I OVERVIEW

Public-private partnerships (PPPs) play a vital role in the delivery of large-scale infrastructure in Australia. Australian governments have utilised models similar to the PPP model since the 1980s; however, there has been a proliferation of PPP projects in the past decade for the procurement of roads, rail, hospitals, correctional facilities, water treatment infrastructure, and other social and economic infrastructure. A large number of projects are in the pipeline for 2019 and beyond.

PPP projects have been characterised by a contracting model in which government entities engage the private sector (typically a consortium) to design, construct, finance, operate and maintain infrastructure, and deliver related services over a concession term.

While many of the benefits of PPPs (e.g., transfer of construction and asset life-cycle risk) can be achieved using other models of procurement, PPPs have unique facets, such as extracting long-term value-for-money through risk transfer to the private sector over the life of the project – from construction through operations to handback.

II THE YEAR IN REVIEW

The year 2018 continued to be a busy period for infrastructure in Australia, with many PPPs in the tender process and the beginning of the tender process for several more.

The New South Wales (NSW) government has undertaken a busy programme of transport Infrastructure projects through a variety of models, including further stages of the WestConnex Motorway, Sydney Metro, Parramatta Light Rail and Regional Rail Project. Ancillary infrastructure for large transport projects has also been a focus area, with a number of over-station development projects procured. In 2018, the Martin Place Metro Project (an unsolicited proposal) achieved financial close, and the NSW government began the procurement process for the Victoria Cross Over-Station Development Project. The Queensland government carried out the request for proposals process for the Cross River Rail project in the second half of 2018. The Cross River Rail project is a tunnels and stations package, with related over-station development covering the Brisbane metropolitan area.

Australian governments at a state and federal level continue to affirm their commitment to the PPP model as well as the infrastructure and construction sector generally. In 2018, the Victorian government published an updated suite of project document templates for use on availability PPPs (with different templates for linear and social infrastructure) along with guidance notes.

In June 2018, the NSW government published the 'NSW Government Action Plan: A 10-point commitment to the construction sector', a statement on the NSW government's commitment to partner with the private sector on the delivery of a large pipeline of infrastructure projects, and the NSW government's commitment to be a 'best in class' client in the construction industry. The 10 points, which include a commitment to procuring and managing projects in a more collaborative way, adopting a partnership based approach to risk allocation and reducing bid costs, are timely given the heightened level of activity in the infrastructure sector in NSW.

III GENERAL FRAMEWORK

i Types of public-private partnership

The National Public Private Partnership Policy Framework (the National PPP Policy) identifies the core elements of a PPP as: the provision of infrastructure and any related services by the private sector; the use of private investment or financing; and complex and lengthy contracts involving long-term obligations and a sharing of risks and rewards between the private and public sectors.2

Further to the above, it is typically the case in Australian PPPs that: the government will enter into a project deed with a private sector counterparty, generally a special purpose vehicle incorporated by a consortium (Project Co);3 Project Co has sole responsibility for procuring the works and services that fall within the scope of the PPP and will subcontract those obligations to relevant subcontractors, for example, design and construction contractors and facilities management contractors. Usually, Project Co will enter into arrangements with debt financiers and equity investors to fund the project, and upon completion of the relevant infrastructure, the government will pay a service payment covering repayment of debt, return to equity investors and the cost of service provision.

In addition to the core documentation, a variety of side deeds and tripartite deeds will be entered into between the government, financiers and key subcontractors to regulate cure rights.

That said, there continue to be variations in the structure and scope of PPPs on a project-by-project basis to reflect particular requirements of that project.

In recent years, governments have begun to explore service-focused PPP models, particularly in the context of social infrastructure. These structures tend to be operator-led (rather than equity or builder-led) and focus on the underlying services that the government is procuring (e.g., health or housing services) rather than the facility or asset (e.g., the hospital or social housing), which is merely there to facilitate the delivery of those services.

The NSW Government's Social and Affordable Housing Fund (SAHF) is an example of a service-focused PPP. SAHF was established in 2016 and has recently completed its second phase of procurement to bring the total number of social and affordable housing dwellings, funded by the SAHF, to 3,400. Governments are exploring these models in the context of social infrastructure because of the long-term recurrent savings they can achieve in areas where service-delivery costs are increasingly rapidly.

ii The authorities

Under the federal system that exists in Australia, the state and territory governments are responsible for the delivery of core services such as transport, health, education, water and corrective services, and the infrastructure required to deliver them. Specialist teams have been established within the treasury departments of the state and territory governments to develop and oversee the implementation of PPP policy and guidelines by the relevant government; for example, 'Partnerships Victoria' has been established by the Victorian government.

