This article is written by Shivani Varade pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.
Table of Contents
Do you know the process that went behind the construction of the Mumbai Metro project? Mumbai Metro is a result of a contract between the Mumbai Metropolitan Region Development Authority (MMRDA), Reliance Energy Limited and Veolia Transport. On observation, this looks like a contract between a government authority (MMRDA), and private parties (Reliance Energy Limited and Veolia Transport). These kinds of contracts are known as concession contracts, where the private party has to design, construct, and own the asset, and transfer the ownership at the end of the contract period.
This article aims to provide an overview of the meaning of concession agreements, public-private partnerships and their types, essential clauses and legal issues in a concession agreement, and the due diligence to be followed while entering into the concession agreement.
What is a concession?
A concession is a license given by the government authorities to private parties for the execution and implementation of the public services which are exclusively held by the government authorities under the law. Concessions effectively shift the cost of building, developing, and maintaining infrastructure to the private sector, relieving some of the pressure on public sector finances. During the concession period, the government’s responsibility is primarily to function as a regulator and monitor the concessionaire’s performance. The term of a concession agreement is typically 25-30 years.
What is a concession agreement?
A concession agreement is a contract between a government and private organization which gives exclusive rights to the private organization to operate the business in the facility specified under the government’s jurisdiction for a limited period under specified terms and conditions. Simply, it allows the government to grant a private entity exclusive rights to build, operate, and maintain a facility for the duration of the concession.
The purpose of a concession agreement is to:
- Vest the concessionaire with all the rights necessary to implement the project and obtain the agreed returns in accordance with the terms of the concession agreement.
- Achieve an appropriate allocation of risks.
Concession agreements are commonly entered in the form of a public-private partnership (PPP) model to execute or provide public services related to infrastructure projects.
What is a public-private partnership?
Public private partnership (PPP) means a long-term collaboration in the form of a long-term contract between a private party and a government agency for providing a public asset or service. Such collaboration helps to finance, build, and operate projects like public transportation networks, parks, and convention centres, etc. The private party bears significant risk and management responsibilities, which could include finance, design, construction, operation, and maintenance of the project in a public private partnership.
Characteristics of public private partnership
The main characteristics of a PPP project include:
- Value for money- It ensures project appraisals and considers the cost along with the risks and service quality.
- Public standard- It involves adequate and prior consultation with end-users and other stakeholders of an infrastructure project as standard. The government remains accountable for the quality and costs of the services.
- Innovation- The combined effect of the public and private sector harnesses the efficiency and innovation of the public sector for establishing a sustainable infrastructure.
Types of public private partnership models
There are different types of PPP contracts depending on the type of the project, investment level, the risk involved and the desired outcome. These are-
BOT (Build Operate Transfer)
The BOT model of PPP helps to develop a discrete asset rather than a whole network. It provides freedom to the private sector during construction and the public sector bears equity risk.
BOOT (Build Own Operate Transfer)
Under this model, the private sector owns the facility with the primary goal of recouping construction costs for the duration of the contract and its operational phase. In such a model, the structure made by the private entity will be transferred to the public entity at the end of the contract. Risk under this model stays with the private sector and are mostly used for the construction of schools, hospitals, metros and ports.
BOO (Build Own Operate)
This model is very similar to the BOOT model of PPP except for the fact that the facility is not transferred to the public sector partner. It is mostly used in water treatment or power plants. In such models, tax exemptions are also available.
DB (Design Build)
This model of the contract is made to build a piece of infrastructure that delivers the performance specification in a PPP contract. It reduces time, saves money, provides guarantees and allocates additional risk to the private sector.
DBF (Design Build Finance)
Under this model, the private sector provides for an asset and finances the capital cost during the construction period.
Difference between concession agreement and other commercial agreements
Difference between lease and concession agreement
First, a concession agreement gives limited rights to use the property for any specified use, whereas a lease agreement creates an interest in the property to the lessor. Second, a concession agreement doesn’t create any inherent property rights, whereas a lease creates interest on the owner’s property. Third, in a concession agreement, investment for undertaking any infrastructure remains the responsibility of the public utility, and in a lease, the private party under the lease must collect the revenue on behalf of the government and will deduct their fees from the revenue collected.
Difference between a lease and any other agreement for the provision of commercial goods and services
Concession agreements differ from the typical provision of commercial goods and service agreements in various aspects, such as:
- They are associated with public goods and services.
- They are the type of contracts with a higher monetary value.
- They are long-term contracts (usually lasting 5 to 60 years).
- They are designed to provide vital services for which there are no alternatives.
Essential clauses in a concession agreement
Some of the essential clauses in a concession agreement are as follows:
1. Definition clause
It contains the definitions of the specific terms used in the agreement.
