Making concessions

Considerable attention has been paid to the complexities of launching concession based projects. Articles and seminars on the subject have proliferated, and the projects themselves are now appearing in greater numbers.

Less public attention has been paid to the premature termination of concessions, though in practice the termination provisions in a concession contract are always strenuously negotiated.

The main variables which bear upon any discussion of termination are as follows:

* Time – there are two main periods to consider:

The first is the period prior to the commencement of construction. Governments frequently argue against the awarding of any compensation for termination during this period, on the basis that little or no investment has been made. However, this ignores the substantial expenditure needed to bring a project to the point of construction commencement – for example, tender costs and the initial capitalisation of the project entity.

The second period falls after the commencement of construction, during which time the risk borne by the funders increases substantially, so that they will insist upon some rights of termination and compensation.

* Causes of Termination

Different causes of termination will attract different consequences. They could include any of the following.

* Force Majeure

Governments are often reluctant to grant to the concession entity an express right of termination in the event of force majeure. In many cases, the concession contract will require a period of discussion and, in the absence of agreement, remit to an arbitration panel the task of determining a fair and reasonable result (which may include termination).

It is common for the government to undertake to repay the project lenders in the event of termination. It also happens – albeit less frequently – that equity investors will receive some repayment of their investment. It is extremely rare for any payments to be made in respect of loss of future profits in the case of termination caused by force majeure.

* Hardship

Concession contracts frequently contemplate events such as new tax or other legislation which, while not amounting to breach or force majeure, nevertheless interfere with the financial performance of the project. While some rights of compensation are occasionally conceded for such events (often in the form of toll increases or concession extensions rather than cash), it is rare to see express rights of termination. Such rights may arise indirectly where, for example, the hardship is such as to cause the dissolution of the concession entity.

* Default of Government

It is common, but not universal, for governments to concede an express right of termination to the concession entity in the event of government default. In that event, both lenders and equity investors are usually paid out, and it is also possible to secure compensation in respect of future loss of profits.

* Default of Concession Entity

Almost invariably, the government will reserve a right to terminate the concession in the event of the insolvency or breach of the concession entity. Even here, however, the concession agreement will sometimes provide for the government to assume the project debt, though this may be subject to the government's cross claims against the concession entity, or be limited to funds realised by the government from the operation of the project.

In addition to surveying the main variables in the termination/compensation matrix, it is useful to bear in mind some miscellaneous points.

* Effect of Governing Law

The host government usually insists on local law governing the concession agreement, even though other project agreements may be subject to foreign law. A careful examination should, therefore, be made of the effect of local law on the

issues of termination and compensation.

For example, under civil law systems, it may be necessary to obtain court approval for the termination of a public contract, and remedies additional to those spelled out in the concession contract may be available (based, for example, on some variation of the principle of unjust enrichment).

It will also be necessary to check that the arbitration and other dispute resolution clauses survive any termination.

* Grace Periods

The concession contract should provide for a substantial grace period following any threatened termination – typically 90 days or longer. Within that period, the lenders may attempt to exercise the substitution rights which are commonly written into the concession contract and to enforce the standstill obligations which they will have secured from the other project participants.

* Continuous Operation

In the event that termination actually occurs, the government will almost always reserve a right to step in and ensure the continuous operation of the project facility, without prejudice to the legal rights of the parties.

This has been a necessarily brief survey of some of the legal considerations which attend a possible termination. In practice, even if a termination event has occurred, it will generally be in the interests of all parties to use the contractual grace periods to avoid a full termination and to negotiate a re-financing and re-structuring of the project. A book, rather than an article, would be the appropriate length at which to review all the issues arising in the course of such a negotiation.

Tim Steadman is a partner in Baker & McKenzie's major projects group.