This article is written by Goutam Mishra, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com. Here he discusses “EPC Contracts vs PPP Contracts: Which Model is Best for Infrastructural Sector?”.
Table of Contents
Introduction
A modern, widespread and well-organised infrastructure growth is one of the most essential components of a country’s development. If India aims a double-digit growth rate, infrastructural development would play a pivotal role in it. Hence, the government has been increasing investment in the infrastructural sector to achieve optimal results. But, for achieving such results, proper allocation of such funds, steady and uninterrupted implementation of the infrastructural projects is a necessity. For smooth implementation of such plans, sometimes the government (or Owner of an infrastructural project) tends to involve other private parties and enter into contracts with them. Such models are designed to facilitate speedy and cost-efficient completion of the projects. In this article, two of such models i.e. the PPP and EPC models have been analysed and compared. Also, the article discusses the HAM model which has come into picture in recent times seemingly has many advantages over other traditional models.
EPC Contracts
Engineering, procurement and construction (EPC) contracts are the contracts used primarily in complex industrial and infrastructure projects like power plants, bridges, dams etc. EPC contracts involve a deal between the owner and a contractor, who is required to deliver certain design, construction, logistics, transport etc. related work to the Project financer. As it transfers the liability to the contractor and mitigates risks of the project, it is favourable for the Project financer. The project financier is absolved of a lot of complexities of engaging and interacting with a lot of people as it only has to appoint a single contractor and oversee the work and progress. They are reassuring for the Project financiers as the contractor is also obliged to deliver the required result within a particular time frame and at a pre-decided cost. But, as a result of these contracts, the contractor tends to establish a great deal of control over the Project designs, selections and decisions. Hence, the Owner must specify and mark clearly the required services and the milestones that need to be achieved. But we can say that the owner has leverage in these agreements.
PPP Contracts
Public-Private partnership (PPP) contracts are agreements between public and private entities, in which the private entity is hired by the public body and is remunerated on a performance basis. They are typically long-term arrangements with most of them signed for a term of 20-30 years. The rationale behind this model is to combine the capabilities of the public and private sector to achieve optimal results.
Types of PPP Contracts
There may be a variety of PPP models that can exist. Some of the common ones are explained below-
- BOT i.e. Build-Operate-Transfer is an arrangement in which the private entity undertakes construction work, operates it for a certain period of time and then it is taken back by the government. It is generally used for discrete assets rather than full networks. For e.g. Toll roads.
- BOO i.e. Build-Own-Operate is a model in which the ownership remains with the private party and it continues to operate that project. It is often used for water treatment or power plants.
- BOOT i.e. Build-Operate-Own-Transfer.
- BBO i.e. Buy-Build-Operate. In this model the government sells the facility to the private entity. The private party renovates and operates the facility.
- DB i.e. Design-Build is a type of PPP model in which the private party has an additional responsibility of designing the framework of the project. It reduces time and complications and helps the public entity save money as only a single party is involved. It burdens the private party with an additional responsibility.
- DBF i.e. Design-Build-Finance.
- DCMF i.e. Design-Construct-Maintain-Finance is a framework in which the private party designs and constructs the project, and then is leased back the property. E.g. Prison projects.
- Management agreements- Under management agreement the public entity transfers the management of the asset, business, property etc. to the private party for a particular period.
- O&M i.e. Operations and Maintenance is an arrangement where the private party takes the responsibility of maintaining and operating the public property/project for the specific amount of time with certain obligations which are specified in the Operation and maintenance agreement.
EPC vs PPP
Is there a difference between EPC and PPP? Both appear to be the same. Both are arrangements between two parties in which one party is required to deliver to the other. So, is EPC a type of PPP only? The answer is no. As discussed above, in the PPP model one party is a government or public sector enterprise and the other is a private party while the same is not true for the EPC model which can have two private entities as parties to the contract.
Also, there is a difference between how the two models work. For better understanding let’s take the example of a project involving construction of a dam by the government. In the PPP model, the government invites bids over this project and grants the project to the entity with the cheapest bid. The project would be financed by the government. Now, if there arises a situation in which there is a delay in the project (For e.g. Due to protest by local villagers), the private entity will have to solve the problem which would involve costs. Now it will have to pitch in a new bid to get compensated for the costs incurred. It will have to deal with the lethargic government machinery in order to get the new bid approved. But, in an EPC model the government would call for individual bids for engineering expertise, procurement of raw materials and the actual construction work. This would in turn increase the efficiency of the project as different parts of the project would not be interrelated and the private party would not have to deal with the political issues (in case any). The government would deal with the complications that arise.
How EPC is better than PPP?
So, which model is actually a better one? While the PPP model may seem better in complex infrastructure projects, the EPC model has many advantages over it. Firstly, it is more viable for the private party. In the EPC model the whole capital is raised by issuance of government bonds and by securing road toll post-construction, contrary to the EPC model where the private party is responsible for raising finances. Government also takes the responsibility of acquiring clearances, permissions, preventing and mitigating other problems that may arise in course of the project. Hence, the private party can focus on planning and designing the project, procurement of raw materials and the construction work which reduces time required in the completion remarkably. As a matter of fact, the government recently adopted the EPC model over the PPP model for construction of national highways because private investors are reluctant to support this model. Also, there are no developments regarding many provisions which NHAI has proposed to improve financing conditions. Hence, NHAI now believes that projects can only be developed through the engineering, procurement and construction (EPC) mode. It is speculated that the EPC model would reduce time and cost overruns.
Hybrid Annuity Model
While the PPP model puts the financial liability completely on the private entity, the EPC model puts tremendous financial burden on the government. Hence, both the models do not seem feasible. Hence, the Hybrid Annuity model (HAM) which is a mix of BOT Annuity and EPC has been adopted in recent times.
BOT Annuity Model: In this model the private party builds the project and transfers it back to the government. The government starts paying the developer once the project is in commercial use.
EPC Model: The government has to pay all the expenses incurred from the beginning of development of the project.
The HAM is an amalgamation and a version which incorporates both the models in it. Under this model the government has to pay 40% of expenses incurred in the form of five annual instalments (annuity) in the construction stage, and the developer needs to arrange the rest of the money at this stage. The rest of the payment is made after the completion of the project on the basis of the value generated and assets created. This payment can be made in the form of variable instalments annually. The private party doesn’t have rights to collect toll in this model.
This model helps to reduce the financial burden on both the parties and increase credibility as both parties have some vested interest in the project.
Conclusion
While the EPC model transfers a lot of risk on the private party, the PPP model makes the government solely liable for the finances. Both the models, though having their own advantages, pose problems for one of the entities. In conclusion, we can say that the HAM is the best option available to us which does justice to both the parties. Agreements and contracts are never flawless. They always need to be improved and improvised according to the needs of the present. No model would work indefinitely and we need to adopt and evolve them constantly.
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