Caltrans Legal Division Contract Law Workshop San Diego, California March 21, 2007 PUBLIC-PRIVATE PARTNERSHIPS Fredric W. Kessler, Esq. Nossaman Guthner Knox & Elliott LLP The information contained herein does not constitute a legal opinion and should not be relied upon by the reader as legal advice or be regarded as a substitute for legal advice. Copyright, 2007 Nossaman Guthner Knox & Elliott, LLP. All Rights Reserved. 1 1
Overview Project Delivery Methods From DBB to PDA The Power of Concession Financing Types of Concessions Pre-Development Agreements Key Concession Contract Terms Protecting public sector while attracting private capital California Legislative Status 2 2
Project Delivery Methods: Public and Private Roles Method Design/ Construction O&M Financing Revenues Legal Authority GA Risk GA Control A. DBB GA/PS GA GA GA Y B. DB PS GA GA GA N C. DBOM PS PS GA GA N D. Availability Concession PS PS PS GA N E. Toll Concession PS PS PS PS N F. Prevelopment Agreement PS PS PS PS N GA Government Agency PS Private Sector 3 3
Project Delivery Methods: Design-Bid-Build as Base Case All projects are delivered through public-private partnerships just a question of degree! Most projects are delivered using the Design-Bid-Build model Public owner: Designs project to 100% PS&E Achieves environmental clearance Breaks project up into biddable scopes Pays all invoices out of allocated STIP funds, other tax revenues and/or bond proceeds Operates and maintains project itself or through separately procured contractors Provides design oversight and construction management Keeps integration, traditional construction contract risk, long term performance and revenue risks 4 4
Project Delivery Methods: Design-Bid-Build as Base Case Private Parties: Design project and perform construction under conventional contracts Have conventional rights to claims and change orders Alternatives frequently require special state legislation and, where federalized, sometimes exemptions from federal rules and statutes (e.g. SEP 14, SEP15) 5 5
Project Delivery Methods: Why Change? To justify deviating from the Base Case, P3 delivery method should offer advantages: Significantly accelerate project delivery Fix costs/completion date early in design phase; unlike Base Case Capture private sector innovation early in project development, especially in design, environmental and permitting processes Efficiently shift to private sector major risks and reduce claims which under Base Case would be government responsibility Encourage lifecycle cost efficiencies and quality facility performance over time Raise more capital to close funding gaps, deliver more mobility sooner 6 6
The Power of Concession Financing Equity Market appetite Factor Traffic and revenue projections Senior debt coverage ratios Subordinate debt coverage ratios Federal tax subsidies Tax exempt interest Depreciation / amortization Subordinate TIFIA debt Blended rate of interest on debt Maximum toll rates Yes Yes, if use PABs Yes Yes Concession Financing More aggressive Moderate to Conservative (1.2 1.3) Moderate to liberal (1.1) Comparable (with PABs + TIFIA) Locked in by contract Strong market demand for debt and equity Tax Exempt Revenue Financing Conservative Conservative (1.25 +) Moderate to liberal (1.1) No Yes No Possible, but not likely Comparable Subject to political risk Deep, liquid bond market 7 7
The Power of Concession Financing Private Equity vs. Tax-Exempt Tax-exempt financing has more conservative debt coverage ratios (limits amount of debt Investor classes are different Private equity investors have sector expertise Private equity investors willing to take longer horizon view vs. typical 20-30 year tax-exempt bond investors Surplus revenues not valued in tax-exempt structure, but highly valued by private equity Accelerated depreciation creates significant value for private equity that public sector cannot realize 8 8
The Power of Concession Financing What equity values (that tax-exempt financing doesn t) $ Surplus adds value Debt Service Operating Costs Y 40 Municipal bond investors rely on historical revenues to determine leverage levels, constraining total value for the owner Equity investors look for future returns based on growth Debt + Equity = Greater Proceeds for Owner of Asset 9 9
Types of Concessions Toll Concessions Availability Payment Concessions Asset Monetization Development Concession Mixed Concession Revenue Positive Revenue Negative 10
Types of Concessions Attributes of an Asset Monetization Long term lease and operation of existing facility ( Brownfield ) Operations, traffic and maintenance history Stable cash flows from tolls Stable expenses Lower risk profile for concessionaire in terms of traffic and revenue Buying a going concern Examples: Chicago Skyway, Indiana Toll Road 11
Types of Concessions Attributes of a Development Concession Project Characteristics Design, Construction, Operation of new facility ( Greenfield ) Long term lease No operations, traffic or maintenance history Unproven cash flows and expenses Reliance on cost estimates and traffic & revenue projections Higher risk profile for concessionaire Construction risk (delay and cost overruns) Traffic and revenue/start-up risk Higher risk profile requires higher return to investor Once past start-up, risks become similar to asset monetization 12