In this agreement, the following words and expressions shall, unless repugnant to the context or meaning thereof, have the meaning hereinafter respectively assigned to them:
‘Performance security’ means an irrevocable and unconditional guarantee from a Bank for a defined sum in the format set forth.
‘Concession period’ means the period starting on and from the Appointed Date and ending on the Transfer Date.
2. Scope of the project
It contains the work to be done under this agreement by the concession holder. Scope of work covers construction, operation, maintenance, along with other obligations set forth by the concession holder under the agreement. It also sometimes involves the obligations of the authority who is providing the concession to the concession holder.
The scope of the project shall mean and include performing and fulfilling all other obligations of the Concession Holder under the provisions of this Agreement and any matters incidental thereto or necessary for the performance of any or all the obligations of the Concession Holder under this Agreement.
3. Grant of concession
This clause states the power of the authority to grant the concession holder the exclusive right to license, operate, maintain, and provide services to the concession holder during the concession period.
Subject to and in accordance with the provisions of this Agreement, the Authority grants to the Concession Holder, the concession set forth herein including exclusive right, license and authority to augment, operate and maintain and provide services and design, finance, procure, construct during the Concession Period, and the Concession Holder hereby accepts the Concession and agrees to implement the Project subject to and in accordance with the terms of and conditions set forth in the Agreement.
4. Concession period
It sets out the term or the duration of the agreement. Generally, for agreements like the construction of the national highway (NHAI), the concession period is set forth for 12 years. The concession period will vary from project to project as per the requirement of the parties.
Subject to early termination of this agreement in accordance with its provisions, the term of this agreement is 60 years from the Appointed Date, i.e the Concession Period.
5. Conditions precedent
It obliges the concession holder to pay for the performance security to the authority and satisfy the precedent conditions. Precedent conditions include;
- Providing performance security to the authority.
- Delivery of the constitutional documents to the authority.
- Providing proof of shareholding pattern signatory of the concession holder, etc.
The conditions precedent required to be satisfied by the Concession Holder within 90 days from the Execution Date shall be deemed to have been fulfilled when the Concessionaire shall have provided the Performance Security to the Authority at any time after 15 days from the Execution Date.
6. Damages for delay by the authority
It gives the right to the concession holder to acquire for the damages in case of delay by the authority in procuring fulfilment, or waiver of the condition precedent within the period specified, or even in case of occurrence of force majeure event.
If the Authority does not procure fulfilment or waiver of the Condition Precedent within the period specified in respect thereof, and the delay has not occurred as a result of the breach of this Agreement by the Concession holder or due to Force Majeure Event, the Authority shall pay Damages to the Concession Holder of an amount calculated at the rate of 0.1% of the Performance Security for each day’s delay until the fulfilment of such Conditions Precedent, subject to a maximum amount equal to the Bid Security.
7. General obligation of the concession holder
It obligates the concession holder to perform the task, provide the services which have been mentioned under the agreement.
Subject to and in accordance with the terms and conditions of this agreement, the concessionaire shall at its own cost and expense, undertake the augmentation, operation and maintenance of the district hospital and observe, fulfil, comply with, and perform all its obligations set out in this agreement or arising hereunder in relation to the district hospital. The general obligations of the concession holder are as follows:
- The concession holder shall arrange for and procure, at its own cost and risk.
- The concession holder shall arrange all infrastructure facilities and utilities for the authority.
- The concession holder shall obtain relevant government instrumentalities, applicable permits to be obtained by the authority.
- The concession holder shall pay the concession fee to the authority.
8. General obligation of the authority
It obligates the authority to perform the task or provide the services which have been mentioned under the agreement.
The Authority shall at its own cost and expense, undertake, comply with, and perform all its obligations set out in this Agreement. The general obligations of the Authority are as follows:
- The Authority upon written request from the concession holder provides reasonable assistance to the concession holder in obtaining access to all necessary infrastructure facilities and utilities.
- Authority shall pay the salary and allowances to the employees, retainers, and staff of the concession holder.
- Authority shall not omit to do an act, deed or thing which may in any manner violate the provisions of this agreement.
9. Representation, warranties, and undertaking of the concession holder/authority
It contains the undertaking, representations, and warrants to be signed by the parties before entering into a concession agreement. It includes the declaration as to the ability or financial power of the parties to execute the agreement and perform obligations mentioned therein.
The concession holder/authority represents, warrants, and undertakes to the authority/concession holder that:
- It has full power and authority to execute and perform its obligations under this agreement and carry out the transactions contemplated hereby.
- It has financial standing and capacity to undertake the project in accordance with the terms of this agreement.
- The information furnished in the bid and as updated on or before the execution date is true and accurate in all respects as on the execution date.
