Creating the Terms and Conditions for PPP Infrastructure Partnerships

Technical Notes

Nov 8, 2013 — Neil Boyle

PPP infrastructure partnerships are much more than a business model that conforms to certain legal formalities. To be sure, partnerships must be supported by law, but modern corporate law in most developing countries is still in process of development and is not likely to be tested anytime soon or regularly in courts of law anytime soon.  In particular, corporate law that recognizes and enforces the varied attributes of hybrid transactions whereby premiums are placed on concepts such as transaction-specific safeguards, the constant and always present human risk factors and the variable environmental risk factors, mutual interests, private ordering, and credible commitment are still absent from many legal systems of developing countries.

PPP infrastructure partnership is about autonomous bilateral governance, which is about mutual interests, which is about credible commitment. The meanings of each of these terms overlap and in practice are applied to affect the same purpose, that is, the governance of autonomous bilateral relations, which describes the governance conditions of PPP infrastructure projects.

Partnership must include all relevant stakeholders under an umbrella partnership with government including the government executing agency, the private investor, and commercial lenders. Partnerships include: private Greenfield investments; specific concessions that grant certain legal rights to private investors for defined periods of time to allow the achievement of agreed ends (examples include BOT, BOO, DBFO, among others); and various contractual arrangements under existing statutes of the state. An example would be a special purpose vehicle (SPV) in partnership with a government executing agency.

Under the usual PPP infrastructure governance condition of exposed transaction-specific assets and unilateral interest relations, holdup hazards are realized. Holdups occur when the non-exposed party withholds investment from the contract thus leaving the investor of the exposed assets vulnerable to loss of value of his assets (i.e., opportunism). However, under the identical bilateral governance and investment exposure conditions and mutual interest of partnership relations, instead of unilateral relations, credible commitments can be realized by the same investments, but only if actively initiated or pursued by one (or more) contract parties. The difference between realizing credible commitments without simultaneously posing expropriation hazards is the quality of the offers made in the interest of credible commitment. This occurs only when relations are governed according to mutual interests and true partnership conditions that are backed-up with credible commitments.

Partnership is determined in the relationship. If the relationship is governed according to the mutuality of interests of the partners, exposed assets are viewed by the counterparty as the credible commitments of supplier’s intentions to be adaptive and to support continuity. Hostage arrangements are necessary constraining conditions for this to occur, but it is the combination of contractual constraints and credible commitments that are the sufficient condition.

Because exposure of non-redeployable assets and holdups are at stake, it is important for the supplier to have a way to infer the interests of the counterparty government buyer, preferably one based on evidence. Learning to read hazardous investments, suppliers can discern the significance of risk and level of trust that buyers place on a particular transaction.

If evidence of a mutual interest relationship occurs prior to the investment of non-redeployable assets as it ideally should, four important project and investment planning criteria are posed. First, building a proper partnership relationship begins with the very first international advertisement calling for expressions of interest to bid. Second, governments will need to signal the FDI market it is prepared to act on the basis of terms of mutuality of interests, autonomous bilateral trading, and bilateral relations based on credible commitments. Third, for government’s message to be perceived as credible, the message will have to be supported by additional durable transaction-specific assets designed to economize on production costs and/or increase revenues; i.e., hard assets have to be put at risk for credibility to be manifest. Fourth, by sending its signal prior to issuing any requests for expressions of interests from qualified bidders, government maximizes its credibility.

Upon fulfillment of these conditions, returns to value enhancing investments made by either party accrue jointly and distribution of gains is decided internally by pre-agreed formula at negotiations. 

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