Types of Concessions Attributes of a Development Concession Nature of Competition Public partner defines project Clears it environmentally Achieves public consensus on project and PPP Validates financial feasibility Sets toll rate schedule Develops complete business and contract terms, technical specifications 13
Types of Concessions Attributes of a Development Concession Nature of Competition Qualifications submittal and short listing Industry workshops One-on-one proposal meetings Competing hard money bids Proposer assembles design, construction, O&M pricing and forces Proposer delivers firm equity/debt commitments Selection primarily a price competition Examples: Port of Miami Tunnel, Knik Arm Crossing 14
Types of Concessions Attributes of a Mixed Concession Combination of existing facility plus new construction Reconstruction Capacity Expansions e.g., managed lanes Project extensions Long term lease Examples VDOT Pocahontas Parkway TxDOT SH 121 5 segments, 24 miles One segment operational and almost complete; one almost complete; two have frontage roads only; one in NEPA process $2.1B up-front payment; $700M NPV of annual lease payments $550M construction Revenue sharing, including refinancing gain Bank debt plus TIFIA; PABs as Plan B 15
Types of Concessions Revenue Positive Concessions Project revenues exceed: Capital costs Debt costs (interest, principal, reserves) O&M costs Handback/end of term costs Return to private partner Can result in upfront payment from private partner to public owner, revenue sharing, or both Examples: TxDOT SH 130, Segments 5&6 16
Types of Concessions Revenue Negative Concessions Project revenues insufficient to cover: Capital costs Debt costs (interest, principal, reserves) O&M costs Handback/end of term costs Return to private partner Competition based primarily on least amount of public funds needed 17
Types of Concessions Contract provides for how gap filled How, when, on what conditions is Owner or other $ funded - Progress, milestone, periodic, etc. It may provide for recapture of $ back to Owner if Project performs above a certain measure Can affect contract provisions on Owner oversight, performance security Examples: TxDOT IH 635, North Tarrant Express 18
Types of Concessions Attributes of an Availability Payment Concession Same as Toll Concession, except Public Owner Retains project revenues, if any, and related risks Pays private party based upon project availability and performance over extended period Private Party Assumes concession type risks, sometimes even usage risk, but not collection of tolls, cost of collection or total revenue collected Competition primarily based on lowest availability payments needed to deliver and operate project 19
Examples Types of Concessions Florida DOT Port of Miami Tunnel British Columbia MOT Sea to Sky Highway 20
Pre-Development Agreements Attributes of PDA Project characteristics PPP formed at beginning or during environmental process Complex, large development project Project configuration fluid Finance plan rudimentary or non-existent Preliminary T&R analysis done and suggests financial feasibility Public partner may lack funds, resources to progress project 21
Pre-Development Agreements Attributes of PDA Nature of Competition: Selection is qualifications based Project understanding Conceptual development and finance plans Track record Pricing of pre-development work Successful work earns exclusive right to negotiate concession agreement 22
Pre-Development Agreements PDA Examples Wide domestic use, little international use California - SR 125, SR 91 Virginia Pocahontas, I-81 Truck Lanes, I-95/395 HOT Lanes, Dulles Rail Corridor Texas TTC-35, SH 130 Segments 5& 6, TTC-69 Oregon Sunrise, Newberg Dundee, I 205 South Corridor Washington Tacoma Narrows 23
Pre-Development Agreements Comparison of PDAs and Toll Concessions Private partner participation in predevelopment work Project definition Environmental review Preliminary T&R work Investment grade T&R study Value engineering Stakeholder relations PDA Strategic partner Strong Technical and economic analysis Yes Yes Yes, all stages Possibly Toll Concession Minimal Role Weak None No Yes Only via Alternative Technical Concepts at proposal stage, and postaward design More limited 24
Pre-Development Agreements (cont d) (cont d) Technical specification development Financial planning analysis Nature of Competition Predevelopment contract Concession contract Transparency Predevelopment PPP Direct participation Yes Qualifications Sole source negotiation (price reasonableness analysis) Less Hard $ PPP Only via industry draft review and comment No N/A Price competition More 25
Key Concession Contract Terms: Quality Design, Construction, Operation and Maintenance P3 Approach Private partner designs, constructs, operates, maintains Private investors and lenders will not accept traditional public sector control How can public partner assure quality? 26
Key Concession Contract Terms: Quality Design, Construction, Operation and Maintenance Tools Performance-based measures and standards specify outcomes, and inspections to measure outcome achievement Private partner project management plan procedures, processes, quality management systems for all aspects of work. Subject to public partner approval Private partner responsibility for acceptance testing and inspection 27
Key Concession Contract Terms: Quality Design, Construction, Operation and Maintenance Tools Use of Independent Engineer Field inspections, monitoring and auditing Document review and audits for compliance with management plan and performance standards Verification testing (at lesser frequency than private partner s testing) Reporting to both parties Measures to assure independence 28