It contains the provisions to compensate one party for all direct costs suffered or incurred he has suffered in case the other party breaches any terms of the agreement. Breach or default herein includes disruption in the operation, or any act resulting from willful or gross negligent acts or omissions. Compensation is calculated by adding up all direct costs suffered or incurred by the authority because of such material breach or default.
In the event of the concession holder being in material breach (not fulfilling any terms of this agreement) or default of this agreement, it shall pay to the authority by way of compensation, all direct costs suffered or incurred by the Authority because of such material breach or default, within 30 days of receipt of the demand supported by necessary particulars thereof.
Legal issues in a concession agreement
The major issues in a concession agreement are involved in the implementation of the concession agreement and investment required in the projects under the concession agreement:
1. Implementation of the concession agreement
It may face competition issues that include abuse of dominant position, creation of combinations and entering into anti-competitive agreements based on the rights vested under the concession agreement. To ensure due to monitoring and prevent abuse of rights in concession agreements, the following positions can be appointed:
- Independent engineer- To undertake due monitoring and inspection of the construction of the project facilities and their maintenance.
- Independent auditor- To undertake the auditing of the accounts of the concession holder to certify the revenue generated by the project and the various expenses being incurred by the concession holder.
- Reporting requirements- The concession holder is imposed with the obligation to maintain specified project-related accounts and submit regular reports to the government authority on various aspects of the project.
2. Investment required in projects under the concession agreement
The investment required in the infrastructure projects is very high, and these costs cannot be easily recovered if the economic atmosphere deteriorates or if the operator discontinued operations. Because the end product resulting from such costs cannot be used for any other activity. Due to this, renegotiation of concession agreements is done in the event of the issuance of a notice of termination.
This can be done in the following two ways;
Clause specific renegotiation
Renegotiation on certain specific clauses which have clear competition law implications such as exclusivity provisions or extend the time frame for exclusivity provisions, the extension of the term of the concession agreement, providing special support to compensate the project against competing facilities.
Overall restructuring of the concession agreement
It involves the restructuring of the majority or most of the material provisions of the concession agreement which is either a materially new and more favourable framework, than what had been available to bidders and potentially interested parties at the time the project was awarded through a competitive bidding process.
However, re-negotiations may raise competition concerns where the terms of the concession agreement are restructured in a manner that they are more favourable to parties that were involved in the initial phase of the bidding process.
Advantages of a concession agreement
Some of the advantages of the concession agreement are as follows:
- The private sector bears a significant share of the risk involved in the project. It spreads the risk involved for both parties and no single party’s share is at risk.
- It involves a high level of private investment which will result in better enforcement and implementation of the projects involved.
- It has the potential for generating profits in all the phases of the project development.
- It ensures faster implementation and has high technological innovation while implementation.
- Using a standardized form of concession agreement reduces unnecessary delays and extra costs involved with transactions.
- It simplifies the bidding process and builds confidence amongst the bidders and investors while investing in infrastructure development.
- It reduces the cost and risks of smaller government agencies and private parties undertaking small projects.
Disadvantages of a concession agreement
Despite the above-mentioned advantages, a concession agreement has the following disadvantages:
- It requires closer regulatory oversight by the government.
- It creates contingent liabilities to the government, especially if the term of the project is long.
- It can have underlying fiscal costs to the government.
- Such projects are a little complex in their implementation and administration.
- To negotiate between parties and landing on making a project deal, sometimes requires a long time.
- The rigid structure of the agreement creates problems for the parties.
- Being lost and exhaustive creates problems in anticipating the risks involved during the execution and operation of the project.
From a legal, financial, and technological standpoint, an acquirer of or investor in a concessionaire normally does extensive due diligence. However, it is recommended that one analyses the following documents and information as part of due diligence because they often have a direct impact on the concessionaire’s evaluation or the transaction itself:
- Tender documentation for the concession’s award,
- Agreement on a concession,
- Contracts for construction,
- Contracts for operation and maintenance,
- Contracts for related consulting services,
- Any correspondence between the concessionaire and the concession granting authority,
- Any documents of a right of way over land that is required for the project, a lease, or another right,
- Environmental approvals,
- Construction projects approvals.
As we have seen, concession contracts are licenses given by the government authorities to the private sector for various infrastructure projects, and so they are of fundamental importance for the development of infrastructure in the country. Parties to the concession agreement must make sure that they include the above-mentioned clauses in their agreement to avoid disputes in the future. Additionally, the parties must also scrutinise the necessary and complementary documents before entering into the contract as non-compliance with environmental and other like regulations, may cause parties to pay huge penalties and stop the construction undertaken in the project. In all, it is recommended that the parties consult their lawyers before finalising the transaction under concession as it involves huge investments.
Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join: