PPP Memo PXV Law Partners

8/3/2019 PPP Memo PXV Law Partners

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Draft for discussion purposes onlyNovember 21, 2010

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Legal Regime for Public Private Partnerships in India- An Introduction

Introduction

1. Public-private Partnership (PPP) is a funding model for public infrastructure projectswhich involves delivery of public goods and services through private enterprise and andefficiency. Private participation allows the government to leverage scarce budgetaryresources, retain ownership of the underlying asset and channelize innovation andproject management efficiencies from the private sector. The private party benefits fromenhanced visibility and bankability which comes from government support.

2. In India, PPPs are seen as an important tool for accelerating infrastructure investmentand bridging the infrastructure gap, which is rapidly becoming a key deterrent tosignificant and sustainable economic growth. Since the economic liberalization initiated in

1992, there has been a shift from state ownership of infrastructure resources to a newmode where PPPs and private sector participation is encouraged.

3. However, since the services being provided under the PPP model is essentially of apublic nature, there is a necessity to strike a balance between competing interest ofpublic sector (who have welfare commitments) and private sector players (who havecommercial objectives), particularly with respect to issues such as price of service,service standards, environmental protection, ability to pay and need to use.

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Legal Regime on PPP

4. In India, the development of infrastructure is a prerogative of both the central as well asthe state (federal governments). Therefore both state and central governments take

initiatives for infrastructure development. Sometimes there are overlaps and conflictsbetween the jurisdiction of the central government and state governments. For e.g., in theroads sector, the central government has the right to develop national highways whereastolls and tariffs from road projects is within the jurisdiction of the state governments.Similarly, major ports are under the jurisdiction of the central government whereas allother ports are under the jurisdiction of the state governments.

5. There is no central legislation or rules with respect to PPP in India. PPP in variousinfrastructure sectors is governed by the provisions of legislation in individual sectors (fore.g., the National Highways Authority of India Act, 1996 with respect to road projects andthe Electricity Act, 2003 with respect to power projects, see Table 2) as well as generallegislation such as the Constitution of India, the Indian Contracts Act. 1872, the Sale ofGoods Act, 1930. The existing legal, policy and institutional framework for infrastructure

evidences significant inconsistency in approaches to regulation of infrastructure projectsand the laws and structure vary across different sectors. There are also a bewilderingnumber of agencies which are involved in the decision making process.

1In the case of Flemingo Duty Free v Union of India, WP 617 of 2007, the Bombay High Court held that

operation of the Mumbai airport by Mumbai International Airport Limited (MIAL), a company with privatesector shareholders is subjected to constitutional obligations (which is usually only applicable to governmententities and government companies) since the power exercised by MIAL is in the nature of statutory/ publicfunction. This judgement imposes additional obligations with respect to fairness, equality etc. on MIAL whichit would not generally been subject to since it is a private sector entity and hampers its ability to function as acommercial entity and may discourage private participants in PPP projects. The judgment is currently inappeal before the Supreme Court of India.


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6. In addition some state governments have passed legislation to specifically deal withprivate participation in industry and infrastructure. States also either have individual PPPpolicies or have elaborate procedures to be followed by state agencies for procurementof goods and services and construction of PPP projects.

7. Under the Constitution of India, State and Central Government entities have obligationsto act in a manner which is fair and equitable, even in case of contractual relationships.State actions which are malafide, illegal or irrational can be set aside as being contrary tolaw.

8. In several infrastructure sectors, independent regulators have emerged as the chosenentity for meeting varied objectives. Independent regulators have both a policy makingrole as well as an adjudicatory and dispute resolution role. However, this is by no means

an universal phenomenon and has been implemented on an ad-hoc basis only in certainsectors (see Table 2). Whilst there is a robust independent regulatory mechanism for thepower and telecommunications sector (and significant benefits of independent regulationhas been realized in these sectors), there is no independent regulator for the roads andrailways sectors. The regulator for the ports sector, the Tariff Authority for Major Ports(TAMP) has only the power to fix tariff and no other policy making or adjudicatory powers.There is no common regulatory philosophy or approach in the evolution of regulatoryinstitutions in the infrastructure sectors.

9. The Planning Commission of India has advocated the necessity to recognize that anuniform robust regulatory institution is a necessary condition for sustainable growth ofinfrastructure and have drafted the Draft Bill for setting up an institutional framework forregulatory commissions. This Bill is intended to supplement existing sector specific laws.

