The Public-Private Partnership Law Review: Australia

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 2021 and beyond.

PPP projects generally utilise a contracting model in which government entities engage the private sector (typically a consortium) to design, construct, finance, operate and maintain infrastructure, deliver related services over a concession term and hand back the asset to the government entity in the required condition at the end of the concession term.

While many of the benefits of PPPs for government entities (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.

The year in review

The year 2020 continued to be a busy period for infrastructure in Australia, with many PPPs in the tender process, several reaching financial close and more reaching completion of construction. Rail and road projects remain a priority in Australian infrastructure procurement although there has been a resurgence of social infrastructure projects.

In New South Wales (NSW), a number of existing PPPs were augmented. This included the Sydney Metro City & Southwest OTS2 PPP, additional facilities to existing school PPPs, a number of unsolicited proposals (such as the proposed M7–M12 motorway integration), and the commencement of full operations on the Sydney Light Rail PPP project and on NorthConnex. The NSW government has commenced an early consortium involvement stage for the Circular Quay Renewal to explore undertaking this project as a hybrid PPP involving infrastructure and real estate assets. The NSW government has taken a varied approach to procurement models utilising large design and construct packages for Sydney Metro and the Western Harbour Tunnel as well as the PPP model.

Victoria continues to be a supporter of the PPP model, with continued procurement of North East Link and the award of the Footscray Hospital PPP. However, the second and third Suburban Roads Upgrade packages were discontinued as the government sought shovel-ready economy-boosting projects in response to covid-19.

In Queensland, the Inland Rail (Toowoomba to Kagaru) PPP project issued its long-awaited request for proposals.

In South Australia, the SA Schools PPP achieved financial close in early 2020, and in the Australian Capital Territory, operations commenced on the Capital Metro PPP light rail project, and the government is considering options for the next stage.

Furthermore, in response to the covid-19 pandemic, various Australian governments have announced infrastructure stimulus programmes in the transition from its response to the health crisis and into the next stages of economic recovery. PPPs are expected to feature in a number of these infrastructure programs.

During 2020, many parties to PPP contracts had to consider whether they were entitled to relief or compensation, or both, under their respective project deeds as a result of the effects of the covid-19 pandemic, including government-imposed lockdowns, restrictions on 'non-essential' work, and interstate and international border closures. In doing so, they have had particular regard to force majeure provisions, change in law provisions and the doctrine of frustration. Each contract is different, and relief will depend on the terms of a particular contract. Generally, the government has taken a pragmatic approach to dealing with the impacts of covid-19 on projects, with an emphasis on keeping projects underway to the maximum extent achievable.

General framework

i Types of public-private partnership

The National Public Private Partnership Policy Framework (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 and the 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 or operation and maintenance contractors. Usually, the project co will enter into arrangements with debt financiers and equity investors to fund the design and construction of the project and, upon completion of the relevant infrastructure, the government will pay a service payment covering the repayment of debt, the return to the 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, and interface agreements with affected stakeholders such as proximate infrastructure and local authorities. That said, there continue to be variations in the structure and scope of PPPs on a project-by-project basis to reflect the particular requirements of a 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.

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 provide 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 governments; 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 NSW Department of Justice, with NSW 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, Sydney Metro is responsible for the procurement of the Sydney Metro 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 the 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 are 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 A$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 a 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 a comparison of 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. Following the arrival of covid-19, these thresholds were temporarily reduced to zero Australian dollars, meaning that all investments required FIRB approval. However, as of 1 January 2021, the pre-existing thresholds were reinstated. FIRB applies a broad national interest test to determine whether to grant investment approval to a foreign entity or government. Under the recent reforms to the FATA Act effective 1 January 2021, FIRB applies an additional pre-transaction mandatory approval requirement for notifiable national security actions. This new requirement empowers the Treasurer to impose conditions or block investment by foreign persons on national security grounds, regardless of the value of the investment. This new national security test (distinct from the pre-existing, broader national interest test) may be relevant for certain PPPs as it enables greater government scrutiny of foreign investment, particularly in sensitive sectors.4 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.

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 capability, 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 a project and how the project can best be delivered, including, for example, departures to risk allocation proposed by bidders and technical solutions. 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.5

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 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 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 less common.

