This article has been written by Saloni Maniyar, pursuing the Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho. This article has been edited by Prashant Baviskar (Associate, Lawsikho) and Smriti Katiyar (Associate, Lawsikho).
Ever thought about how the public infrastructures and service models are constructed or what is the process used to build them? These projects require huge financial planning and resources. We can look into the construction of the Mumbai Metro project. Mumbai Metro project was brought into effect through a contractual relation between the Mumbai Metropolitan Region Development Authority (MMRDA), Reliance Energy Limited, and Veolia Transport. This is a contract between government authority (MMRDA) and private entities (Reliance Energy Limited and Veolia Transport). These types of contracts go by the name of concession contracts wherein the government or any local government body authority grants the private entities certain rights to design, build, operate or own for a limited period of time and transfer the ownership right at the end of the contract period.
The aim of this article is to provide an overview of concession agreements, public-private partnerships, and BOT contracts; How this contract works, the risk factors involved, and the advantages and the disadvantages.
What is a concession agreement?
A concession agreement is a contract between government authorities and private entities wherein the government grants a concession (which is a license) to private parties providing exclusive rights to execute and implement the projects or services which are particularly held by the government under the law. In return for such rights, the government allocates the risk to the concessionaire. The concession is for a limited period with setting forth terms and conditions. The government authority will be responsible during this period to monitor the project and the concessionaire’s performance.
Such concession agreements are commonly entered to execute and develop public infrastructure projects or services under the public-private partnership (PPP) model.
What is a public-private partnership?
Public-Private Partnership refers to a long-term contract for a period of 20-30 years between the government or government-owned entity and private entities for the purpose of building projects, assets, or services for public benefit. Under these contracts, the capabilities of the public and private sectors are combined to get optimal results. Here, the private sector undertakes the responsibilities of financing, designing, building, and operating projects like public transportation networks, parks, museums, etc., and the public entity shares the risk involved in the project with the private entity. To understand PPP in nutshell, PPP is an alternative method to undertake capital-intensive infrastructural projects that are financed by the private sector. This can be an upgrade, renewal of existing infrastructure, or designing and building entirely new infrastructure. There are various types of PPP contracts depending upon what kind of project it is, involvement of risk factors, the requirement of finance, and desired result. These are –
These contracts are developed to serve a particular purpose as they are formed to construct a particular asset rather than an entire network (you could say toll road). Herein, the private sector is given the freedom to construct and the public sector will bear the equity risk.
Under this model, the private entity after building the project does not transfer it to the government, instead, they build and own the facility for a certain period of duration mentioned in the contract with the sole purpose of recovering the investment cost involved in construction during the operational phase. The project or facility at the end of the contract is handed back to the government. This model is usually undertaken to build schools, hospitals, ports, etc. wherein the financial requirement is huge.
This model is very similar to the above BOT model with the exception that the project or a facility built and owned is not subsequently transferred to the government. These types of models are eligible for tax exemption and are usually used to build a water treatment facility or power plant projects.
Under this model, the contract is provided to a particular private entity instead of a consortium for performance specification which in turn shall save time, money and provide a performance guarantee at a better rate.
Under this model, as the name suggests, the private entity will construct a facility and finance the capital cost involved for the construction period only. Of all these models, BOT contracts are most commonly used while developing infrastructural facilities or services involving huge capital investment and equivalent risk factors as well.
What is a BOT contract?
BOT contract is a model used to finance projects that require large financial investment, typically infrastructure projects. Under the BOT scheme or contract, one or more private entities are brought together which would later form a consortium (this consortium consists of financers, architects, developers, and engineers). These private entities receive concessions (it is a license provided by the government authorities with a purpose of execution, implementation, and construction of public utility infrastructures or services which are exclusively under the law under the government domain) from mostly government authority or any local government body to undertake, finance, design, build and operate a facility for a period stated under the concession contract. Herein, a public administration delegates a license to a private entity to design and construct the facility as well as operate and maintain the facility for a period of contract.
How do BOT contracts work?
Under such contracts, a government entity grants a concession to design, build and operate the facility for an agreed time period (25-30 years) with the aim of recouping the investment amount and then transferring the said facility to the government to control, on the expiration of the contract period.
BOT contracts are usually the projects with large-scale financial requirements, greenfield infrastructure projects (new projects), or brownfield infrastructure projects (existing projects) that are otherwise financed by the government. Private entities have the responsibility to raise and bring in the finance required for the facility or project and to operate and maintain the facility as well as retain the revenues generated during the operational phase. The facility will be transferred to the government at the end of the concession agreement. The government pays the private entities a fee which can be a fixed sum or milestone payments or a combination of both which shall be recovered by the entities.
In a BOT contract, the project company or operator generally obtains its revenues through a fee charged to the utility/government rather than tariffs charged to consumers. In this case, ownership of the facility rests with the government.
