The Public-Private Partnership Law Review: South Korea
With the enactment of the Promotion of Private Capital into Public Overhead Capital Investment Act in August 1994, Korea introduced the public-private partnership (PPP) scheme in earnest.2 Under the PPP scheme, the government sought to supplement its insufficient finances by inviting private funds to construct public infrastructure, such as roads, railroads and harbours. Since then, Korea has continued to make efforts to create an environment suitable for private partnership for approximately 20 years through statutory amendments and system improvements. The current PPP framework is being operated transparently and fairly, pursuant to the Act on Public-Private Partnership in Infrastructure (PPP Act), its enforcement decree, the Public-Private Partnership Project Basic Plan (PPP Basic Plan), the detailed methods and guidelines prescribed by the Korea Development Institute's Public and Private Infrastructure Investment Management Center (PIMAC),3 and ordinances legislated by each local autonomous government.
By amending and publicly announcing the PPP Basic Plan annually,4 pursuant to the PPP Act, Korea is responding to changes in conditions of the private investment market. Moreover, by developing guidelines on various types of evaluation and enforcement processes and standardising the qualification examinations, infrastructure project basic plans and concession agreements, Korea is striving to enhance transparency and fairness in implementing PPP projects.
Triggered by the deterioration in government finances caused by the foreign exchange crisis in the late 1990s, the demand for PPP projects in Korea increased exponentially. At that time, PPP projects were boosted by the large influx of foreign infra funds, which had an abundance of experience in implementing PPP projects and the requisite capital. The number of projects and the total invested amount eventually peaked in 2007, subsequently declining as the financial crisis subsided. However, PPP projects for public infrastructures, such as roads, railroads, harbours and terminal sewage disposal plants, have continued to build and rebuild Korean infrastructure.
The year in review
According to the 2019 PPP Basic Plan and 2020 PPP Basic Plan announced by the government (Ministry of Strategy and Finance), the total number of PPP projects that the government is currently participating in is 75, with a total investment of 38.1 trillion won. According to the National Balanced Development Project announced on 29 January 2019, a total of 23 projects (total investment amount of about 24 trillion won) were exempted from preliminary feasibility studies, and PIMAC launched two preliminary feasibility studies in 2020. According to data, a total of nine preliminary feasibility studies were conducted in 2020 alone, so more PPP projects are expected to be added to the PPP Basic Plan to be released in 2021.
i Types of public-private partnership
PPP projects under the PPP Act are largely categorised into projects to be operated on a lease basis by a private entity (a build-transfer-lease type) and those projects to be operated on a non-lease basis. Non-lease based projects are in turn categorised into build-transfer-operate (BTO), build-operate-transfer (BOT) and build-own-operate types. The BTO type is further divided into a type in which the project operator fully bears the project risk, and a type in which the project operator and the government share the project risk. According to the PPP Basic Plan announced in 2020, out of a total of 75 PPP projects currently being undertaken by the government, 46 are non-lease based, while 29 are lease-based.
ii The authorities
As briefly explained in the Section I, PPP projects are undertaken in accordance with the PPP Act. The Ministry of Strategy and Finance annually announces the PPP Basic Plan according to the PPP Act, and only when the outline for an infrastructure project has been set forth in the PPP Basic Plan may the detailed plan for such infrastructure projects be established by the competent authority. On the basis of such detailed plan, private entities may bid to undertake such an infrastructure project, and after a successful negotiation with the preferred bidder, the competent authority of the project may enter into a concession agreement with the preferred bidder. The PPP project in all aspects is undertaken in accordance with the terms of the concession agreement.
In principle, for a project with a total project cost of 50 billion won or more and a government expenditure amount of 30 billion won or more to be provided for in the PPP Basic Plan, such project must be recognised as a feasible project on the basis of a preliminary feasibility study in accordance with the National Finance Law, unless otherwise exempted.5 Preliminary feasibility studies for PPP projects are carried out by PIMAC under the oversight of the Korea Development Institute.
In some cases, however, preliminary feasibility studies for a project may be exempted for exceptional reasons as prescribed by the PPP Act. Prior to 2019, the bar for obtaining exemption from a preliminary feasibility study had been high; however, under the National Balanced Development Plan announced on 29 January 2019, it is disclosed that preliminary feasibility studies were exempted for 24 projects.6 Most recently, the national government has announced its plan to exempt preliminary feasibility studies for the project for planned consruction of an international airport on Gaduk Island to serve the greater Busan metropolitan area in the southwestern part of Korea.7
If there arises any issue with preliminary feasibility studies, an audit is conducted by the Board of Audit and Inspection, and if a corrective order is issued as a result of the audit to identify and correct the inadequacy, additional feasibility studies may be conducted for a project.
iii General requirements for PPP contracts
Only certain types of infrastructure building project may receive private investments. For a project to be undertaken as a PPP project, the objective of such a project must be such public infrastructure in which private investment may be made under the PPP Act, and projects that are prohibited from being undertaken as a PPP project according to laws, such as national defence facilities, may not receive any private investment. There is no required minimum or maximum project period as no such requirement is stipulated in the PPP Act, and the project period is specified only when the detailed plan for a specific project is announced.