While treasury departments and their specialist teams exercise a coordination and supervisory function in respect of PPPs, individual projects are typically procured by the government agency that has responsibility for delivering the service that will be enabled by the infrastructure. For example, the New Grafton Prison was procured by the New South Wales Department of Justice, with New South Wales Treasury providing support in relation to PPP policy and financial matters. Similarly, transport-related PPPs are often implemented by transport and infrastructure agencies within each government – for example, the Melbourne Metro Rail Authority is responsible for the procurement of the Metro Tunnel project.

In a recent development, the Commonwealth government has established the specialist Infrastructure Project and Financing Agency, which will support the Commonwealth in structuring, awarding and implementing infrastructure projects.

States and territories have (to varying degrees) implemented template project documentation to ensure consistency of key-risk allocations across projects within their jurisdiction and reduce bid costs. In 2018, Victoria released an updated suite of project document templates. The creation of template documents has led to significant convergence in the form and risk allocation of the template documentation between the states and territories.

iii General requirements for PPP contracts

A government agency that is procuring a PPP must have statutory power to do so and must comply with any applicable legislative requirements, such as planning legislation. The statutory power requirement is typically satisfied by broad statutory powers to procure infrastructure and execute contracts rather than specific references to PPPs.

Beyond this, there is limited express legislative or regulatory constraints on the use of PPP contracts in Australia. Governments generally use policies and guidelines to set out the rules around the use of PPPs.

The most important of these is the National PPP Policy referred to above. The National PPP Policy has been endorsed by all Australian state and territory governments and applies to all PPPs that are released to the market. The National PPP Policy identifies projects with a total capital value exceeding $50 million as those likely to have potential to provide value for money using a PPP model.

In some states, the National PPP Policy is supplemented by state-specific PPP guidelines, for example, the NSW PPP Guidelines, which set out state-specific requirements of PPPs.

The PPP policies also set out financial thresholds and tests that must be applied in deciding whether to utilise a PPP. Financial thresholds vary between each jurisdiction, but a government will usually be required to consider using a PPP model if the value of the project is between A$50 million and A$100 million or over. In respect of tests, a government must consider whether a PPP is in the best interests of the public and delivers value for money. This determination will typically involve the development and assessment of a 'business case' for the proposed PPP, which will include a 'cost-benefit analysis' as well as comparing the cost of procuring the project as a PPP against the government building, operating, financing and maintaining the relevant infrastructure.

Certain pieces of state, territory and federal legislation will also be applicable to PPPs on a case-by-case basis. Two key pieces of federal legislation with common application to PPPs are the Foreign Acquisitions and Takeovers Act 1975 (Cth) (FATA Act) and the Competition and Consumer Act 2010 (Cth) (Competition Act). The FATA Act regulates investments in Australian companies and infrastructure projects by foreign-owned entities or foreign governments. The FATA Act sets out thresholds for when a foreign entity or government must seek approval of the Foreign Investment Review Board (FIRB) to proceed with an investment. FIRB applies a broad 'national interest' test to determine whether to grant investment approval to the foreign entity or government. The Competition Act aims to promote competition, fair trading and consumer protection in Australia. Bidders participating in PPPs in sectors where there are competition concerns may be required to obtain approval from the Australian Competition and Consumer Commission.

IV BIDDING AND AWARD PROCEDURE

i Expressions of interest

PPPs are generally awarded through a competitive tender process that seeks to ensure that the government obtains a proposal that maximises value for money.

The release of an invitation for expression of interest (EOI) is generally the first step in the competitive tender process. The EOI phase serves the purpose of establishing the terms and conditions of the procurement and informing the market about the project and the tender process, including timelines and the criteria that will be used to evaluate proposals. The EOI phase also serves to inform the government as to the level of market interest in the project, the capacity and availability of the market to actually deliver the project, and the market's views on the best means of delivering the project. After receiving EOIs, the government will shortlist a number of parties to proceed to the next stage of the tender process.

ii Requests for proposals and unsolicited proposals

In a traditional PPP procurement the government will issue a request for proposal (RFP) to the bidders shortlisted from the EOI phase. The RFP will typically provide bidders with detailed information about the government's technical, commercial and legal requirements, as well as more detailed evaluation criteria against which proposals will be assessed.

The government will also generally release draft versions of the contractual documentation that set out the legal terms and conditions upon which the government wishes to undertake the PPP. Bidders have the opportunity to propose departures to the contractual documentation as part of their response to the RFP.

