This article is part of the PLC multi-jurisdictional guide to Construction and Projects. For a full list of jurisdictional Q&As visit www.practicallaw.com/constructionhandbook.
The American Society of Civil Engineers published its annual infrastructure report, estimating that the United States (US) must spend hundreds of billions of dollars to repair, replace or expand its infrastructure. US General Accounting Office and US Federal Highway Administration studies agree with those estimates.
Federal, state and local government spending cannot provide all the necessary funding. Public private partnerships (PPPs) are emerging as an alternative source of infrastructure funding. Although they can take many forms, PPPs are used to construct and operate facilities that would usually be built and operated by a government agency. These projects include toll roads, bridges and tunnels, power projects, water and sewage treatment projects, hospitals and schools.
Offshore firms previously participating in projects elsewhere in the world must adapt to the way PPPs are addressed in the US. The requirements for PPP vary among the US states: participating in a PPP in California will not necessarily prepare a party to participate in a PPP in Texas.
This chapter focuses on toll roads, as they are the most visible PPP projects in the US, and discusses the:
Structure of PPPs, including a definition of PPP, the parties to the PPP team and the types of concessions.
Current legal framework for the use of PPPs.
Public policy considerations, describing the different approaches taken in the US.
Allocation of risk and compares it to more traditionally financed public projects.
PPPs can be used in many ways to suit many needs. The National Council for Public Private Partnerships defines PPP as:
"…a contractual agreement between a public agency (federal, state or local) and a private sector entity. Through this agreement, the skills and assets of each sector (public and private) are shared in delivering a service or facility for the use of the general public. In addition to the sharing of resources, each party shares in the risks and rewards potential in the delivery of the service and/or the facility."
PPPs allow governments to build projects for which funding may not otherwise be available. They also allow private investors to tap potentially lucrative sources of revenue while meeting a public need.
Private investors frequently form a separate corporate entity or limited liability company (LLC), usually as a special purpose entity (a concessionaire). The concessionaire contracts with the public agency for the long-term right to build, operate and obtain the revenue from the completed project (a concession) (see box, Typical structure of a PPP project).
The concessionaire engages all of the other participants in the project and bears the risk related to this. Other participants frequently include:
Lenders and investors who provide funding.
An engineering and design firm to design the project.
A construction company and various trade subcontractors to build the project (the construction company often serves as the design/builder for the project, as design/build project delivery mechanisms are becoming more prominent in the US construction market).
An operations and maintenance (O&M) company to operate the completed project and to maintain it throughout the life of the project.
It is not unusual for the construction company and the O&M company to participate in the project as investors. In addition to traditional lending and investments by PPP team members, infrastructure funds have recently developed as sources of funding. Private equity firms established these specifically to invest in infrastructure projects.
PPP projects can be used on brownfield sites or greenfield sites:
Brownfield. This is typically an existing project that may require modernisation or expansion. The concessionaire may sign only an operating and maintenance agreement, under which the concessionaire has the:
right to operate the project for a specific period;
responsibility for maintaining the project.
Alternatively, the concessionaire can lease the facility, and operate and maintain it. Payments can be structured in several ways:
the concessionaire can pay a significant lump-sum payment to the public agency and keep the tolls generated;
the public agency can receive the tolls and pay the concessionaire an agreed sum monthly or annually (availability payments). Availability payments are based on the project being 100% available for public use. There are stipulated reductions in the payments whenever the availability of the project falls below 100%.
The Chicago Skyway and the Indiana Toll Road are two recent examples of brownfield project concessions.
Greenfield. These projects are usually design, build, operate and maintain arrangements. The concessionaire builds the new facility, retains all or a portion of the tolls, and turns over the facility to the public agency at the end of the concession. Two Texas projects, SH-121 and SH 130, are recent examples of greenfield projects.
The Capital Beltway Hot Lanes Project in the Washington, D.C., metropolitan area, is a hybrid of brownfield and greenfield projects. It is a managed lanes project, under which the concessionaire is building new high occupancy toll lanes within the right of way of the toll-free Capital Beltway. The concessionaire sets and collects tolls based on travel times, congestion and number of occupants in the vehicles. Users can choose the new lanes and pay a toll, or continue to travel toll-free on the Capital Beltway. At the end of the concession the project will be turned over to the Virginia Department of Transportation.