If a project may receive private investment, the private party may negotiate for better terms. The basic principle governing a detailed project plan is that the private operator be allowed to operate the project for a period sufficient to recover its investment, and the private operator may also submit its opinions on the detailed project plan announced by the government to propose an amendment to the key terms of the detailed project plan, including the project period.
Although there are some publicly available guidelines as a means of suggestion for the terms for a PPP project, such terms are not usually binding and often negotiable. Both the PPP Basic Plan and the detailed project plans are published on the PIMAC website. The Ministry of Strategy and Finance's general guidelines for the promotion of PPP projects suggests a method of calculating the rate of return and usage fee for a non-lease based project, but such suggestion is not binding on the project operator. The contracted rate of return for a certain project may only be finally determined upon negotiation between the private business entity and the competent authority. In the case of lease-based projects, the guidelines also suggest a method of calculating the lease payment on the basis of, inter alia, the interest rate for construction, the five-year government bond interest rate, the inflation rate and the penalty rate, but such suggestions are also only for reference, and the contracted lease rate is to be finally decided upon by negotiation between the private business entity and the competent authority.
On the other hand, a regulatory requirement provides that, in the event of the sale of shares in a PPP project company by a sponsor holding 5 per cent or more of the shares in the PPP project company, such a sponsor must obtain approval from the competent authority.
Bidding and award procedure
After private business entities (or consortiums) bidding to participate in a PPP project submit their bids, including their project plans, with the competent authority, the authority selects a bidder as the preferred bidder after reviewing all bids, which must contain project plans, and informs the bidder of its appointment as the preferred bidder. When appointing a bidder as the preferred bidder, the competent authority evaluates the submission, which includes but is not limited to the following:
- the project plan;
- the financing plan and total project cost;
- the period of use without tolling;
- the expenditure plan;
- the ancillary business plan; and
- the facilities management plan.
If an agreement is reached on the conditions of project implementation upon negotiation with the preferred bidder, and after PIMAC has examined the terms of the concession agreement and reviewed whether the concession agreement violates the PPP Act, the Enforcement Decree, the PPP Basic Plan or the guidelines, the competent authority appoints the preferred bidder as the project operator enters into the concession agreement with the project bidder. If the concession agreement contains terms requiring government support, the Minister of Strategy and Finance must opine before the competent authority and the project operator enter into the concession agreement.
In some cases, the competent authority may undertake a PPP project as proposed first by a private entity. In such cases, when selecting the preferred bidder, up to 5 per cent of preferential bonus points may be given to the private entity that first proposed the project, but such private entity is not guaranteed to be appointed as the project operator.
i Expressions of interest
The competent authority must establish and design appropriate evaluation criteria on the basis of the characteristics of each project in accordance with applicable laws. The evaluation criteria for a project plan must be objectively established and reviewed in detail, and be assigned appropriate weights by the competent authority. Such criteria must be specifically set up and designed in the detailed project plan. The weight for the technology and price factors must be appropriately allocated by giving consideration to the following:
- the characteristics of the project, the difficulty of construction and operation, and the price competition environment; and
- in the case of projects that are judged to be relatively less important in terms of technology and management capabilities, more weight, up to 50 per cent of the total score, is allocated to the price factor.
To avoid excessively affecting the evaluation results by giving excessive weight to specific criteria or certain ranks within a criterion, an appropriate allocation of points must be maintained not only among the criteria, but also within each criterion.
The evaluation criteria are presented objectively and concretely as much as possible, and quantified as much as possible, and the calculation method for assigning points for evaluation must be suggested in advance.
However, if qualitative evaluation is inevitable, objective evaluation criteria such as the use of the rating system must be applied to reduce discretionary factors as much as possible.
ii Requests for proposals and unsolicited proposals
A detailed project plan drafted by the competent authority on the basis of the PPP Basic Plan is publicly announced on PIMAC's website, and contains requests for proposals for private entities to participate in a PPP project.