During the RFP phase the government often holds a series of 'interactive workshops' with shortlisted bidders. At these workshops, representatives of the government and shortlisted bidders meet to discuss key aspects of the project and how the project can best be delivered, including, for example, departures to risk allocation proposed by bidders. Ideally, the use of interactive workshops should facilitate the development of proposals that are mutually acceptable to both the government and the shortlisted bidders.

Finally, following evaluation of the proposals, the government may sometimes require some or all shortlisted bidders to submit a 'best and final offer' (BAFO). The decision to request a BAFO is purely at the government's discretion, and it will often ask shortlisted bidders to improve their pricing and withdraw specific departures during the BAFO stage.

Unsolicited or market-led proposals are increasingly common in the Australian market. Every jurisdiction publishes guidelines that set out the process for submitting an unsolicited proposal and the criteria against which proposals are assessed. Although the exact assessment criteria differ between governments, proposals are generally required to demonstrate, among other criteria, uniqueness and value for money. The requirement of uniqueness is because of the fact that in adopting an unsolicited proposal, the government foregoes a competitive tender process. Accordingly, an unsolicited proposal will only be adopted where the proponent has offered a unique offering or proposal – for example, the ability to contribute land that is proximate to the site of the project.

In 2018, the Martin Place Metro Project achieved financial close. This project involved an unsolicited proposal by Macquarie Group to build a new underground train station at Martin Place in Sydney, as well as to purchase the air rights for two commercial and retail towers above the station. This project is a significant example of unsolicited proposals achieving value-for-money outcomes, as taxpayers are expected to bear only a 'small portion' of the A$378 million cost of the new station.4

Another notable recent unsolicited proposal was the West Gate Tunnel Project in Victoria, which reached its conclusion in late 2017. The proponent was able to offer the Victorian government a unique proposal by financing the transaction through the extension of its tolling concession on other Victorian toll roads.

iii Evaluation and grant

Following the RFP phase, the government will look to select a preferred bidder. The selection of the preferred bidder is determined through application of the evaluation criteria that accompanied the RFP. The government generally has a broad discretion in formulating the evaluation criteria it applies. For example, the government can elect to have a combination of weighted and unweighted criteria, 'pass/fail' criteria, or comparative assessment. Notwithstanding this flexibility, government procurement and probity guidelines and policies and the risk of a process contract having been formed dictate that the government must be consistent in its application of evaluation criteria. Consistency in this context refers to both applying the evaluation criteria in accordance with an evaluation plan or protocol and consistently across bidders.

Once a preferred bidder is selected, the government and the preferred bidder will move to negotiate any remaining departures to the contractual documentation so that it can be finalised and executed. This is generally a more intense and shorter phase as the government is motivated to achieve financial close and avoid prolonged negotiations in circumstances where competitive tension has been reduced. In some tenders the government may continue negotiations with two or more preferred bidders in order to maintain competitive tension; however, this is uncommon.

The government is generally not obliged to select a preferred bidder or award a contract. This is because the terms and conditions of most tenders will preserve the right of the government to elect to abandon the process in its absolute discretion. Situations where tenders have been abandoned include changes of government and changes in economic conditions.

V THE CONTRACT

i Payment

In recent years, infrastructure in Australia has been generally procured on an availability payment model. Under an availability payment model:

  1. Project Co will fund construction costs typically through debt and equity funding until the construction is complete and services commence;
  2. during the operations phase, Project Co will be paid a monthly or quarterly services payment to cover the costs of service provision, repayment of debt funding and return to equity investors. The service payment will be subject to abatement for failure to meet certain requirements and key performance indicators (KPIs). Such KPIs may relate to the level of availability, quality of services performed and other standards of performance that are driven by the policy objectives of the government (for example, on the New Grafton Correctional Centre PPP project, KPIs are calibrated to incentivise Project Co to minimise rates of recidivism). The extent to which service payments may be abated varies depending on jurisdiction; and
  3. the government may on certain projects make capital contributions during the construction phase or a contribution to pay down a portion of Project Co's debt upon the project becoming operational and achieving certain conditions reflecting a steady state of operation.

Traditionally, economic infrastructure (such as toll roads and tunnels) had been procured on a user-charge format where Project Co had been entitled to collect tolling revenue from the ultimate user of the infrastructure in order to cover its costs of service provision, repayment of debt funding and return to equity investors. In a number of cases, actual traffic volumes (and therefore toll revenues) fell significantly short of modelled traffic volumes leading to the failure of the projects. Accordingly, there has been limited appetite over the past decade from private-sector financiers and equity investors for this payment model. There have, however, recently been a number of unsolicited proposals that have resulted in at least partial use of a user-charge payment structure.

ii State guarantees

Australian federal, state and territory governments have typically maintained credit ratings sufficient to not require financial guarantees for PPP projects. Further scrutiny may be required when the government counterparty is not a significant department or is some instrumentality of government. However, other than in NSW, it is unusual for any guarantee to be provided in respect of a PPP.

