A Governance Approach for Managing PPP Renegotiations

Proper project preparation and contract management are keys to successful project implementation. Photo credit: ADB.

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Published: 25 May 2022

Design a framework that minimizes extra-contractual renegotiations and upholds prudence and transparency.

Introduction

The rise of public–private partnerships (PPPs) since the 1990s has helped mobilize more private capital for public infrastructure and services in Asia and the Pacific. However, along with the increase in PPPs has come an increase in contract renegotiations and terminations.

Renegotiation refers to updating or reworking existing contractual provisions. PPPs are long-term contracts, which is why renegotiation is sometimes necessary because costs, policies, and other circumstances change over time. However, this presents a unique risk to the development, implementation, and financing of infrastructure projects as this is susceptible to misuse especially for corrupt purposes. This can also affect the transparency in public procurement.

A prudent approach and a clear framework are needed to protect the interest of the parties involved and the credibility and efficiency of PPP projects. 

Analysis

Achieving the benefits of PPPs in terms of timely and efficient construction and service delivery depends on the quality of project preparation, structuring, procurement, and implementation. However, the incomplete nature of contracts over the long term means that even well-prepared projects may result in renegotiations due to changes in legal, technical, and commercial factors over time. Parties resort to renegotiations to save the project when contract termination would be politically imprudent for the government or may subject the private contractor to negative public perception.

A Global Infrastructure Hub study in 2018 showed that almost a third of PPP infrastructure projects globally were subject to renegotiation. Latin America had the highest rate (58%), and transport was the most affected sector (42%). East Asia and Southeast Asia had the least renegotiation events compared with other regions with 12% and 13%. The study also identified increased construction costs (21%), government policy changes (19%), and changes in tariffs or tariff regulations (16%) as the most common reasons for renegotiation.

Unforeseen circumstances can also affect project implementation and require renegotiation. A case in point is how the coronavirus disease (COVID-19) pandemic is affecting PPP projects in all stages of the development life cycle. The Asian Development Bank (ADB) has released a guidance note, COVID-19 and Public Private Partnerships in the Asia and the Pacific, which presents governance practices that help to mitigate the risks and outlines important considerations for managing PPP projects in a rapidly changing and uncertain situation.

The main problem with renegotiating a contract is that this may reduce the overall economic benefits of PPP arrangements by changing the tendered and agreed risk allocation, construction timeline, and revenue projections. The originally tendered project during competitive bidding might differ materially from the renegotiated project. It puts into question transparency in public procurement. Bidders of the project may challenge the renegotiated contract in court.

There is also the risk of “opportunistic renegotiation” or the misuse of the renegotiation process for corrupt purposes. Governments are often under political pressure to deliver on the promised infrastructure. Following the award of a contract, renegotiations may put power into the hands of the concessionaire and enhance the pressure on the government to continue implementing the project or risk its termination. The concessionaire can take advantage of its strengthened negotiating position outside the original procurement process and impose higher pricing (i.e., monopolistic pricing). An off-balance sheet PPP transaction will exacerbate the pricing power of the private partner especially if there is no public oversight.

When the parties do not reach an agreement to renegotiate the PPP, and a termination occurs, the government often needs to fully compensate the private partners for the debt and foregone earnings from the failed project. The government can decide to form another PPP to implement the project, implement the project on its own, or not implement the project at all. These adjustments are costly. In South Asia, 8% of PPPs result in early termination before the contracts expire. While the rate may not seem high, it has significant economic impact on the stakeholders, including the private sector, the community beneficiaries, and state-owned banks.

Recommendations

Governments should maintain a prudent approach to renegotiations. It is critical to develop standard PPP contracts that include robust contractual provisions that can address and manage project variations and changes (e.g., force majeure, material adverse government actions, changes in law, and dispute resolution mechanism) and their corresponding cost implications.

A good PPP contract limits the use of extra-contractual renegotiations or at least minimizes the process for good faith attempts to salvage a project that is not commercially or technically viable for reasons outside the control of the government and the private partners. The effective use of adjustment mechanisms within a contract can avoid opportunistic renegotiations.

A framework for regulating renegotiations should encompass at a minimum the following: 

  • There should be a competitive tender for additional works not addressed under the PPP agreement scope change provisions.
  • Full justification, especially for cost change, should be approved by a government authority (other than the procuring authority) and be made public.
  • Renegotiations should be banned during the first few years of a contract if institutional frameworks are not well-established or if renegotiation is a persistent problem. 
  • Independent monitors should be involved. The procuring authority should not be able to unilaterally renegotiate a PPP contract.
  • Quality project preparation, structuring, procuring, and contract management should be prioritized to reduce or mitigate the need for renegotiations.

Chile, for example, sought to reduce the frequency with which it was experiencing PPP renegotiations. To address this issue, the government adopted a framework to govern renegotiations. If there are additional costs to the government following contract signing, the Ministry of Finance must approve the amended contract. The Ministry of Public Works (where the concession unit is located) must be able to justify the changes in a public report. If the price increase exceeds 5% of the approved capital works, an open and competitive tender for the new works must be conducted to avoid monopolistic pricing by the contractor. The framework also created an independent technical panel that reviews and authorizes renegotiations. These reforms significantly reduce the frequency of PPP renegotiations.                

David Bloomgarden
Public–Private Partnership Expert

David is a PPP expert with over 30 years of global experience in policy, management, and project design and implementation. As PPP Consultant, he has advised the World Bank (Global Infrastructure Facility) and the Asian Development Bank on infrastructure governance and development of knowledge products on quality infrastructure investments. Prior to his current role, he was the Chief of the Inclusive City Unit of the Inter-American Development Bank.

Hanif Rahemtulla
Principal Public Management Specialist, Sustainable Development and Climate Change Department, Asian Development Bank

Since joining ADB in 2017, Hanif’s focus is on leading and contributing to operational engagements in public investment management for better service delivery. Prior to ADB, he was the senior operations officer at the World Bank Group (2010–2017). He has supported operations in India, Viet Nam, Indonesia, Tajikistan, and Mongolia. He has a doctorate degree from University College London and is a postdoctoral fellow at Canada’s McGill University.

Adrian Torres
Chief of Public–Private Partnership Thematic Group, Asian Development Bank

Adrian Torres has over 23 years of professional experience in public–private partnership transactions. He has performed a variety of roles such as transaction advisor (buy side and sell side), policy advisor, debt provider (sovereign and nonsovereign), and principal investor in several large and complex PPP transactions. He holds a master’s degree in Economics from the University of Sydney and a dual bachelor’s degree in Civil Engineering and Business Administration from RMIT University.

Colin Gin
Assistant General Counsel, East Asia Regional Department and Public-Private Partnership, Asian Development Bank

Colin Gin has over 30 years of professional experience. He provides legal advice on the Asian Development Bank’s (ADB) nonsovereign operations and PPP related projects. He helps ensure that the bank’s operations are consistent with its policies and procedures. He obtained his bachelor’s degree in Law in 1991 and his master’s degree in Commercial Law in 1993 both from the University of Auckland, New Zealand.

Asian Development Bank (ADB)

The Asian Development Bank is committed to achieving a prosperous, inclusive, resilient, and sustainable Asia and the Pacific, while sustaining its efforts to eradicate extreme poverty. Established in 1966, it is owned by 68 members—49 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance.

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