10. The most common models for PPP prevalent in India are summarized in Table 1. Almostall projects which are being developed on a PPP basis are BOT or BOOT projects.


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Government Agencies and Entities in PPP

11. The following governmental agencies are responsible for implementation on PPP in the

country

(i) Committee on Infrastructure (COI), which is headed by the Prime Minister ofIndia is entrusted with the responsibility to initiate policies that ensure time-boundcreation of infrastructure and delivery of services in PPP projects.

(ii) The Planning Commission of India assists the COI through its Secretariat tothe COI. The Planning Commission is responsible for drafting of the ModelConcession Agreements for the various PPP sectors as well as other projectdocuments.

(iii) Private Public Participation Approval Committee (PPPAC), is an inter-ministerial committee entrusted with the responsibility of approving individual

PPP projects,

(iv) PPP Cell, Department of Economic Affairs, Government of India which isfocused on mainstreaming PPPs across the country and taking initiatives tocreate a pipeline of PPP projects.

(v) Several States have PPP Cells, which are typically the Industrial DevelopmentBoards of the state, which act as nodal agencies for development of PPP andoverall planning of PPP projects within the state.

Table 2: Different Models of PPP in India

Build Own and Operate (BOO)- the project developer is authorised to finance, construct, own, operate andmaintain an infrastructure or development facility, from which the developer is allowed to recover the total investment,operating and maintenance costs and a reasonable return thereon by collecting tolls, fees, rentals or other chargesfrom the facility users.

Build Operate Transfer (BOT)- the project developer is authorised to finance, construct and operate the facilityover a fixed term during which the project developer can recover charge the total investment, operating andmaintenance costs and a reasonable return thereon by collecting tolls, fees, rentals or other charges from the facilityusers. After the specified period, the project developer transfers the facility to the government at the end of a pre-negotiated fixed term.

Build and Transfer (BT)- the project developer undertakes the financing and construction of the infrastructurefacility. On completion of the project, the government pays the developer its total investment expenses as per theagreed schedule and a reasonable rate of return thereon.

Build Lease and Transfer (BLT)- the project developer is authorised to finance and construct the infrastructurefacility. On completion, the developer turns it over to the government on a lease for a fixed period after whichownership of the facility is automatically transferred to the government. The developer is paid a lease rental.

Build Transfer and Operate (BTO)- the government contracts out the construction of the infrastructure facility tothe private developer to build the facility on a turn-key basis. Once the facility is commissioned satisfactorily, the titleis transferred to the implementing agency. The contractor however, operates the facility on behalf of the implementingagency under an agreement.


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(vi) The Indian Infrastructure Finance Company Limited (IIFCL) is a funding

agency which has been set up to provide long term loans to project companies.The Government is also in the process of setting up the Indian InfrastructureDevelopment Fund (IIDF) for resources outside India and refinancing projectswhich have already achieved commercial operation.

PPP in Roads, Ports, Airports and Railways

12. Several PPP projects have already been sanctioned in India, particularly in sectors suchas road, port, telecommunications, airports and railways. The Government has also takensteps to standardize the Model Concession Agreement for award of projects in varioussectors. Bidding documentation is also in the process of being finalized. Efforts havebeen made to contractually address concerns of commercial viability and funding and atransparent and objective process for selection of private participants is being

implemented in almost every sector.

13. A summary of PPP activities in roads, airports, railways, power and ports is in Table 2.

Table 2: Highlights of PPP in Key Sectors

Roads andTransportation

Ports Airports Railways Power

- LegislativeFramework -National HighwaysAuthority of IndiaAct, 1956- permitsthe Central

Government toenter into anagreement withprivate parties fordevelopment andmaintenance ofnational highways.Developers areentitled to collectfees for suchservices at suchrate as the CentralGovernment mayspecify

- Foreign DirectInvestment (FDI) of100% is permitted

- National HighwaysAuthority of India(NHAI) is the nodalagency- there is noindependentregulator

- National HighwaysDevelopmentProject (NHDP) (of6 phases) has

- India has12 majorports and 187minor ports

- LegislativeFramework

major portsgoverned by theMajor Port TrustAct, 1963 (MPTA)and other ports bythe Indian PortsAct, 1908. MPTAwas amended in1997 to specificallyenable privateparticipation.

