The P3 delivery method is rapidly maturing in the US market and there is a wealth of information focused on how a P3 project can be best utilized to optimize the most efficient risk transfer among the appropriate stakeholders.
Much of this discussion focuses on Value for Money over the life cycle of the asset, and assesses the risk relationship between the Public Owner and the Special Purpose Vehicle (“SPV”). However, due to the prime contractual relationship between the Public Owner and SPV, and the private financing associated with these projects, the ensuing flow down of certain terms to the Design-Builder (“DB”) can go over and beyond what is considered normal in traditional project delivery methods. While every P3 project is highly localized and unique, and the US P3 market is still developing (especially in social infrastructure), common heightened risk factors have come to the forefront in the agreements between Owners and SPVs, which will impact a DB.
Security: In many such transactions, the DB is required to provide a letter of credit to secure its performance. These letters vary as a percentage of the total DB contract, however they are often up to 10% of contract value and thus worth several million dollars. This type of requirement puts downward pressure on corporate balance sheets exposed to unilateral drawdowns by the SPV. This is in addition to parent company guarantees, payment and performance bonds and broad termination and indemnity provisions, all of which are also typically required in P3s, but not in privately commercial development.
Liquidated Damages/Overall Liability Caps: It is common in traditional, privately financed delivery models for a DB to receive a cap (a maximum amount) to the amount of liquidated damages for delay, an overall cap on liability for damages, a waiver of consequential damages, and other terms which help to provide an upfront definition to a Project’s risk profile. Although the risk of timely completion, whether due to the DB or other factors, is arguably no different than privately financed projects for private owners, P3s tend to have a higher than normal overall liability cap and liquidated damages exposure for the DB.
Relief Events: Depending upon the nature of the P3 project (e.g. greenfield versus active site), onerous terms can exist which would limit the DB from seeking what would traditionally be appropriate relief for events such as differing site conditions, coordination of utilities, and extreme weather events.
With the foregoing deal points in mind, concessionaires often state that to achieve the appropriate risk balance, all exposure related to the design and construction must be pushed down to the DB. However, an emerging market reality is that a sophisticated DB, with the financial wherewithal and track record necessary to execute what are often highly demanding and complex projects, will likely demand that such risk factors be weighed against the costs necessary to mitigate these issues and the value for assuming such risks. For example, as it applies to the liquidity requirements described above, the SPV and the DB should proactively examine the practicality of providing a mix of such security with more traditional security instruments such as performance bonds, special P3 bonds, retainage, and other tools, including subcontract default insurance. On the other hand, there exists a growing school of thought from the DB industry that for these projects to make sense, there should be a financial upside associated with these impositions.
While optimum risk transfer and private sector innovation are universally lauded as benefits of any P3 project, it is incumbent upon all stakeholders to ensure that P3s make sense for the DB to participate in as well. Ultimately, the best overall value as to the design-construction phase will come from DBs who are the most sophisticated and/or are the best in the construction industry. DBs must be adequately incentivized to participate in P3 rather than divert resources to pursuing and building under other more well-established delivery methods. In order to do so, and as demand for privately financed public improvements increases, the P3 industry will need to consider relaxing certain DB deal points to bring them on par with industry standards, or the financial upside associated with P3 must be compelling for the DB.