Public-private partnerships, or P3s, have captured the attention of construction industry professionals and civic leaders as an alternative to traditional methods of delivering public infrastructure projects. Around the world, governments are looking toward P3 delivery models as alternatives for many of the largest, most complex, and costliest infrastructure projects—something that is remarkable given the fact that the P3 industry barely existed 15 years ago.
In the U.S., P3 concepts have given some hope to government officials who lack adequate fiscal resources to fund maintenance and repair projects or to pay for costly system upgrades and capacity improvements using traditional means of infrastructure finance. Public-private partnerships are generally viewed as opportunities to deliver complex projects more economically, faster, and with significantly less impact on state and local bond caps. Massachusetts has been moving cautiously with regard to implementing P3s of the nature seen elsewhere around the world and in other U.S. jurisdictions but that may be in the process of changing.
Because of the broad spectrum of projects and deal structures that may be classified as a public-private partnership, there exists no generally accepted definition of public-private partnerships that defines the term to any detail. In general, the concept involves a transaction based on contractual agreements between a public agency (typically a state or local entity) and a private sector partner that enables the skills and assets of each participant (public and private) to be shared in delivering a service or facility for the use of the general public, while also sharing in the risks and rewards potential in the delivery of the service or facility. The Canadian Council for Public-Private Partnerships defines P3s as “a cooperative venture between the public and private sectors, built on the expertise of each partner, that best meets clearly defined public needs through the appropriate allocation of resources, risks.” The U.S. Department of Transportation defines public-private partnerships simply as “agreements formed between a public agency and a private sector entity that allow for greater private sector participation in the delivery and financing of transportation projects.”[1]
What is driving the need for alternatives to traditional methods of financing and delivering infrastructure? The answer is multifaceted, but two of the principal factors are the need for new sources and increased levels of funding, and greater efficiency and innovation in constructing and managing our infrastructure assets. For the past several years, the state of the country’s bricks and mortar infrastructure has garnered more attention than it has anytime since the 1930s—and, according to many stakeholders—not a moment too soon.
On March 19, 2013, the American Society of Civil Engineers (ASCE) issued its latest report card on America’s infrastructure, rating the nation’s overall infrastructure a D+.[2] Only five segments of infrastructure scored a grade of C- or higher (rail, solid waste, bridges, ports and parks) with all other segments (aviation, dams, drinking water, energy, hazardous waste, inland waterways, levees, roads, schools, transit and wastewater) scoring grades of D+ or lower.[3] According to ASCE, the estimated cost of simply maintaining our country’s roads, bridges, water systems, dams, ports, and other core public facilities exceeds $3.6 trillion over the next 7 years.[4] Amongst policy makers at the state and federal levels, there seems to be little disagreement that the need for additional infrastructure investment is real; that it is growing; and that there is currently no consensus as to how to fill the financing gap.
State of Public-Private Partnerships
In the United States, public-private partnerships use one of several possible deal structures each falling along a spectrum of private entity involvement and risk assumption. P3 structures for green field facilities (i.e. new facilities) include design-build, design-build-operate-maintain, design-build-finance, and design-build-finance-operate and maintain. Structures used for renovation of brownfield, or existing, facilities include operations and maintenance agreements and long-term leases.[5]
Most of the P3 activity in the U.S. has come at the state and local levels. As of July 2013, the roster of completed or in-progress public-private partnership projects (excluding those projects that are limited to design build delivery) is substantial and growing steadily as governmental entities across the country are initiating P3 procurements on a weekly basis. As of this writing, thirty-three states have authorized some form of public-private partnership delivery method. In Massachusetts, use of P3 delivery methods has been slower to development, particular for projects were the private partner is providing the project financing—as opposed to projects that were financed through traditional means but required the project developer to assume operations and maintenance responsibilities.
Despite the Commonwealth’s cautious start with P3s, the Legislature has taken measurable and concrete steps to open the door to public-private partnerships. In 2009, the MassDOT Public-Private Partnership Infrastructure Oversight Commission was created as part of the reorganization of the Commonwealths’ transportation agencies. In 2013, the Mass P3 Commission has been meeting monthly and has evaluated a number of major infrastructure projects and identified several for further study.