- Privateparticipation isbeing encouragedin construction ofnew infrastructure,development ofcarriage and cargohandling,development ofports, operatingberths, shipbuilding etc.

- Projects operateon revenue sharebasis

- Investment of

- LegislativeFramework-Airports Authorityof India Act, 1994amended in 2003,allows a private

party to develop anairport afterreceiving a licensefrom AAI orthrough a jointventure with AAI

- The otherimportantlegislation in theAircraft Act, 1934

- Airports Authorityof India (AAI) is thenodal agency

- 100% FDI ispermitted ingreenfield airports,in brownfieldairports, FDI ispermitted inexcess of 74% withthe consent of theForeign InvestmentPromotion Board(FIPB)

- MCA and biddingdocuments are in

- Indian Railwaysoperates theworlds secondlargest rail networkestablished routelength of 62,759

km

- Containermovement hasalready beenprivatized

- No independentregulator

- Privateparticipation isbeing encouragedin modernization ofrailway stations,freight corridors,container traffic,manufacturing oflocomotive works,catering services,hotels and foodplazas

- Significantemphasis isexpected in urbanrailway systems

- MCA for containeroperations,

- LegislativeFramework-Electricity Act,2003

- Independent

central and stateregulatorycommissions are inplace

- Private sectorparticipation ispermitted ingeneration,transmission ordistribution ofpower (generationdoes not require alicense,transmission anddistributionrequires a license)

- 100% FDI ispermitted

- Bidding guidelinesand standardpower purchaseagreement havebeen promulgatedby the Ministry ofPower forprocurement ofpower by


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Roads andTransportation

Ports Airports Railways Power

been initiated tobuild new roadsand upgrade andwiden majorhighways(including 4 laningand 6 laning ofhighways).

- Estimatedinvestment of USD20 billion isexpected in thefirst 3 phases ofthe NHDP.

- Projects are basedon toll or annuity

- Grants and viabilitygap funding by theGovernment

- Model ConcessionAgreement (MCA)is in place

- Emphasis onurbantransportationinfrastructure

development-National UrbanDevelopment Planin place

around USD 25billion is expectedby 2012 includingUSD 9.07 billion inshipping projects

- National MaritimeDevelopment Planis in place tofacilitate privateinvolvement,improve servicequality andpromotecompetition

- 100% FDI ispermitted

- MCA for majorports is in place

- Tariff for majorports is determinedby the TariffAuthority of MajorPorts- there is noindependentregulator withadjudicatory ordispute resolution

authority

the process ofbeing developed

- For Greenfieldprojects, financinggaps are proposedto be fundedthrough viabilitygap funding

- Airport EconomicRegulatoryAuthority (AERA)is the independentregulatory authority

which isresponsible fortariff fixation

redevelopment ofrailways and urbanrailways are inplace

- Land around thestations which isowned by therailways can beused commercialdevelopment tohelp reduce projectrisks

- Investment more

than US $ 80billion is expectedprior to 2012

government owneddistributionlicensees. TheBidding Guidelinesenvisages twotypes of bids- (i)Case 1 Bids -where the location,technology, or fuelis not specified bythe procurer(s) and(ii) Case 2 bidswhich are locationand fuel specific.

Role of the Government

14. The Government has a significant role to play in supporting a PPP project. Governmentobligations in PPP projects is generally of the following nature:

(i) providing land for the project including forest land, land in coastal regulatory

zones etc.;

(ii) provision of utilities, water, approach roads, electricity, security and otherfacilities;

(iii) facilitating obtaining of various approvals and consents required for the projectand ensuring cooperation of the local and municipal governments;

(iv) providing fiscal incentives such as income tax exemptions, tariff support, stampduty exemptions;


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(v) providing legislative and contractual support such as no competing facilities

within a specific area, truck bans for bypass projects etc,;

(vi) providing support in case of funding gaps, such as guarantees, grants andviability gap funding;

(vii) providing support to financing including termination payments, direct agreementswith lenders; and

(viii) supplying key inputs to projects.

Award of Projects

15. In India, most PPP projects are awarded through a competitive bidding process wherethe government invites bids from all interested parties.2

There have been certain projectswhich have been awarded on a negotiated basis, but instances of such projects areextremely rare. Under Rule 135 of the General Financial Rules, 2005 which is applicableto central government entities and government companies, public procurement of goodsand services should be in a transparent, efficient and economical manner and suchentities have the obligation to ensure fair and equitable treatment of suppliers andcontractors participating in the public procurement process. The procuring authority mustbe satisfied that the goods or services meet the technical requirements and the price ofsuch goods and services are reasonable and consistent with the quality provided. Theprocuring authority is required to record all the considerations which they took intoaccount at all stages of the bidding process.