A private entity may submit its proposal for a PPP project even if the project is not part of government-initiated projects. Such a private entity must follow certain requirements in submission of a proposal. If the competent authority decides to undertake the PPP project as proposed, the competent authority must make a public announcement for inviting bids for the PPP project to be undertaken, including the terms of the project, so as to allow any third party to participate in the bidding process. After evaluating all the bids, the competent authority must select a preferred bidder with which the concession agreement may be entered into upon negotiation. Subject to a presidential decree, the private entity that made the initial proposal may be given a favoured status during the process of selection of the preferred bidder, which includes up to 5 per cent of preferential bonus points to be provided to the private entity that first proposed the project. However, such private entity is not guaranteed to be designated as the project operator.
iii Evaluation and grant
The Basic Plan may be referred to by private business entities preparing a project plan for their bids to be filed with the competent government authority: private entities, either on their own, or in a consortium, may submit their bids along with their project plans for a single infrastructure project. The competent authority would then review the bids, including the project plans submitted by various private entities, and designate one private entity or consortium as the preferred bidder, and the terms of the concession agreement to be entered into by the preferred bidder and the competent authority would be finalised upon negotiation. After execution, the competent authority and the preferred bidder will bound by the terms of the executed concession agreement.
Based on the concession agreement, the project operator or the project company (the concessionaire) will apply for the competent authority's approval of the project plan, including the project design drafted pursuant to the proposed concession agreement. The project company will commence the construction of public infrastructure as a PPP project according to the project plan and the concession agreement upon the competent government authority's approval based on the latter's review, in accordance with the relevant statutes and detailed project plan. After the competent government authority issues the completion or commissioning of the work for the project, including the construction of the facilities, the relevant PPP project will commence commercial operation.
In accordance with the principle that tolls are paid by users of the infrastructure, users who use the infrastructure pay tolls. Although in the past, the government provided a minimum revenue guarantee (MRG) for projects where the revenue from the tolls did not meet the contracted rate of return, for recent PPP projects, only in exceptional cases is an MRG offered by the government. Therefore, the project operator must make an accurate forecast of demand and capital procurement and establish an appropriate operation plan to recover the invested capital.
ii State guarantees
Under the PPP Act, direct financial support to private parties may take the following three forms: construction subsidies, minimum revenue guarantees and termination payments.
Construction subsidies are financial support provided by governmental authorities at the construction phase, and the timing of such support is decided in the concession agreement in connection with the concessionaire's capital investment plan.
Under minimum revenue guarantees, the government or local autonomous governments guarantee a certain ratio of the revenue under the concession agreement, which is intended to reduce the financial risk of private parties to attract private investment in PPP projects. However, as previously stated, a government guarantee has rarely been provided for recently promoted PPP projects.
Termination payments are made to the private partners by the competent government authority when the concession agreement is terminated. Since ownership to the relevant infrastructure belongs to the government or local autonomous governments upon termination of the concession agreement, termination payments were introduced so that the benefits that the government enjoys from such infrastructure projects do not constitute unjust enrichment for the government. Termination payments are paid in different ranges by each type of PPP project.
Although they are not direct financial support, other forms of support are available for private partners. The provision of credit guarantees through the industrial infrastructure credit guarantee fund performs the role of supporting private partners to provide more easily obtain loans.
The PPP Act explicitly stipulates the basis for establishing a collective investment scheme8 for PPP projects, and provides exceptions on the establishment and operation of such collective investment schemes so as to attract PPP project financing. Moreover, the PPP Act permits the issuance of public infrastructure bonds so that private partners can issue long-term bonds to participate in PPP projects.
Moreover, if meeting certain requirements, private partners may also be provided with tax-exemption benefits that exempt such private partners from paying development charges, overpopulation charges or local taxes that they have to pay in the process of implementing a PPP project.
iii Distribution of risk
As previously stated, a government guarantee is rarely provided for recently promoted PPP projects. Therefore, a project operator must make an accurate forecast of demand and capital procurement and establish an appropriate operation plan to recover the invested capital.
iv Adjustment and revision
Under the PPP Act, the competent authority may propose to amend the terms of the concession agreement in cases where the national or local government deems such amendment necessary for a national or public purpose. The terms of such amendment will be decided upon mutual consultation between the private operator and the competent authority. If the project cost is not recovered as a result of such amendment, the competent authority must compensate the project operator to the extent of the loss incurred by such project operator.
v Ownership of underlying assets
The ownership of underlying assets depends on whether it is a BTO or a BOT method. The underlying assets may be offered as a security for debt financing of a project by the project operator.
vi Early termination
A project operator's appointment may be terminated early or cancelled for cause so long as such cause is one of the grounds for termination prescribed in the PPP Act. The grounds for early termination or cancellation are satisfied:
- if the private operator made misrepresentations in its bid for a project;
- if the project operator fails to fulfil its obligations under the concession agreement for the project without reasonable cause;
- if the project operator fails to comply with the requirements under the PPP Act;
- if such termination is necessary for the public benefit, such as the efficient operation of infrastructures; and
- force majeure events such as natural disasters and war, etc.