Public private partnerships have also garnered attention in the context of water infrastructure projects. Water infrastructure funding has been a focus of the Legislature in 2013 and the water infrastructure bill (Senate Bill No. 1947) now pending before the Senate Committee on Bonding, Capital Expenditures, and State Assets includes language that requires all RFPs for DBFOM and DBOM projects to receive “input” from the MassDOT P3 Commission. If the final bill maintains this current language it will authorize, at least implicitly, the use of using delivery methods in the water sector which could significant increase public private partnership activity in the state.
The Legislature also created a public private partnership study commission to “review and evaluate the administration and fiscal impact of public-private partnership policies or other alternate finance and delivery methods in the commonwealth, including, but not limited to, design-build-finance-operate-maintain services or design-build-operate-maintain services, as defined in section 62 of chapter 6C.” Section 183 of chapter 38 of the Acts of 2013.
The recent attention being paid to P3s by the legislature, state agencies, and authorities indicates that the political leadership critical to making public private partnerships successful is developing in Massachusetts.
III. Considerations for Public-Private Partnerships
If the public private partnerships are on the horizon for Massachusetts, what are the considerations for project stakeholders? The National Council on Public-Private Partnerships, a leading resource for P3 trends, identifies seven keys to success for any public-private partnership transaction. They include: (i) strong public sector leadership; (ii) a supportive statutory environment in the jurisdiction; (iii) an organized public sector partner; (iv) well-drafted contractual agreements; (v) a clearly defined revenue stream; (vi) stakeholder support; and (vii) and a carefully selected partner.[6]
One of the key hurdles to the development of P3s has been the lack of political support in many states, including Massachusetts. Policy concerns stemming from the impacts of privatization on labor, and the public’s hesitancy to privatize those aspects of our infrastructure that have traditionally been owned and operated by public entities, are complex issues that require strong leadership to overcome. States and municipalities that have led the way in implementing public-private partnerships have found ways to address these concerns, but without strong support and leadership from public officials, implementing the P3 delivery model is not possible.
It is also axiomatic that public participation in private sector partnerships that involve the use of public funds and relate to public assets must be undertaken pursuant to a broad array of federal, state and local laws and regulations. Public-private partnerships require a legal and regulatory framework that protects the private partner’s financial investment and property rights while enabling commercial contracts to be legally enforced.[7] Because the use of public-private partnerships is a decision left to the individual states, the laws governing their implementation vary from state-to-state. Clarity regarding the types of P3s that are authorized, the types of projects that may be delivered using the P3 model, the method of selecting private partners, the scope of ancillary state laws and regulations (e.g., public bidding requirements, prevailing wages laws, bonding requirements, etc) that will apply is critical to a successful process, as well as the audit and oversight requirements that will be applicable to the private partner.
Legal challenges to the public-private partnership model can also be a significant risk to any project and should be considered and thoroughly evaluated early on in the project development process. Like traditionally procured projects, legal challenges have the potential to delay projects, impose mitigation requirements, or alter other fundamental aspects of the project. Such an outcome becomes even more significant in a public-private partnership context because of its impact on complex project financing arrangements with multiple debt and equity parties. Legal challenges to P3 projects may include challenges based on public interest grounds, challenges to the procurement of the project and its compliance with the jurisdiction’s P3 enabling statute, or challenges relating to the environmental impacts of the project.[8]
A recent example of how a legal challenge can disrupt a P3project comes from the Commonwealth of Virginia where, in Danny Meeks, et al. v. Virginia Department of Transportation, et al., a state circuit court held that proposed tolls and certain terms of the partnership agreement for a $2.1 billion river crossing project were unconstitutional. The circuit court held that the agreement between the state’s private partner, Elizabeth River Crossings LLC, and the Virginia Department of Transportation (VDOT) violated the Virginia Constitution because, inter alia, toll setting and collection constituted a non-delegable legislative function. The anticipated toll revenues from this project were, of course, a significant part of the capital stack for the project which included $664 million of private activity bonds and a $422 million federal loan under the Transportation Infrastructure Finance Innovation Act.[9]
In addition to the legality of the toll setting and collection scheme, opponents of the Elizabeth River Crossings Project argued that VDOT had no authority, either under PPTA or any other applicable law, to execute a partnership agreement that contained provisions compensating the private partner in the event competing facilities were constructed or taxes imposed on toll revenue—two provisions that were part of the 58-year concession agreement executed in connection with the Elizabeth Crossings project. The Meeks decision was overturned on appeal but it created significant uncertainty for the project at a critical time in the project development process. Other states are likely to see close scrutiny of public private partnerships and legal challenges.