The projects eligible for PPPs are governed by the laws of the states in which they are located. 23 states and the territory of Puerto Rico currently allow PPPs. (A survey of the current state laws governing PPPs can be found on the Federal Highway Administration's (FHWA) website, www.fhwa.dot.gov.) The FHWA offers model legislation for states to consider. However, state laws differ in relation to many of the key provisions that affect how PPPs are:
Allowed to operate.
These laws vary widely and any party seeking to participate in a PPP must be thoroughly familiar with the requirements of the laws in the state where the project is located. For example, some states:
Can accept unsolicited proposals while others must solicit proposals for particular carefully defined projects.
Establish agencies or authorities that act only with regard to toll facilities while others empower their Departments of Transportation to award and administer PPPs.
Address PPPs with legislation while others use their regulatory power.
Are limited to specific pilot projects while others are not so limited.
Provide by statute or regulation limits on tolls/user fees, rates of return on investment and similar issues while others address those issues only in the concession agreement.
The provisions of these statutes and regulations can have a significant impact on the success or failure of a PPP project.
As more state and local governments recognise PPPs' potential, more scrutiny focuses on public policy considerations that could or should govern PPPs, to better protect the public interest. In England, Europe and Australia, there are a variety of formal mechanisms to evaluate PPPs before they are awarded. This is to ensure that the public interest, governments and taxpayers are properly served by concessions that may both:
Last from 25 to 99 years.
Have a substantial impact on parties affected directly and indirectly.
GAO Report. At the request of the US Congress, the US Government Accountability Office (GAO) performed a study on current and proposed PPP projects in the US, and examined the use of PPPs in England, Europe and Australia. The GAO issued its report in February 2008 ("Highway Public-Private Partnerships: More Rigorous Up-Front Analysis Could Better Secure Potential Benefits and Protect the Public Interest" (GAO-08-44; GAO-08-1149R) (GAO Report)). The GAO Report reviewed:
The benefits, costs and trade-offs of highway PPPs.
How public officials have identified and acted to protect the public interest in these arrangements.
The federal role in highway PPPs and potential changes in this role.
It is expected that the GAO Report and its recommendations will affect the way states approach PPPs in the future.
FHWA Report. The Federal Highway Administration (FHWA) has taken a leading government role in encouraging states to consider using PPPs for their transportation infrastructure needs. The FHWA is an excellent resource for state and local governments on PPP issues. In January 2009, the FHWA issued its Public Policy Consideration in Public-Private Partnership (PPP) Arrangements (FHWA Report).
The FHWA Report identified 14 issues (see below) to be considered for PPP projects. It is expected that states will consider the issues raised in the FHWA Report as they enact additional legislation or modify existing regulation. These issues will both:
Likely be addressed in solicitations for PPPs.
Influence public agency negotiations of concession agreement terms and conditions.
Therefore, prospective concessionaires should carefully review all statutes and regulations applicable to a project to see if they address these issues. If the statutes and regulations are silent, prospective concessionaires should address these issues in the terms and conditions of the concession agreement.
Public agencies recognise the need for limits on toll rate increases to satisfy taxpayers. The PPP project is often the preferred transportation route in an area, giving the concessionaire potential monopoly power. Unrestricted toll rate increases would be unacceptable to the public.
Public agencies also recognise the need for the concessionaire to be able to service its debt and provide a reasonable rate of return for its investors. Therefore, toll rate increases are usually addressed in the concession agreement. Mechanisms such as higher rates during periods of congestion to control traffic and tying increases to economic indices have been used. Alternatively, the ability to raise rates has been tied to formulas intended to limit the rate of return on the concessionaire's investment (page 6, FHWA Report).
PPPs are only attractive to the private sector if investors can earn a reasonable rate of return on their investments, considering the risks of the project and the term of the investment. Public agencies use several approaches to address this issue:
Limiting toll amounts. This involves limiting toll amounts and placing strict requirements on maintenance standards.
