6.1. Introduction to the Basic PPP Project Structure

Note: DBFOM=Design-Build-Finance-Operate-Maintain; EPC=Engineering, Procurement, Construction; O&M= operation and maintenance; SPV= special purpose vehicle.

1. The consortium constitutes the SPV, which signs the contract.

The government (the procuring authority) is contracting with a private agent for the DBFOM of a new (or upgraded) infrastructure.

Typically, the government will award the contract to a company or group of companies (consortium). After awarding the contract, the consortium will have to incorporate a specific company[61] (the Special Purpose Vehicle, SPV) in accordance with the relevant legislation governing the formation of companies. The SPV will sign the contract with the procuring authority (this milestone is also referred to as “commercial closing”[62]), and the consortium members will execute the shareholders agreement (#1b).

By the contract signature, the private partner assumes the obligations described in the contract as follows.

• To finalize the design of the infrastructure, construct or develop the infrastructure asset (including obtaining all permits necessary if obliged to do so).
• To finance the works and other development costs (the full costs, or a relevant portion if the contract has a co-finance structure with grant financing from the government).
• To operate and maintain the asset (after commissioning the asset and obtaining approvals and authorizations).

2. The SPV executes financial agreements and implements its contract structure (downstream project contracts).

After contract signature, the SPV will do the following.

• Enter into the guarantee agreements for the performance bond.
• Enter into the insurance agreements and policies[63].
• Enter into the financing agreements, that is, the loan agreements[64], also commonly referred to as “financial close” (#2).
• Enter into the “downstream” contracts, i.e. the contracts with the construction or EPC contractors, and O&M contracts with the O&M contractors. (#2b and #2c[65])

In some projects, the authority will enter into a direct agreement with lenders (#2d) (see section 7.5).

Through the downstream contracts, the private partner is delegating responsibilities and transferring the risks to third parties in exchange for a price (noting that those third parties may belong to the same group of companies, as a shareholder of the SPV).

In most situations, there will only be one construction contract with a single contractor or with a group of contractors acting as a joint venture. However, in more complex projects, there may be several contracts for specific parts of the construction work.

For example, a light rail project may involve supply, installation and construction works. The SPV may enter into a single contract with a group of companies that will divide the works amongst themselves. Alternatively, the SPV may enter into separate contracts with different groups of contractors for the specific elements of the rail system development: civil works, tracks, systems (electrical, signalling and communications), and rolling stock. In the former case, the risk of proper integration of all the elements of the system is transferred to the contractor group and in the later it is retained by the SPV.

3. Construction works are executed, and funds (the proceeds of debt loans and equity contributions) are disbursed (#3 and #3a). The SPV pays the construction contractors (#3c).

Construction will typically start when the procuring authority gives the construction order. This occurs once final project design is approved and other pre-set conditions are met. Some of the pre-set conditions may be the procuring authority’s responsibility (for example, to provide the right of way or the land), and some others may be requirements of the lenders (such as final clearance of some permits).

In some countries, bank practice may be that the shareholders of the SPV have to invest the equity commitment prior to making drawdowns of the loan amounts granted by the lenders. In other countries, the loan drawdowns will occur in parallel with equity investment, in fixed percentages[66].

The contractor is paid the price of its construction contract in a progressive manner as agreed in the contract. In some projects, it may receive an advance payment for collecting materials, machinery and equipment, and in other projects, it may receive a relevant portion of the price at completion of the works.

However, the most common approach is monthly progressive payments against the successive and partial invoicing of the works executed. The works will commonly be reviewed by technical advisors appointed by the lenders.

To guarantee appropriate construction performance to the SPV and lenders, the construction contract will require the construction contractor to provide security, such as bank guarantees and/or parent company guarantees.

In the typical PPP as illustrated in figure 1.10, with total finance coming from the private sector (by means of equity and debt), the private partner will not receive any payment from the government or from users until the works are finalized and commissioned. However, if a specific government-pays project includes several facilities, the government may make partial payments starting when each facility becomes operational, but only making full payments once all facilities are operational. In addition, as explained in section 2, there are variations of PPPs that mix public and private financing (that is, “co-financing schemes”), where the public partner will provide payments during or at the completion of construction.

4. Operations commence (#4) and the SPV starts receiving payments from the government and/or users (#4b). The SPV pays the O&M contractors (#4c).

In most projects, the procuring authority only authorizes the commencement of operations once construction is completed and the works are commissioned. When the contract is of a user-pays type, the SPV will be allowed to start charging users (with some projects involving upgrades to existing transport infrastructure, charges to users may occur during construction). When the contract is of a government-pays type, the SPV will be allowed to start invoicing the procuring authority at the frequency established in the contract (for example, monthly) and according to the payment mechanism defined in the contract. These will be up to an amount equal to the payment offered, minus payment deductions or abatements (see box 1.21 below).

With the funds collected, the SPV will first offset the O&M costs which typically correspond to payments due to O&M contractors. Secondly, the SPV will pay the taxes and set aside the prescribed reserves required by law and by the contract. The remaining funds will be used to pay interest and repay debt, as well as make distributions to the equity holders.

O&M fees to be paid to O&M contractors may be for a fixed yearly amount or may be variable (as a percentage of revenues, especially when the revenue stream of the project company is based on demand or volume). These fees will usually be subject to the same deductions and/or liquidated damages that affect the original revenue of the SPV, partially or totally transferring the O&M performance risks to the O&M contractors.

During the Operations Phase, there will be a number of investments to be made (renewals or reinvestments, also referred to sometimes as “major maintenance” or “life-cycle costs”) so as to keep the asset in appropriate condition during the entire life of the contract. These works are usually done by the O&M contractors under the O&M contracts, but they might be handled and contracted separately under a specific contract for renewals.

5. Paying Back the Loan (#5) and Equity Distributions

The repayment profile is usually defined in advance in the financial agreements, and it is constructed to meet the Debt Service Cover Ratio.

Revenues may be paid to equity holders only when O&M costs, taxes and debt obligations are paid as scheduled and reserves are duly funded. The financial agreements usually include additional restrictions on payments to equity holders.

The bottom line is that the majority of the return to the shareholders (in the form of dividends (#5b)) will only come into place in the later stages of the contract[67].

6. Hand-back

Unless an early termination event occurs (that is, the contract is terminated before the original term expires due to a serious default by the private partner, a force majeure event occurs, or there is a unilateral decision by the procuring authority), the contract will expire in accordance with its terms.

At that point, the infrastructure will return to the hands of the government, which may re-tender the management of the asset in a new contract, contract the O&M of the asset in shorter-term contracts, or chose to directly manage the asset itself.

The handover of the asset to public hands is also commonly referred to as “hand-back”. It is good practice to require the private partner to hand-back the infrastructure in a specified condition. To meet these requirements, the private party will have to make some investments prior to hand-back. This is typically done during the last years (1 to 3 years) prior to the contract expiration date.