16. Typically, the bidding process consists of two steps, the first stage is a qualification stage,where the bidders qualify if they meet certain technical and financial requirements. In thesecond stage, the qualified bidders submit a commercial bid along with a bid bond, whichcan be encashed in case of default by the bidder. The Letter of Intent is issued to thesuccessful bidder.

17. Since the decision to allot a PPP project is an economic and policy decision, courts of lawwill not interfere with the decision of the government to undertake the project and allot theproject to a private party. Additionally, the decision to award a contract is a commercialdecision and the courts will not review such a decision.

3However, if the decision of a

public authority in granting a contract is malafide, bad in law or violates the principles ofequality and fairness, or suffers from procedural impropriety, then courts of law caninvalidate such decisions.

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18. There is no requirement for the government to award the contract to the lowest bidder ifthere is a commercial justification. The government also has the right to reject all bidsand call for a new bid if none of the bids are to its satisfaction.

2In Nagar Nigam, Meerut v Al Faheem Meat Exports, (2006) 13 SCC 382, the Supreme Court of India held

that all contracts by public authorities should be granted by public auction such that all interested parties canparticipate. Negotiated deals are not advisable except in exigent circumstances.3

Balco Employees Union v Union of India, (2002) 2 SCC 333 (Supreme Court of India); Air India Limited vCochin International Airport Limited, (2000) 2 SCC 617 (Supreme Court of India).4

Centre for Public Interest Litigation v Union of India, (2000) 8 SCC 606.


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19. To prevent corruption and procedural impropriety, the rules of the Central Vigilance

Commission on tenders advise government entities to not engage in negotiations with thelowest bidder prior to awarding the contract.

Contractual Structure

20. Typically a project involves a concession agreement in terms of which a concession isgranted to the developer and which sets out the rights and obligations of the developer.Other typical agreements include: (i) an escrow agreement/ accounts agreement in whichthe project revenues are deposited and which is charged for the benefit of thegovernment agency. Proceeds from the account are used for payment of governmentdues and taxes and the revenue share owing to the government; (ii) lease deed for usageof the underlying land for the project; (iii) substitution agreement/ direct agreement whichgives the lenders step-in rights in case of a default by the concessionaire; (iv)

shareholders agreement between the private parties holding shares in the projectcompany; (v) loan agreements entered into between the project company and lenderswith respect to the financing of the project; and (vi) engineering, procurement andconstruction contracts for supply and construction as well as other sub-contracts forconstruction and operation of the facility.

21. A typical project structure along with contractual relationships is specified in Table 3.


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Table 3: Typical Contractual Structure for PPP

22. The key provisions of a model concession agreement for PPPs is as follows:

- Scope of the Project;

- Explicit award of the concession;

- Rights and privileges of the Concessionaire with respect to the project;

- Term of the concession, construction period, operation period; theconcessionaire is expected to achieve commercial operation within a specifictime period failing which there is an obligation to pay delay liquidated damages tothe Government;

- Concession fee and revenue share of the government entity;

- Tariff principles and manner of determination of tariff, user fees etc;

- Conditions precedent to the concession. This typically includes achievement bythe concessionaire of certain specific milestones, such as financial close with itslenders, execution of contracts for engineering, procurement, construction etc.These milestones are required to be achieved within a specific time period, failingwhich the concession agreement may be terminated and the bid bond forfeited;

- Design and construction standards and requirements;

Government(Central and/or State)

Project Company

Investors/ Shareholders(including technical

collaborators)

Lenders

Engineering andSupplyContractors

PROJECT

ConcessionAgreement

ShareholdersAgreement

EscrowAgreement (forrevenue share)

CreditAgreements

Sponsor Support

SubstitutionAgreement

Engineering,Procurement,Construction

Contracts

Operations &MaintenanceContractorO& M Contract

Equity participation byGovernment (joint venture

partner)

Lease Deed


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Service standards for operations;

- Obligations and responsibilities of the Government and public entities;

- Lock-in period and restrictions on exit by the project promoters;

- Change in law and force majeuere protection;

- Rights of lenders, including step-in and substitution rights;

- Events of default and remedies available to a party in case of default by the otherparty;

-

Provision for termination payments by the government in case of termination as aresult of default or in case of extended force majeuere. If termination is as aresult of default by the concessionaire, the termination payment is typically 90-95% of the total outstanding debt obligation of the concessionaire. In case oftermination due to default by the government, the termination payment is 100%of the total outstanding debt plus a return on equity invested (15-20%).