Solicitations. Public agencies that use solicitations for projects rely on competing proposals to reduce rates of return. They then cap the rate in the concession agreement.
Availability payments. These can be used to control return. Offerors compete on a variety of issues, including the amount of the availability payments that the public agency makes in exchange for 100% availability of the facility. Availability payments are then the concessionaire's sole source of revenue and the toll revenue is paid to the public agency. This approach places greater risk on the winning concessionaire, who must operate the project very efficiently to maximise its rate of return. However, the risk that toll revenues are less than projected becomes the public agency's risk. The rate of return is not usually capped with this arrangement.
Revenue sharing. Revenue sharing can be used to control return. The public agency receives either:
a portion of the toll revenue during the project;
all of the toll revenue beyond a certain fixed sum each year.
On the Dulles Greenway Project in Virginia, the Virginia Department of Transportation originally used a public utility rate setting mechanism. This involved the concessionaire proposing toll rate increases and participating in public hearings (in the same way in which electric and gas utility companies do). Rate increases were not assured and political risk (public opinion) became a factor in contract negotiation. Virginia no longer uses this method.
Concession terms of US projects have ranged from 25 to 99 years. Some states have statutes limiting the term. Other considerations affecting the term may include:
The time needed to recover the cost to build, operate and maintain the facility with a reasonable rate of return.
Relevant tax laws and the ability to depreciate assets.
Changes in consumer demand for the facility, including the development of newer, potentially competing facilities.
Some concession agreements provide the parties with the ability to extend the term, for example, if traffic volumes are lower than projected (which affects the total revenue earned). Significant financial analysis is required on both sides before a concession agreement is executed.
Public agencies should evaluate a project to determine whether traditional public financing would result in a better financial result for the state than using a PPP. Public agencies must satisfy state legislators and taxpayers that they are properly meeting their obligations to protect public assets and the public treasury. Public agency decision-making is subject to intense scrutiny. Awarding a PPP to a private contractor could be criticised as giving away a public asset for too small a public benefit.
Agencies must undertake a sophisticated financial analysis that weighs all of the relevant factors including the:
Availability of public finance at a reasonable price and within statutory debt ceilings.
Timetable for undertaking required projects.
Revenue that the PPP will generate for the state.
Prospective concessionaires must be aware of these issues because they may result in delays to the award of a concession that could increase the initial costs of investment, proposal preparation and start of revenue.
The public agency must assess whether it would be better to either:
Receive a large payment up front.
Receive a share of the revenue during the course of the project.
This issue primarily affects the public agency. However, the public agency's plans may affect how the concession is structured, so understanding the plans for the proceeds can influence the PPP team's proposal approach.
Factors that influence the decision include:
Whether the public agency can value the revenue stream (existing projects like the Chicago Skyway and Indiana Toll Road have track records to consider compared to a new project).
The use that the public agency has for that large up-front payment.
In some states, statutes require that the agencies' proceeds from the PPP must be:
Paid into a transportation trust fund.
Used to reduce public agency debt.
For mass transit projects in the state.
The Chicago Skyway and the Indiana Toll Road both provided for substantial up-front payments from the concessionaire (US$1.8 billion (as at 1 October 2010, US$1 was about EUR0.7) and US$3.8 billion, respectively). In relation to the Chicago Skyway and the Indiana Toll Road, the agencies invested the payments in other projects and reduced existing transportation project debt.
The public agency must evaluate whether it would be better to use traditional public financing or a PPP for a particular project. England has developed comprehensive guidelines for evaluating this. There are no US state guidelines or requirements in this regard. However, both the GAO and the FHWA suggest approaches, usually driven by the need for the project and the amount of public financing available to pay for it. The cost of public financing must also be considered (page 21, FHWA Report).
Concession agreements typically establish standards for maintaining the facility during the entire term of the agreement. During the early stages of the term the concessionaire readily spends money on maintenance. This is because there is a high likelihood that the investment will be returned, as a facility that functions well will be more attractive to users. The problems usually arise near the end of the concession, when the value of the maintenance appears less important to the concessionaire. Agencies address this issue in several ways:
Agencies may require the concessionaire to either (page 22, FHWA Report):
post a surety bond or a letter of credit; or
establish a cash reserve from toll revenues to cover the cost of repairs that should have been done but were not.