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.

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. the 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, the 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 the 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 the 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 the project co was entitled to collect tolling revenue from the ultimate user of the infrastructure to cover its costs of service provision, repayment of debt funding and return to equity investors. Thereby, the project co accepted the risk of traffic volumes and associated revenue. In a number of cases, actual traffic volumes (and therefore toll revenues) fell significantly short of modelled traffic volumes, leading to the failure of projects. Accordingly, there has been limited appetite over the past decade of private sector financiers and equity investors for this payment model. However, there has 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. The change has not in practice appeared to diminish the provision of guarantees for projects where required.

iii Distribution of risk

A key attraction of the PPP model is the ability for the government to allocate to a 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 the 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 have traditionally been allocated. It is worth noting that on some large projects the government has shifted toward greater sharing of subsoil construction risk (contamination, utilities, geotechnical risk) following reduced appetite for these risks in the private sector.

RiskGovernmentProject coComment
PlanningYYRisk of approval based on reference design allocated to government. Changes required to accommodate private sector delivery solutions allocated to the project co.
Other approvalsY
Land acquisitionYOther than in respect of extra land required to accommodate the project co delivery solution.
Design riskY
Construction riskYSubject to some limited project-specific extension events.
Financing riskY
Completion riskY
Site conditionsYYGenerally allocated to the project co, although it is common to include some risk sharing in respect of contamination.
Operational performanceYSubject to some limited project-specific relief events.
Maintenance/
life cycle
YSubject 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 riskYSee above in relation to the prevalence of availability-based PPPs.
Change in lawYYChange in law relief for the 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 the project co, although it is often subject to financial thresholds.
InflationYYConstruction cost inflation risk is allocated to the project co.
The service payment during the operational phase will typically be indexed, and certain services may be reviewable. The project co takes risk of adequacy of contractual indexation and the potential for certain reviewable services to be replaced.
Force majeure disruptionYYRisk 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 a 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, 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 the project co.

Typically, the 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 the 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 a 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 the project co has failed to cure usually applies through the financiers' direct agreement with the government counterparty, with the financiers' cure rights operating in priority to the government's cure rights.

Compensation to a 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 the government's operational discretion is not fettered.

Compensation to a 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 the 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 a project.

Compensation to the 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.

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, Victoria has sought to utilise longer-term finance options on their recent projects including 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.

Recent decisions

While there have not been judicial decisions that have substantially affected the operation of the PPP framework, there were a number of well-publicised disputes and settlements with respect to PPPs in their delivery phase during 2020, including in particular on the West Gate Tunnel PPP.

Outlook

There continues to be strong demand for infrastructure in Australia and we expect 2021 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 procurement to include the systems, stations, trains, operation and maintenance package of Sydney Metro; Western Sydney Airport, set for procurement in mid-2021; and potentially some road projects;
  2. Victoria's North East Link PPP and Frankston Hospital PPP will remain under procurement, and Victoria has foreshadowed a number of large rail projects;
  3. in Queensland, the Gowrie to Kagaru section of the Inland Rail project has proceeded to the RFP process; and
  4. in the Australian Capital Territory, the government is considering its strategy for Stage 2 of the Canberra Light Rail PPP Project with further stages under consideration.

More broadly, we expect the following trends to continue to develop in 2021:

  1. following the covid-19 pandemic, more detailed treatment in project agreements for pandemics and epidemics and the ongoing effects of covid-19, including from a work continuation and work, health and safety perspective;
  2. unsolicited proposals: private sector parties continuing to make use of the states' and territories' unsolicited proposal regimes to bring innovative solutions to infrastructure gaps and government support for these where they are stimulatory from an economic perspective and consistent with existing infrastructure commitments (e.g., augmentations) or post-pandemic priorities (e.g., health and resilience). or both; and
  3. 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.

Footnotes

1 Andrew Griffiths and Nicholas Carney are partners and Aggie Goss is a special counsel 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.

4 The Hon Josh Frydenberg MP, Major reforms to Australia's foreign investment framework pass the parliament, 9 December 2020, https://ministers.treasury.gov.au/ministers/josh-frydenberg-2018/media-releases/major-reforms-australias-foreign-investment-0.

5 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.

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