Key Concession Contract Terms: Quality Design, Construction, Operation and Maintenance Regular performance measurement inspections and reports by private partner to determine and maintain asset condition Public partner audit and monitoring of IE and private partner, and spot testing and inspection Renewal and replacement scheduling and reserves Handback requirements 29
Key Concession Contract Terms: Quality Design, Construction, Operation and Maintenance Changes in Standards What is private sector obligation to conform to future changes in standards? PPP solutions vary Conform at public partner s election and expense (cost and revenue impacts) Conform at private partner s expense Sharing of cost risk 30
Key Concession Contract Terms: Reasonable Tolling Structure and Profits Public sector needs: Maximize its income? Minimize toll rates? Prevent excessive profit? Manage traffic demand and congestion? Depoliticize setting toll rates? Toll exemptions for critical public purposes? Tools: Indexed toll rate schedule caps future toll rates, depoliticizes Set initial rates Use stated rates of increase and/or inflation indices for capping future toll rate adjustments CPI, GDP, GSP, ECI 31
Key Concession Contract Terms: Reasonable Tolling Structure and Profits Toll Pricing congestion management Dynamic toll rates varying by time of day, level of congestion SR91, San Diego, SH 121, IH 635 (managed lanes) Banded revenue sharing generates public partner revenues, prevents excessive profit Public partner takes escalating share of toll revenue as rate of return increases Examples: Pocahontas: 40% of real net cash flow after IRR on total investment = 6.5%; 80% after IRR=8.0% Segments 5 & 6: 4.65% of gross revenue until IRR on equity = 11%; 9.3% of next band of gross until IRR = 15%, 50% of all further gross 32
Key Concession Contract Terms: Reasonable Tolling Structure and Profits Shadow tolls and availability payments reduce or eliminate tolls, prevent excessive profits, depoliticize Toll exemptions / suspensions Police, fire, emergency vehicles Transit vehicles School buses Contractor vehicles Suspend tolls for mass evacuations, emergency traffic diversions 33
Key Concession Contract Terms: Balanced Approach to Competing Facilities Public Sector Need - right to build other projects over time to address traffic safety and system capacity issues Private Sector Need - protection of the originally expected revenue stream 34
Key Concession Contract Terms: Balanced Approach to Competing Facilities The Mistakes of SR91 Contract prohibited operation of competing facilities Exceptions too narrow Result: Private partner had, and exercised, legal right to enjoin expansion of free lanes on SR91 The Lessons Learned The sole remedy is $ to cover net revenue impact No right to enjoin. Public sector free to build whatever it wants 35
Key Concession Contract Terms: Balanced Approach to Competing Facilities Exceptions for: All projects identified in transportation plans All projects outside a competing facilities zone Improvements for safety, maintenance or operational purposes Certain capacity improvements ITS systems, metering devices, intersection grade separations, restriping that adds lanes HOV/HOT lane additions on other roadways Transit and other non-highway projects All projects outside public partner s control 36
Key Concession Contract Terms: Effective Remedies Scale remedies to the type and severity of breach Liquidated damages for delayed completion, noncompliance with routine covenants Owner step-in rights, including receivership Work suspension during construction Anticipatory breach and assurances of future performance for persistent default Termination for major uncured default Lender rights to notice and cure Termination compensation to private partner 37
California Legislative Status History AB 680 adopted in late 1980 s; repealed in 2004: SR-91 and SR-125 Local Government Authority: Gov. Code 65864 et seq. (City/County Development Agreements) Local Government Privatization Act of 1985 Gov. Code 5956 et seq. (AB 2660) Individual agencies with broad enabling legislation 38
California Legislative Status AB 1467 Chaptered May 2006 4 project pilot program 2 in No. Cal and 2 in So. Cal and at least 2 must be sponsored by local transportation agencies Key Provisions/Concepts Designed for goods movement projects Can only toll commercial or non-commercial vehicles with 3 or more axles Legislature can reject contract within 60 days after submission P3 Agreement must establish specific toll rates Investor can earn reasonable return Reversion to government agency No more SR 91 non-competes 39
California Legislative Status Issues with AB 1467 Post-award legislature involvement How much flexibility in terms of setting toll rates? Indexing? Congestion Pricing? What is a reasonable rate of return? Conveyance at expiration at no charge Government reimbursed for provision of services Non-compete clauses Is DB permissible? Prescriptive specs 40
California Legislative Status Where do we go from here. Amend AB 1467 to address issues Expand AB 1467 for other projects Seek new/other P3 legislation Regional agencies are key!! Specific project-focused legislation Runner Bill 41
CONTACT Fredric W. Kessler Partner Nossaman Guthner Knox & Elliott LLP 445 S. Figueroa Street, 31st Floor Los Angeles, CA 90071 (213) 612-7829 fkessler@nossaman.com www.nossaman.com 42