Concession agreements provide the public agency with rights to monitor, inspect and audit the facility to confirm that proper maintenance is being done. Concessionaires should include maintenance costs for the life of the project (and the cost of security instruments) in their projections and address security for maintenance issues in their proposals.
Concession agreements may also provide for expansion of a facility during the term, to prevent the project from becoming obsolete or substantially diminishing in value. Formulas to trigger improvements are usually used. On the Texas SH-130 Project, the concessionaire must both:
create and use a "speed measurement system" to monitor traffic speeds;
provide monthly reports to Texas DOT.
If average traffic speeds diminish indicating that the facility is congested (therefore reaching or exceeding capacity), the concessionaire must expand the facility at its own cost (page 26, FHWA Report).
The concessionaire must return (hand back) the facility in good repair. The concessionaire's incentive to invest money in the project near the end of the term wanes. Concession agreements are usually specific in relation to the facility's condition at the end of the term. Agencies usually require the concessionaire to either:
Post security such as a surety bond or letter of credit.
Establish a cash reserve from toll revenues.
This is to provide resources for the public agency to make repairs if the concessionaire fails to meet its hand-back obligations. These obligations are typically contractual and not pursuant to specific statutes or regulations.
Concessions in the US typically last from 25 to 99 years. It is possible that during the term of the concession a public agency will determine that additional facilities are needed, and those new facilities may or may not be tolled. Facilities that were not planned at the time the concession was awarded could become competitors of the PPP project. The concessionaire often takes this risk, although some concession agreements provide that the public agency will supplement toll revenues if traffic volume is less than the public agency projected during the solicitation process. Additionally, concession agreements may provide for the possibility of extending the term of the concession if the volume of traffic using the facility is less than projected.
There are a number of statutory provisions that address the issue of competing facilities (pages 32 to 39, FHWA Report). For example, California and Colorado statutes prohibit an agreement with the concessionaire that would affect the states' ability to build other projects (CAL. STS. HIGH CODE § 143(d)(3) (2007) and COLO. REV. STAT. 43-3-304 (2007)). A North Carolina statute requires that the North Carolina Department of Transportation (DOT) maintains non-tolled facilities corresponding to the route of a tolled project (N.C. GEN. STAT. § 136-89.197 (2007)). Delaware statutes allow the Delaware DOT to protect PPPs from competition from other Delaware projects (DEL. CODE ANN. tit § 2009 (2008)).
Early PPP projects in the US started with unsolicited proposals identifying a potential project for development. Most states now solicit proposals for specific projects that they have evaluated for development as a PPP. By soliciting proposals agencies have a better chance of obtaining competition for a project. The solicitation process also ensures that bidders address a common set of requirements and obligations.
When proposals are solicited, some of the risks that a concessionaire faces may be eliminated. For example, by preparing a solicitation, the public agency has done some level of due diligence and public inquiry to determine that:
The project is needed.
There is some level of public acceptance.
In addition, the public agency will have completed any required environmental impact study. In the case of unsolicited proposals, the potential concessionaire will need to invest a lot of money, time and effort both:
Identifying a project.
Convincing the public agency that the project is viable.
There may then be substantial public review. The public can oppose the project. All of these things result in a longer term of investment without return and the risk that the investment will be lost if the public agency decides not to proceed on a PPP basis. A further risk is that the public agency may decide to proceed with the project, but only on the basis of a competitive solicitation process.
When a public agency issues a solicitation it has:
Evaluated the need for and viability of the project as a PPP.
Obtained the public's approval through the process of public hearings.
Probably obtained input from potential competitors. This allows it to determine that there will be competition and consider requirements for the project that will maximise that competition (rather than drafting requirements that will favour one offeror to the exclusion of others).
The solicitation is usually a two-step process:
The public agency evaluates the qualifications of concession teams and determines a short list of the most qualified teams.
Concession teams submit detailed technical and pricing proposals that the public agency evaluates.