A significant headwind to the deployment of public-private partnerships is the complexity of the transactions, in particular the required financial and legal agreements. The unique and custom nature of these transactions—no two are ever exactly the same with respect to the facility to be constructed, the financing schemes, or the allocated risks—makes it challenging for project sponsors to realize economies of scale that are achieved on projects delivered using traditional delivery methods that have standardized the full spectrum of project activities. On the developer side, public-private partnerships are costly and time consuming endeavors that require years of project development and market positioning efforts. Developers must also contend with each state’s unique P3 enabling acts and regulatory frameworks that govern public-private partnerships as well as other laws and regulations that apply to construction, labor, real estate, and corporate matters, just to name a few. These requirements must be fully understood and analyzed by the private partners before a partnership agreement may be entered into. In addition, developers must invest significant resources into due diligence of each individual project.
As a result of the complexities inherent to the P3 delivery model, the legal agreements that define the partnership between the public entity and the private partner are voluminous, complex and expensive to develop and negotiate. Beyond the comprehensive development agreement between the public and private partner, additional negotiations and contracting are required with each of the primary subcontractors. By any measure, the complexity of the contracting process of any P3 project is significant and should not be overlooked.
There are seven categories of risk common to P3 projects[10] that must be addressed:
- Design/Development Risk
- Construction Risk
- Revenue Risk
- Financial Risk
- Unexpected Event Risk (including political/regulatory risk)
- Performance Risk
- Environmental Risk
A well-drafted set of legal documents that details the allocation of these risks and other contractual obligations amongst the parties in a clear and precise fashion is critical for the success of a public-private partnership. Because the partnership agreements must govern a relationship that may last over a period of decades and must contemplate numerous variables and details, the partnership agreement must have clear provisions that establish a framework for dealing with a full spectrum of risks and disputes in a cost-efficient and equitable manner.
Conclusion
The growing interest in public-private partnerships among government entities and private partners in Massachusetts and elsewhere is a positive sign for badly deteriorated infrastructure. With the consistent success of large core and social infrastructure projects, P3s will be seen as a viable model for states that are new to the public-private partnership process. Developing a favorable legal climate for P3s in Massachusetts, programming a consistent pipeline of projects, supporting local governments to build management and oversight capabilities, and bundling projects to increase efficiencies and reduce costs will all be important factors to the successful deployment of P3s
*This article originally appeared in the CIM Construction Journal, December 2013.
[1] http://www.fhwa.dot.gov/ipd/p3/defined/
[2] http://www.infrastructurereportcard.org/
[3] http://www.infrastructurereportcard.org/a/#p/grade-sheet/gpa
[4] Id.
[5] http://www.fhwa.dot.gov/ipd/p3/defined/index.htm
[6] http://www.ncppp.org/ppp-basics/7-keys/
[7] Straus, Alan G., Expert Roundtable on PPP, September 6. 2007.
[8] http://ppp.worldbank.org/public-private-partnership/legislation-regulation/framework-assessment/legal-environment/legal-challenges-against-ppp-projects
[9] http://www.bondbuyer.com/issues/122_85/state-court-2-billion-dollar-virginia-p3-unconstitutional-1051251-1.html
[10] Straus, Alan G., Proceedings from the Expert Roundtable on PPP, September 6. 2007.