In PPPs, liquidated damages are the preferred remedy for late service commencement. Liquidated damages are a payment representing a genuine pre-estimate of the actual losses or damages suffered if the private partner fails to achieve service commencement on time. The events giving rise to liquidated damages, and the amounts, should be set out in the contract. In some jurisdictions, liquidated damages are referred to using the term “penalties”, while in other jurisdictions, the term “penalty” is a different concept referring to amounts which bear no relationship to the harm suffered by the other party and which are unenforceable.
An example would be the cost to the government of renting alternative accommodation or paying higher service fees in the absence of the services to be rendered by the private partner under the PPP contract. In many PPPs, both the government and the lenders are entitled to liquidated damages. The liquidated damages payable to the lender are often significantly larger than those payable to the government, and they provide a strong incentive for the private partner to complete construction on time.
10.2.1. Impact of Late Delivery of Works on the Private Partner and Government
The private partner suffers a number of negative impacts from late completion of the Construction Phase that then impacts on operational commencement. The first is that revenue is lost and the lenders require that their loans be serviced even though there is no revenue to do so. The private partner must raise this in the way of additional capital, and this decreases shareholder returns. Where the fault lies with the construction contractors, the private partner will levy liquidated damages on this contractor.
The private partner may also be subject to liquidated damage claims by the government, and may have performance bonds or other forms of security called in by the government. At the same time though, the government suffers the loss of the services to the users. Both parties suffer reputational damage as a result of delays.
10.2.1.1. Financial Impact
These include the imposition of liquidated damages on the private partner and its sub-contractors, the calling of bonds in the security package, the loss of revenue, and the continued debt service obligations. Operations sub-contractors often claim against the private partner for costs incurred in delayed starts.
The loss of revenue is always severe as the private partner has a shorter period to earn revenue and, especially in government payment PPP contracts, this loss is never regained. Simultaneously, shareholder returns are reduced. This may even extend to reduced refinancing gain opportunities.
10.2.1.2. Operational Impact
The operational impacts of delayed service commencement relate largely to the delay in the provision of the services. Where these involve social infrastructure like hospitals and schools, patients may receive inadequate treatment at alternative facilities, and learners may miss the start of a school year. In economic infrastructure, the main operational impact is the loss of revenue to be earned as the asset stands idle.
10.2.2. Processes in Cases of Late Delivery of Works
The government’s contract management team must closely monitor the progress of the works and the quality thereof as certified by the independent certifier. Poor quality will result in delayed completion as the private party struggles to commission the work and obtain the certification needed to begin the Operations Phase.
10.2.2.1. Liquidated Damages
PPP contracts typically have a specific regime for the claiming of liquidated damages and the procedures must be closely followed. An example of a trigger is that the service commencement date is missed. However, it is normal for there to be some requirement for a notification to the private partner followed by a remedy period. If the contract management team is lax, procedural irregularities could undermine this process for claiming liquidated damages.
10.2.2.2. Construction Bonds
A construction bond will usually take the form of an on-demand bank guarantee which can be called by the recipient when, for example, the service commencement date is not met. The private partner may well require a construction bond from the construction contractor who will pass through the costs and time effects of providing such a bond to the private partner. This increases the cost of the project, but provides security in the case of a default. This default risk is highest in the early stages of the Construction Phase because the government may not be able to find another party to take over the project and therefore may incur significant cost in reinstating it.
The calling of a performance bond requires that contractual triggers are met. As with liquidated damages, these include missed dates for completion, a failure to remedy, and above all the correct following of procedures by the contract management team of the government.
10.2.2.3. Sponsor Support
It is quite common for PPP contracts to require some form of support from shareholders or key sub-contractors to the private partner because the private partner is a Special Purpose Vehicle and has no inherent ability to provide technology support or experienced human resources (as could a large existing enterprise specializing in a type of technology or construction particular to the PPP).
Sponsor support usually takes the form of undertakings from one or more of the sponsors of the private partner in favour of the lenders and/or the private partner to support the private partner’s obligations. One of the undertakings may be to provide technical support and/or general undertakings to ensure that the private party reaches service commencement on time.
As with liquidated damages and construction bonds, sponsor support needs to be triggered by the failure to reach service commencement by the scheduled date.
10.2.2.4. Long Stop Date
Many PPP contracts contain a “long stop date” by which services must commence regardless of what events or claims occur during the Construction Phase. If, notwithstanding all of the remedies described above, the services have not commenced by the long stop date, the government must commence the process to terminate the PPP contract. This is described in more detail below.