Construction Risk in P3 Projects. Timothy J. Murphy Partner McMillan LLP

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1 Construction Risk in P3 Projects Timothy J. Murphy Partner McMillan LLP

2 Risk Transfer in a P3 Key aspects of a P3: Private sector financing Public sector clarity through output specifications Integrated design and lifecycle obligations Key principle: Allocating risk to the party best able to manage it 2

3 Risk Transfer in a P3 Public Sector Benefits Procurement process emphasizes public sector clarity around needs Decreased change orders Lowers likelihood of budget creep Assumption of financial risk by the private sector Payment at commencement of operations Incentive to on time completion May permit acceleration of infrastructure 3

4 Risk Transfer in a P3 Public Sector Benefits (Cont d) Transfer risk of cost overruns Private sector bids to fixed price and takes pricing risk Annual payment structure, subject to market testing and benchmarking, leaves cost inflation risk with private sector 4

5 Risk Transfer in a P3 Public Sector Challenges Reduced Transparency and Accountability Offset by disclosure standards, value for money audits, online posting of key contracts, clear RFP process Lobbying restrictions Increased transaction costs Cost of money Bid costs Increased legal and financial complexity Offset by value for money in the risk transfer 5

6 Risk Transfer in a P3 Public Sector Challenges (Cont d) Credit crunch Lower lending limits Increased rate spreads Increased covenants Value for money problems? The challenge of effective communications (reluctant governments and active labour opponents) 6

7 P3 project structure The role of the Special Purpose Vehicle The role of the lenders The role of equity The drop down principle: no stranded risk 7

8 Special considerations for the contractor as consortium partner Negotiating with consortium members equity, service subcontractors Negotiating with lenders Retaining professional advisors Legal, tax, accounting, financial model auditors, lender counsel, lender technical advisors Role of contractor as subcontractor vs consortium lead 8

9 Key contractual terms Fixed completion date for construction phase Guaranteed construction price Full design and construction risk pass down Performance guarantees Liquidated damages for delay Security from the contractor and/or the parent Limitations on contractor termination rights 9

10 Key contractual terms (Cont d) Equivalent project relief Large caps on liability Fraud, contract cost, insurance proceed exemptions Restrictions on claims for time extension and additional costs Bankability 10

11 Contractors beware It s not your father s CCDC Passdown of financial risk Credit crunch: increased pressure for indemnities EPR principle applied to: Delayed public authority payments Insurance proceeds 11

12 Subcontractors Project size requires qualified subs Risk passdown to the subs LDs Security Assignability of subcontracts Design Risk Build/finance issues Design/builders 12

13 The role of architect/consultant SPV retains independent certifier Lender technical advisor as payment certifier Interface issues with the service provider EPR relief Design cooperation Defects repair Insurance overlap (equipment etc) 13

14 Supervening events Entitlement to extra time, extra costs or simply waiver of certain payment obligations depends upon type of event Types of supervening events Change in Law Variations Delay Events Compensations Events Excusing Causes Relief Events Force Majeure Defaults 14

15 Default and compensation Termination for convenience Project Co Default Public entity default Special mechanisms imposed by lenders and project entities Construction reserve accounts Liquidated damages 15

16 Mitigating the risk Insurance All Risks Wrap up Pollution Automobile Commercial general liability Professional liability Equipment issues (overlap with service period) 16

17 Insurance (Cont d) Pay attention to: Limits Deductibles Additional insureds Insurance Trust Agreement Uninsurable risk Coverage: Testing and commissioning, soft costs, delay in start-up, profit, resultant damage 17

18 Bonding and Subguard Insurance Subguard Insurance Protects GC against Sub default risk Does not protect subs against owner or GC risk Qualified subcontractors General coverage vs project specific Gap bond Definition of self-performed work Sureties and new lender covenants 18

19 Surety bonds Multiple obligee riders Standard form changes Permitting construction contract changes Lender rights Assignability 19

20 Limitations of Liability Dropdown principle Interface with Service Provider Caps and exclusions Insurance proceeds Fraud Contract price (or a portion thereof) 20

21 Early involvement with the project agreement 21

22 McMillan LLP Projects Group Brookfield Place 181 Bay Street, Suite 4400 Toronto, Ontario M5J 2T3 Attention: Tim Murphy (416)