The public agency can provide stipends for proposal preparation. Unlike the typical state or local design-bid-build project that is awarded on the basis of low price, the PPP award is usually determined on the best value offered, taking both price and technical proposals into account. The winning proposal and the complete final concession agreement become public documents, increasing the transparency of the process and the resulting award.
There is always a risk that the concessionaire will default materially on its obligations or become bankrupt. Therefore:
The concessionaire usually must post some form of security (for example, a surety bond or a letter of credit) as protection for the public agency.
Cash reserves may be established from toll revenues.
Agencies typically address default and bankruptcy in the concession agreement rather than as a result of statutory requirements. Those provisions usually allow the public agency to replace the concessionaire, but may require the public agency to protect lenders' rights to recover amounts loaned from tolls paid on the project.
In relation to the Indiana Toll Road and Chicago Skyway Projects, the concession teams took over existing, functioning facilities with many long-term public employees. Generally, the concessionaires were required to offer those employees comparable positions with comparable compensation and benefits (pages 57 and 58, FHWA Report). In these situations, concessionaires:
Must comply with state and federal non-discrimination and equal opportunity laws.
May be required to comply with statutory minority, women-owned and disabled business enterprise requirements in relation to subcontractors, suppliers or vendors used during the concession term.
Most infrastructure projects are subject to National Environmental Policy Act requirements. Concessionaires are likely to require wetlands permits from the US Army Corps of Engineers. These can only be obtained after the final project design is completed. Therefore, under contract, law and regulation the concessionaries bear at least some of the obligations and risks related to compliance with federal, state and local environmental laws. Additionally, concession agreements usually require the concessionaire to comply with all applicable federal, state and local laws. Failure to do so is likely to be a material breach resulting in a default.
These obligations continue throughout the concession term. The public agency will probably not be responsible for the cost of compliance with future laws or regulations, or changes in current laws that add more stringent requirements. Rather, the concessionaire bears the risk and cost of compliance with new or modified laws and regulations.
The concessionaire must perform due diligence to determine applicable laws. It should also consider negotiating some financial consideration from the public agency if a new or revised law negatively affects the project's cost (page 62, FHWA Report).
PPPs pose risks for all participants:
Investor. An investor must identify a project and submit a proposal to an interested public agency. It must convince the public agency of the value and the viability of the project. Some of this risk is reduced if the public agency solicits proposals for a specific project. Once a project is identified, there is a risk that others will offer competing proposals. Public opinion may affect the award of the project and the public agency's negotiating position.
Public agency. The public agency must deal with the possibility that the project will not be popular or that the terms it gave the concessionaire are perceived to be too generous.
On some projects the public agency must pay the concessionaire if the project does not generate the expected revenue. For example, if there is a shortfall in toll revenue because other public roads projects diverted traffic away from the PPP, the public agency may be required to make up a portion of the shortfall with payments to the concessionaire.
Concessionaire. A PPP may proceed from proposal to completed project faster than a conventional, publicly financed project. However, the time and money that the concessionaire spends (from presentation of a proposal to negotiation and award of the concession contract) is frequently greater than a bidder would spend on a conventional government project. Investors must be prepared to be patient with the process. The concessionaire must take the risk that it can build and operate the project within its cost forecast so that it will make a profit.
The parties to the concession agreement should aim to provide a project that is needed and that provides a reasonable return on investment for the concessionaire. The parties must avoid terms that will result in a windfall for the concessionaire because of the potential significant political consequences. The parties must also avoid a revenue sharing arrangement between the concessionaire and the public agency that eliminates a reasonable return, or worse a financial failure for the concessionaire.
PPPs are successfully used in Europe and Asia to provide needed infrastructure projects when government funding is not available. PPPs should be a valuable supplement to government infrastructure spending in the US to meet its substantial infrastructure needs. While these projects present some unique challenges, they also present opportunities for significant rewards.
Qualified. Maryland, 1979; Texas, 1981 (non-practicing); District of Columbia, 1991; California, 1995
Areas of practice. Construction law - US and international; US government contracts; litigation; arbitration; international arbitration.
Qualified. District of Columbia, 1977; Virginia, 1976
Areas of practice. Construction law - US and international; US government contracts; litigation; arbitration; international arbitration.