New Risks May Arise From Operations and Maintenance Contracts on P3s
Across the country, the gap between public infrastructure needs and the ability to pay for them is growing larger. Public-private partnerships help fill the gap, enabling public entities to utilize private funding for big infrastructure projects.
But P3s have their drawbacks, and they can create new risks for the contractors who work on these projects, especially those firms that engage in long-term operations and maintenance work as part of the P3 agreement.
One example is ITR Concession Co. LLC, private operator of the 157-mile Indiana Toll Road (ITR), which filed for bankruptcy protection in September. In 2006, private investors paid $3.8 billion to operate the road for 75 years, but the toll road struggled with heavy debt and lower-than-expected traffic. While the two-part restructuring reportedly will not affect the operator's 283 employees or operation and maintenance of the road, the case illustrates the financial risks of P3s.
ITR is not an isolated case. A number of other P3 private operators, also known as concessionaires, have filed for bankruptcy in recent years. "As with any business, not all projects are successful," says Matt Girard, president of the P3 division of the American Road and Transportation Builders Association. "Bankruptcy can and does happen. These situations reinforce the need for investors and contractors involved in P3s to do their homework better and approach these projects more conservatively. If you take on private-revenue risk, then price it accordingly."
Girard is also the chief operating officer of Denver-based Plenary Concessions, the operator of the 18-mile segment of highway U.S. 36 between Denver and Boulder. In 2013, Plenary Roads was awarded a 50-year contract with the Colorado Dept. of Transportation. The company agreed to deliver $20 million in equity and another $154 million in financing for reconstruction of U.S. 36, including adding two new express toll lanes, then maintain the new toll lanes and the four existing lanes for the term.
Risk is shared. CDOT pays Plenary Roads milestone payments during the project and pays off the balance of construction debt with 50 years of toll revenue from express lanes. As part of the arrangement, Plenary Roads will also assume operations and maintenance responsibilities for the existing Interstate 25 express lanes in Denver, also in exchange for toll revenue.
"A lot of risk can be avoided with knowledge," Girard adds. "We looked at traffic studies and years upon years of data for the existing I-25 lane, and came up with what we believe are realistic projections for the toll revenue and for the operations and maintenance costs for both I-25 north and U.S. 36. Only time will tell."
The Devil Is in the Details
All projects, whether undertaken using conventional procurement methods or a P3 approach, have risks, says Brian Middleton, project director for the Regional Transportation District's FasTracks Eagle P3 commuter rail project in Denver— the first transit P3 project in the country. RTD's contract calls for annual payments over 28 years to private consortium Denver Transit Partners, led by Fluor Enterprises and Macquarie Capital Group. Commuter rail lines are set to be designed, built and open to the public by 2016.
"The devil is in the details of the contract," Middleton says. "It is really no different than any other construction project. Contractors need to look at what needs to be done, and use their experience and expertise to determine the risks and what contingencies they need."
For untolled P3 projects or those for which revenues are not expected to cover the debt-service costs, the private entity is paid via availability payments. Such payments compensate the concessionaire for its role in designing, constructing, operating and maintaining the facility for a set period. While the revenue risk in this scenario is retained by the public entity and income is more predictable, there is still no guarantee that the private-sector contractor will get paid. Payments owed to the concessionaire are subject to legislative appropriations and changes in laws.
"Most states can only project their funding out so many years, so there's always a risk that future funding won't be approved. However, there is a hierarchy of payments, and P3s are typically at the top of the hierarchy," says Andrea Warfield, executive director of O&M at Texas-based Fluor, the engineering manager for the Eagle P3 project. The firm holds a 50% share in the engineering, procurement and construction contract, and a 33% share in operations and maintenance.
Payment security can be complicated, too. Few payment protections exist for projects on public land, as mechanic's lien laws generally do not allow contractors to file liens against federal, state or local governments, says Logan Hollobaugh, claims management and corporate counsel for Chicago Bridge & Iron Co.
"Every state has its own mechanic's lien laws, and they all seem to be slightly different. While liens are not available on public lands, they may be available on public funds or leasehold interests. It all depends on the language and interpretation of the law," Hollobaugh says. He advises contractors to determine whether lien rights exist on the particular project before bidding or starting work on a P3.
On a toll-road project, one California court determined that the contractor could place a lien on the private interest—leasehold and franchise rights—on the public land. In Nevada, the lien statute may allow a contractor to initiate a mechanic's lien, but that right depends entirely on whether the P3 deal is structured as a lease transaction, Hollobaugh adds.
More often than not, the responsibilities for designing, building and financing are bundled together with long-term operations and maintenance contracts in which the private-sector partner assumes responsibility for the asset operation and management for a specified term. In exchange, the O&M contractor, usually a P3 member, is paid either on a fixed-fee basis or an incentive basis. The firm receives premiums for meeting specified service levels or performance targets.
"One of the biggest mistakes a contractor can make is to take on performance standards that are unachievable," Warfield adds. "Most contracts contain steep penalties for not meeting performance standards, and those can add up over time."
To ensure achievable standards, Warfield recommends meeting with the asset's current owners. "They know best what they do and what needs to be done. They are a key resource in determining what drives costs," she says.
Life-cycle planning is also critical to reducing O&M risks, Girard says. "If you're the O&M contractor or the concessionaire and going to be on the hook to take care of an asset for 50 years, then you need to be a part of the process from day one, before even bidding on the job. You need to be an active participant in the design and construction discussion to ensure that you have a quality asset to maintain and operate," he adds.
The goal is not only to maintain the asset for the life of the term but also to satisfy "hand-back" clauses in most contracts, which require the asset to be returned to the owner in a certain condition, with a certain amount of life left in it. Failure to do so can result in penalties, Warfield adds.
"A priority in the bankruptcy of a public infrastructure asset is to ensure that the asset, whether it be a road, bridge or tunnel, remains operational for public use. That means the O&M contractors are typically at the head of the queue to get paid," says John Parkinson, executive director of the Association for the Improvement of American Infrastructure.
He adds, "At the end of the day, even those projects that end up in bankruptcy are not failures. The taxpayers and the public still have an operational asset to use, one that the state could not have delivered without private investment and risk."