These types of contracts are formed for a special purpose particularly for a given project and the government usually dives in for such contracts for two main reasons; first, the risk factor involved in the project is shared with the concessionaire and second, finances are raised by the private entities. The presence of these elements makes the BOT scheme preferable by government bodies.
Who are the parties involved in BOT contracts?
The government is the initiator of the infrastructure project and decides if the BOT model is appropriate to meet its needs taking into account other economic and political factors as well.
They come together to form a special purpose entity and contribute towards the financial requirement of the project.
The bank will finance the project on a ‘non-recourse’ basis which means it has recourse to the special purpose entity and all its assets for the repayment of the debt.
Other parties to the contract
The special purpose entity will subcontract to perform its obligation under the contract such as the supply of raw materials and other resources necessary to a third party.
Benefits and pitfalls of BOT contract
- It reduces public sector borrowings and direct spending since the project is financed by the private sector to provide capital requirement.
- By engaging private entities who are experts in their respective fields, the government gets the benefit to use best management skills in the construction, operation and maintenance of the project.
- It saves a considerable amount of time and accelerates the development of the project.
- Participation of private entities ensures efficiency and quality standards by using the best resources and equipment.
- It allocates the project risk and burden that would otherwise would have to be borne by the government to the private entities.
- These projects are conducted through bidding criteria and thus completed at lowest cost possible.
- Transaction costs involved in the project are high around 5 to 10 percent of total project cost.
- These kinds of contracts are not suitable for smaller projects.
- Risk factor involved under the project is high and the success of the project is relative to raising of required finance.
- BOT contracts involve multiple entities to finance it and the legal and institutional framework applied is complicated.
- The passing procedure of BOT contracts may take time to ensure complete benefits are realized.
Essential clauses under BOT contract
This clause incorporates the definition of certain specific terms used under the agreement
For the purpose of this agreement, the following words and expressions shall, unless repugnant to the context and meaning thereof, have the meaning hereinafter respectively assigned to them:
‘Competent Authority” includes any court of competent jurisdiction and any local, national or supranational agency, inspectorate, minister, ministry, the official or public or statutory person (whether autonomous or not) in or of, or of the government of, [country];
“Concession” means the rights and obligations acquired and assumed by the Concessionaire under this agreement;
Scope of the project
This clause contains all the necessary, required and ancillary work to be done by the contractor under the agreement. Scope of work contains designing, building, financing, operating, and maintaining the facility and other set forth obligations under the agreement.
- Sample clause
The concessionaire shall have the right and obligation at its cost, with due care and diligence and in accordance with good engineering and operating practices, to design, build, own, operate, finance, and maintain the project subject to and in accordance with the provisions of this agreement.
Grant of concession
This clause contains the power of the government authority to grant concessions to the contractor to finance, design, build and operate the facility during the concession period.
- Sample clause
The concerned government authority hereby grants the contractor the concession with an exclusive right to design, implement, finance, build and operate the facility during the concession period and the contractor hereby accepts the rights granted through concession subject to and in accordance with terms and conditions set forth under the agreement.
Arrangement with third parties
This clause states the arrangements entered into by the contractor with the third parties such as workers, suppliers, and other small contractors and local bodies for effective implementation of the project under the agreement.
- Sample clause
The contractor shall be entitled to enter into agreements with the third parties relating to the supply of materials and other resources, manpower required to build the project, and other resources necessary for the implementation of the project provided the arrangement is not in violation of any statutory requirements and is not in breach of any provisions and obligations mentioned under the agreement.
Statutory requirements and consents
This clause contains all the necessary and mandatory permissions, approvals and consents to be obtained from the concerned authority and other condition precedents that are required to be adhered to by the contractor subject to terms and conditions of the agreement.
- Sample clause
Without prejudice and subject to the provisions mentioned under this agreement, the contractor shall pay for its own costs and expenses and carry out all and any necessary obligations under this agreement so as to comply at all times with all statutory requirements and required consents (including those introduced after the date of this agreement).
Time for completion
This clause mentions the time period by which the project undertaken by the contractor shall be completed subject to terms and conditions of the agreement.
- Sample clause
The contractor shall execute the project that it shall be complete in accordance with the concession specification and shall pass the performance tests within the time for completion.
As we have seen, BOT contracts are contracts licensed by the government authorities to private entities to build and operate infrastructure projects and infrastructure projects have a vital role to play in the economic development and upliftment of the country. These projects have high capital requirements which alone cannot be supported by the government budget. Therefore, the government introduces private entities into these projects who can bring in and raise the required finance. The Government of India is accepting the private sector participation in domestic public infrastructure development projects where the BOT scheme is preferred by both public and private sectors. The Government of India has amended several bills and rules to increase private participation, BOT projects still lack a defined legal framework.
- https://www.investopedia.com/terms/b/botcontract.asp#:~:text=by%20the%20 government.-,Under%20a%20build%2Doperate%2Dtransfer%20(BOT)%20 contract%2C,that%20originally%20granted%20the%20concession.
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