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Structuring and Drafting the Tender and Contract

54.5 Equity Participation by the Government

The government may provide equity to the project company directly (participation from the procurement agency) or through a public infrastructure fund.

Sometimes the motivation is to increase day-to-day control and have direct access to accounts and daily management of the company. This should always be considered with caution as it may be a strong factor in discouraging bidders and creating conflicts. For example, the government/public sector agency might have to share in the liabilities arising from early termination of the contract. There can be obvious conflicts of interest between being the 'client' and an equity holder. The nominated director from the government/public agency has a duty to the company that could put him/her in a difficult position, particularly in relation to the confidentiality of information and organizational strategy/intent in dealing with disputes/termination.

One approach to mitigate this concern is for the government’s equity participation to be made through a trust fund (to avoid conflicts of interest).

Another reason for government equity participation may be to have access to any upside in the project, that is, it is a method to share the profits from the project. There are other ways a project can be structured to allow the government to share in profits without the need for it to take an equity stake; the pros and cons of each of these options should be considered if the government wishes to have access to the upside of the project.

In other cases, the objective is to help make the project commercially feasible. This may be the case if there is no appetite in the financial investor market to co-invest with promoters, and/or if the requirement for equity investment is of a challenging size. It may also be the case if the government wishes to increase affordability by decreasing the net overall burden of the project in terms of costs (by participating as an equity partner on favourable conditions, in terms of return or rights), as in the case of other public financing mechanisms described in the previous section.

The government equity investment may have significant implications for the financial structuring, especially when participation is on favourable conditions. For example, in Spain, there are many “mixed equity companies” (which are by legal definition a type of contract, but which usually have all the characteristics of a PPP) where the private shares are granted with preferred economic rights. This is done by means of preference in dividends or the recognition of a special management fee that is only granted to the private equity partner to increase its equity return vis-a-vis the equity internal rate of return (IRR) of the public shareholder.

Contract provisions concerning government equity participation

The impact of this scheme on the contract provisions is clear: the contract package must clearly define the rights and obligations of the public partner as a shareholder and the special rights of the private equity holder. This should be captured in the Articles of Association of the SPV, and it should be further developed in a specific shareholders’ agreement between the private equity investors and the public equity partner (a draft of which will form part of the contract package tendered out).

Examples of specific conditions to limit the presence of the public party as an equity partner are as follows;

  • In some contracts, the public equity partner accepts a lower equity IRR than that of the private equity holder. The mechanisms for such economic preference should be included in the articles of association or shareholders agreement, but sometimes they are also incorporated in the body of the contract;
  • The public party as an equity partner may not be obliged to inject additional equity if an unexpected capital increase is required by a risk event. If this occurs, the public party has to accept a dilution of its economic rights;
  • The public party shares may not have voting rights, but only economic rights (sometimes known as class B shares); and
  • The need to set out the rights to sell to third parties — trying to avoid or mitigate the inflexibility that public ownership of shares will usually imply due to regulations on the disposal of public assets.


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