- Dispute resolution mechanism.

Additional Areas for PPP

23. In addition to the traditional infrastructure areas, PPP projects are expected to play anincreased role in sectors such as:

(i) Urban transportation including Mass Rapid Transport Systems (MRTS);

(ii) Water and waste water management;

(iii) Sewage and solid waste management;

(iv) Healthcare;

(v) Education;

(vi) Information technology and e-governance;

(vii) Agriculture, horticulture, bio-fuels etc.; and

(viii) Tourism.

24. Significant private investment is expected in these sectors in the next few years.

25. Multilateral agencies such as the International Finance Corporation (IFC) and the AsianDevelopment Bank (ADB) have been playing a large role in developing PPP institutionsin several states in India. ADB is in the process of examining the PPP regulatory andpolicy framework with an aim to propose a National PPP Policy Framework which willcontain a national set of principles for PPP in terms of definitions, processes, possible


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institutions, project structure and recommended legislative arrangements. ADB would be

examining international, national and local level best practices and suggesting reforms tothe regulatory framework to develop a formal structure which will provide a supportivepolicy environment for PPP.

Key Reforms from a PPP perspective

26. As noted above, several projects have been implemented in India, particularly in theroad, ports and airports sectors. Standardized documentation for bidding and concessionhave also been developed in these sectors. However, significant barriers continue toexist for private participation in infrastructure in India.

27. Key legal, institutional and regulatory changes are required for unlocking of the PPPpotential for India:

(i) Legislative and regulatory reforms are required for institutionalizing PPPs acrossthe country and ensuring regulatory consistency across states and sectors. As ofdate there is no national policy, handbook or comprehensive guidelines withrespect to PPP. There is a lack of a central legislation which captures andinstitutional and regulatory policy with respect to private participation in theinfrastructure sector.

(ii) Additionally reform is required to increase the capacity of the public sectorto obtain bids for, enter into contractual arrangements for and managementof contracts in complex PPP transactions which involve significant privatecapital investment and bank debt.

(iii) The processes for obtaining approvals is required to be streamlined and thenecessity for the private sector participant to coordinate with various localand municipal governments, as well as different departments of the state andcentral government should be reduced, to reduce uncertainty with respect tothe project and to decrease the gestation period.

(iv) PPP contracts should be more robust and provide adequate protection toenvironment such that the projects are bankable. Definitions should reflectcommercial realities. For examples, while considering termination payments,debt outstanding should include refinanced debt (which is often not the case)and equity should include quasi-equity and preference share capital. Thecontracts should also be realistic in risk allocation and risks should beallotted to parties best equipped to handle such risks- for e.g., the

requirement to obtain approvals should be with the government whereas theobligation to raise funding should be with the private party. Loading all therisks on the private developer would not be commercially attractive.

(v) PPP contracts should limit the scope of government intervention in theproject and define the scope of government supervision. Political risk anduncertainty should be eliminated to the extent possible

(vi) Bankability of PPP projects continue to be doubtful. Since no security can becreated over underlying assets in most cases, lenders envisage significant


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risk. For example, in the financings of the Delhi and Mumbai airports, the

lenders do not have a mortgage on the land given to the project company.

Further, the claim of the lenders on cash flows of developers is subservientto the rights of the government authority. Efficacy of security enforcement islargely untested in India, more so for security which created on public assetse.g. security on airport or road related assets. A comprehensive policy forsubstitution rights of lenders needs to be crystallized especially in relation toPPP projects where public assets/operations are involved.

(vii) The developer should be allowed to unlock the value created in a PPPproject after completion of construction, for e.g, raise additional debt bysecuritizing the receivables from the project or by getting strategic investors.

28. There is fantastic potential for PPP in India (and a large part of the US$ 500 billionrequired in the Indian infrastructure sector, would come from private funds) once the legaland institutional roadblocks are overcome.

Documents

PPP Memo PXV Law Partners