In addition, early termination is also possible upon occurrence of any of the causes for termination of the concession agreement.
In most PPP projects, it is possible to finance a project in the form of third-party capital and, in fact, project finance accounts for an important part of the financing for PPP projects in Korea. In general, the debt-to-equity ratio is in the range of 8:2 to 6:4 for most PPP projects in Korea. In a case where Korean financial institutions are the lenders for project financing, Korean financial institutions require the project sponsors to enter into an agreement to inject additional capital into the project operator to make up for insufficient funds, in contemplation of a possible shortage in the funds to repay the loan. Cross-border financing is also possible. It must be noted that Korea has a stable foreign exchange market; nevertheless, to deal with the exchange risk, the sponsors of a project operator often elect to enter into a foreign exchange hedging agreement.
There is no noteworthy recent judgment by the court or arbitral tribunal regarding PPP projects. However, in early 2021, a consortium that was not selected as the preferred bidder for the Guri Smart City Construction Project, one of the recent PPP projects that invited private entities to bid, filed for the cancellation of Guri City's preferred bidder selection decision against Guri City. The consortium's case was dismissed by the court. Since the selection of the project-preferred bidder is made under a strict and transparent procedure in accordance with the PPP Act, Enforcement Decree, Enforcement Regulations, Basic Plan and Guidelines, the selection of the preferred bidder is rarely rescinded.
The government has implemented a strong policy drive to revitalise PPP projects to overcome the economic downturn caused by the covid-19 pandemic. Recently, it also revealed that it plans to exempt the preliminary feasibility study for the new international airport project on Gaduk Island, which will become the second-largest international airport in Korea. Furthermore, on 4 February 2021, the Ministry of Land, Infrastructure and Transport's initiative to redevelop or rebuild large-scale housing complexes, which had been mostly implemented by the private sector, was announced. Public redevelopment and public reconstruction are not PPP projects, but there is controversy over whether they can be viewed as a new type of PPP project in that privately owned land (housing site) is developed by the public. The government showed reluctance regarding large-scale civil engineering works at the beginning, but since the National Balanced Development Plan was announced in January 2019, many plans for large-scale construction projects have been announced. However, since a detailed project plan has not yet been announced, it is necessary to observe a little more about whether additional PPP projects, including public institution projects, will be undertaken in detail.
1 Soongki Yi and Young Woo Park are partners and Pilwoon Oh is a senior foreign attorney at Yoon & Yang LLC.
2 Several public infrastructures were constructed under the PPP scheme even before the enactment of this Act. However, the aforementioned projects were tailor-made by enacting and applying special legislation for each project. The PPP scheme was not stimulated before 1994 because each piece of special legislation had raised controversy that each project was a government attempt to provide special benefits to the private enterprises that participated in the relevant public infrastructure projects.
3 This is a government agency established under the PPP Act and serves as an information investment agency in charge of assisting the PPP projects executed between private partners and competent government authorities by providing preliminary feasibility studies and qualification examinations for projects that exceed a certain size.
4 When the PPP Basic Plan is revised, the government's fiscal expenditures must also be amended. Therefore, in the case of a PPP project with a total project cost of 100 billion won or more and a government expenditure amount of 50 billion won or more, only those projects found to be suitable for fiscal expenditure on the basis of the result of the preliminary feasibility studies are reflected in the PPP Basic Plan. Preliminary feasibility studies are carried out by PIMAC, and exemptions may be granted only for special reasons.
5 The preliminary feasibility studies must be conducted not only for PPP projects but also for government projects where national expenditures are invested.
6 Projects allowed for such exemption from preliminary feasibility studies include government projects.
7 In principle, an exemption from the preliminary feasibility study is made only if the grounds for such exemption have been specified in the PPP Act, but there are several cases where preliminary feasibility studies have been exempted on the basis of suspected political motives such as found in the Four Rivers Project, the National Balanced Development Plan and the Gaduk Island New Airport Project.
8 Although only a corporate-type collective investment scheme was permitted before 2011, a statutory amendment now also permits investment trust-type collective investment schemes. Accordingly, public-type infra funds have also been established.