NSW has specific legislation governing the giving of government guarantees. Until 2018, this was legislated under the Public Authorities (Financial Arrangements) Act 1987 (PAFA Act), and it was common practice for PAFA Act guarantees to be provided on PPPs in NSW. In 2018, the PAFA Act was replaced by the Government Sector Finance Act (2018) (GSF Act), which provides for a substantially similar framework under which the state of NSW may guarantee contracts entered into by government agencies, known under the GSF Act as GSF Agencies.

iii Distribution of risk

A key attraction of the PPP model is the ability for government to allocate to Project Co the risks it believes may be more efficiently priced or managed by the private sector.

The National PPP Policy sets out guidance in relation to typical allocation of risks in PPPs. This is supplemented and adapted by various guidance issued by the state and territory governments in relation to their particular approach to PPPs. The allocation of risk may also vary where there are particular facets of a PPP that lend themselves to an adjustment of the typical risk allocation.

The following table sets out certain key risks of a PPP and how they will be typically allocated.

Risk Government Project Co Comment
Planning Y Y Risk of approval based on reference design allocated to government. Changes required to accommodate private-sector delivery solution allocated to Project Co.
Other approvals Y
Land acquisition Y Other than in respect of extra land required to accommodate Project Co delivery solution.
Design risk Y
Construction risk Y Subject to some limited project-specific 'extension events'.
Financing risk Y
Completion risk Y
Site conditions Y Y Generally allocated to Project Co although common to include some risk sharing in respect of contamination.
Operational performance Y Subject to some limited project specific 'relief events'.
Maintenance/life cycle Y Subject to some limited project specific 'relief events'. Some road PPPs may include risk-sharing regimes in relation to maintenance costs where traffic thresholds are exceeded.
Demand risk Y See above in relation to the prevalence of availability-based PPPs.
Change in law Y Y Change in law relief for Project Co is typically limited to a narrow category of project-specific changes in law during the construction phase. During the operations phase broader change in law relief is typically available to Project Co, although it is often subject to financial thresholds.
Inflation Y Y Construction cost inflation risk is allocated to Project Co.
The service payment during the operational phase will typically be indexed and certain services may be reviewable. Project Co takes risk of adequacy of contractual indexation and potential for certain reviewable services to be replaced.
Force majeure disruption Y Y Risk generally shared – the specific sharing varies from project to project.

iv Adjustment and revision

Australian PPPs typically include a detailed modification and change compensation regime under which the parties agree the principles for allocating and valuing the time, cost and performance impacts of modifications to the project.

The cost of such changes can be calculated using a variety of methods, including reference to actual costs, pre-agreed margins, schedules of rates and the base case financial model. Most of the time, changes that are processed through the modifications regime do not require an amendment to the underlying project contract.

It is increasingly common to see modification regimes that also include mechanics to implement certain pre-agreed changes that were anticipated at execution but that may either require further development or approvals or may be contingent on the occurrence of other events.

There has been a trend over the past few years to include detailed augmentation regimes in rail PPP contracts to allow for the extension of projects. Augmentations have been undertaken on the Gold Coast Rapid Transit PPP project and are anticipated on the Sydney Metro NorthWest OTS PPP project and the Australian Capital Territory Capital Metro PPP project.

v Ownership of underlying assets

Most PPPs in Australia provide for the government to own the asset from the beginning of the operating term.

At the conclusion of the operating term there will typically be a handover process consisting of an asset condition audit and rectification process to ensure: that the government receives an asset that is in the contractually mandated condition; and the smooth transition of operations and maintenance responsibility.

vi Early termination

Australian PPPs usually contain a detailed regime for default (and related cure rights) and termination. Such regimes will invariably be asymmetrical, with the government counterparty enjoying the benefit of far more extensive rights with respect to default and termination than Project Co.

Typically Project Co's termination rights (if any) will be limited to protracted force majeure disruption to the project. The default and termination regimes will often codify the rights of the parties to the exclusion of the parties' rights at general law.

Default by Project Co

A cascading approach is commonly adopted for Project Co default:

  1. mere breaches of the contractual documentation may be dealt with by notification and remedy period;
  2. more serious defaults (often termed 'major defaults') will typically give rise to a cure or prevention regime; and
  3. the most serious defaults will give rise to immediate default termination rights.

