect the taxpayers from their elected representatives
Prohibits gifts of public funds to private parties
Prohibits lending of public credit to benefit private parties
Prohibits the acquisition of stock
 Effect of limitation
 Generally limits the ability of a public agency to be a “partner” with
private enterprise
 Prohibits public agency from guaranteeing the performance of what is
essentially a private function
 The public agency is limited in its ability to participate in the “upside”
and the “downside” of a business venture
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Procurement Rules
 One of the goals of a public private partnership may
be to lower the cost of the project that would
otherwise be subject to public procurement
requirements
 Incidentally, many public projects are intertwined
with private functions. E.g., a public library and city
hall amid retail shops; a hotel adjoining a public
convention center, a public museum built as an
integral part of a bank headquarters
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Public Procurement Requirements
 Traditional public works requirements are primarily set forth
as state legislative requirements (or local procurement codes)
 Design, bid, build –with the emphasis on “bid”
 The public agency is required to accept the lowest bid
 The concept of “lowest cost” being attached to lowest bid has
been overtaken with
 Prevailing wages
 Change orders at the expense of the governmental owner
 Recognition that the “bid” is not the actual cost to be paid by the
owner, as the owner is not able to make design changes in order to
keep costs within “budget”
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Federal Tax Constraints
 Tax exemption is a benefit that carries with it certain
constraints
 Unlike a private financing where the lender may have full control
with respect to the property/the project pledged, the federal tax
rules related to tax exempt financing may require that the “use”
of the property be limited to a “permitted tax exempt use”
 Failure to comply with those federal tax rules will jeopardize the
tax status of the project debt – and any action that eliminates the
tax exemption will correspondingly eliminate a favorable
financing cost
 The access to or requirement to maintain federal tax exemption
will affect project feasibility analysis. A project that is financially
viable without regard to the continued maintenance of tax
exempt financing is a stronger project from a credit perspective.
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Additional Federal Tax Constraints
 The IRC will limit the availability of federal tax
benefits
 Projects that are financed on a tax exempt basis will
not be eligible for depreciation entirely, or at a
minimum, not on an accelerated basis – on the tax
return of the private party
 Private participants will pay particular attention to all
federal tax aspects of their role in a public private
partnership. Access to tax-exempt financing may
not be financially preferable to other tax benefits.
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The Role of Government
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Checklist for Government Support Arrangements
 Determinable Tax
 Mitigation of Change of Law
Liabilities (“PILOT”
Risks
Agreements)
 Mitigation of Uninsurable
 Credit Support for
Force Majeure Risks
Governmental Obligations
 Priority or Parity on State Assistance in Obtaining
Controlled Transportation
Governmental
Facilities (e.g. port facilities)
Permits/Approvals
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Assistance in Obtaining Governmental Permits/Approvals
 Defining the Scope of Necessary
Permits/Approvals/Regulatory Exemptions
 Government Support to Facilitate
Processing of Approvals (e.g., NEPA “lead
agency” status)
 Applicability to Extensions and Renewals
 Combine with due diligence of
procurement rules and
Franchise/Concession Requirements
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The Way Forward: Role of Government
 Traditional Government Financing
 Governmental grants/Revolving Funds/“6320” corporations to attract private capital
 P3 Structures
 Transaction-specific innovation
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Why do P3s succeed and why do they fail?
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
Politics/philosophical misunderstandings and differences
The public/private universe is comparing Venus to Mars
 Constituency: Shareholders (or private owners in a non-public owners) vs. the
general public
 Control: State legislature v. shareholders
 Motivation: General (and often unrelated) political issues (affecting the public
partner) v. Internal political issues (affecting the private partner)
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Sunshine Effect
 Negotiations with a public partner invite public scrutiny
 Public records issues
 Public notice and public hearing requirements
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Motivations of the parties negotiating may not be different; however, the reward
systems are different
When parties who are not similarly situated are negotiating, the probability of
miscommunication is enhanced and the opportunities for mistrust and
negotiation breakdown escalate
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Conclusions
 Estimated infrastructure needs in the
hundred of billions of dollars
 Without suitable mitigation, structural, legal,
and regulatory risks may reduce flow of
private capital to infrastructure projects
 Existing paradigms must be adapted to
accommodate changes in the market
 Governmental support central to attracting
private investment
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Speaker Bios
Roger Stark (Washington, D.C.) concentrates his practice on a wide variety of domestic and
international energy and infrastructure transactions. His experience includes complex project
and structured financings, mergers and acquisitions, privatizations and all manner of commercial
agreements relating to energy and infrastructure. Building on over 10 years of domestic practice
involving projects in 12 U.S. states, he has worked in over 25 foreign countries and is fluent in
Spanish and proficient in Portuguese.
J.D., Vanderbilt Law School (1984), B.A., Queens College of the City University of New York
(1981)
+1.202.778.9435
[email protected]
Cynthia Weed (Seattle) has nearly 30 years of public finance experience and has worked on a majority of
the private activity bonds issued in Washington since they were authorized by statute in 1981. She has
collaborated on notable public/private projects including the following in Washington state: Tacoma Narrows
Bridge (a historical engineering fete financed by approximately $800 million in tax-exempt bonds); Safeco
Field ($500 million Seattle Mariners baseball stadium financed through general obligation bonds issued by
King County backed by several non-voted public tax sources); Pacific Place and Related Development ($500
million plus privately financed multi-block redevelopment of the downtown Seattle retail core); and Seahawks
Stadium (new $500+ million NFL football stadium financed through $300 million in bonds issued by the State
and at least $130 million in private funds (from billionaire Microsoft co-founder, Paul Allen). In addition, she
has worked on numerous urban center and port renewals (multi block development with various civic, retail
and residential development projects).
J.D., University of Missouri (1978), B.B.A. University of Wisconsin (1969)
+1. 206.370.7801
[email protected]
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Questions?
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