A separate cure regime for financiers where Project Co has failed to cure usually applies through the financiers' direct agreement with the government counterparty.

Compensation to Project Co for termination for default will usually be calculated based on the fair market value of the project (valued either through re-tender or by an independent valuer if there is no liquid market for the project).

Termination for convenience

Most PPP contracts include an ability for the government counterparty to terminate for convenience. It is extremely unusual for a government counterparty to terminate for convenience; however, it is a typical inclusion so that government's operational discretion is not fettered.

Compensation to Project Co for termination for convenience will typically be on a more generous basis than for other termination scenarios and may, in some projects, include an amount to compensate Project Co for lost future profits.

Termination for neutral events

Most PPP contracts include provision to terminate for the occurrence of protracted force majeure or uninsurable events that materially disrupt the project.

Compensation to Project Co for termination for a neutral event varies; however, it will typically be sufficient to cover debt repayment, and will in some projects include partial compensation to equity investors.

VI FINANCE

Australian PPPs are usually financed through a combination of bank debt and equity investment, although there has been increasing speculation in relation to the return of bond financing to the Australian PPP market. In this regard, it was recently announced that the Victorian Outer Suburban Arterial Roads – Western Package PPP project was financed by a mix of bond, debt and equity financing.

In general, the gearing of debt to equity will depend on the particular risk attributable to the project.

As noted above, financiers will typically have entered into a contract with the government counterparty to regulate cure rights where termination rights have accrued in relation to the project.

VII RECENT DECISIONS

There were a number of significant disputes on PPPs in the delivery phase during 2018.

In particular, in NSW there has been a well-publicised dispute between Transport for NSW and the builder of the Sydney Light Rail PPP Project, Acciona. Acciona has made a number of claims directly against Transport for NSW rather than against the project vehicle. This has led to a tightening by procuring authorities of provisions regulating this type of direct claim and the subject matter of the claim across projects currently in procurement.

VIII OUTLOOK

There continues to be strong demand for infrastructure in Australia and we expect 2019 to continue to be a busy year for those involved in the PPP market. Looking around the states and territories:

  1. in NSW, demand for infrastructure continues unabated and we expect current strong levels of activity to continue. In particular, Western Harbour Tunnel and Beaches Link Tunnel and further stages of the Sydney Metro project are expected to commence the RFP stage in early 2019;
  2. Victoria is committed to bringing to market the North East Link PPP, further packages of its Outer Suburban Arterial Roads, and a programme of rail projects;
  3. in Queensland, the Australian Rail Track Corporation has committed to commence the Toowoomba to Kagaru section of the Inland Rail freight corridor project; and
  4. the Australian Capital Territory is formulating its business case for the augmentation of the ACT Capital Metro PPP project.

More broadly, we expect the following trends to continue to develop in 2019:

  1. unsolicited proposals: namely, private-sector parties to continue to make use of the states and territories' unsolicited proposal regimes to bring innovative solutions to infrastructure gaps;
  2. bond finance: an increasing consideration by private-sector counterparties of bond-financing as an option for PPPs now that this has re-emerged as a viable and competitive option for some projects;
  3. demand risk: more consideration of the private sector's ability to take some appropriately bounded demand risk in PPP projects; and
  4. service-focused PPPs: experimentation by government with service-focused PPP models such as NSW's Social and Affordable Housing Fund Phase 2 (as discussed in Section III(i)), where the government is focused on service provision (as opposed to just capital asset development).

Footnotes

1 Andrew Griffiths and Nicholas Carney are partners, and Lan Wei is a solicitor at Herbert Smith Freehills.

2 Department of Infrastructure and Regional Development (Cth), National Public Private Partnership Policy Framework, October 2015, https://infrastructure.gov.au/infrastructure/ngpd/files/National-PPP-Policy-Framework-Oct-2015.pdf, p. 6.

3 In practice, a governmental authority or entity will generally be the public sector counterparty to the PPP contractual documentation. However, for simplicity's sake, the general term 'government' has been used to refer to the procuring authority or entity. Further information about which governmental authority is responsible for using a PPP is provided in Section III.ii, 'The authorities'.

4 Jacob Saulwick, Macquarie Group seals deal for new Martin Place metro station and towers, Sydney Morning Herald, 12 September 2018, https://www.smh.com.au/national/nsw/macquarie-group-seals-deal-for-new-martin-place-metro-station-and-towers-20180912-p5038p.html.