Flexing Ppps

Flexing PPPs

VALUE FOR MONEY ON PPP EXPANSIONS OBTAINING VALUE FOR MONEY ON PUBLIC PRIVATE PARTNERSHIPS THAT WILL BE EXPANDED WWW.DLAPIPER.COM

Contents

1 Introduction �� 4

2 The PPP model �� 5

3 Building additional flexibility into PPPs ��11

4 Alternative delivery models ��13

5 Which is best? ��15

Case studies ��16

Our broader infrastructure and construction team ��26

Summary

A number of major transport projects are presently being delivered under Public Private Partnership (PPP) contracts. In each case, it was likely from the outset that the new transport system would be extended during the life of the PPP contract. However, PPP contracts can be inflexible, relative to other contractual delivery models, when it comes to making changes to a project. This lack of flexibility can leave government vulnerable to private sector profiteering on the commercial terms of significant extensions. This paper considers how governments can manage this vulnerability when contracting under a PPP contract. It also considers whether alternative contractual models might provide government with better value for money over the longer term.

3 FLEXING PPPs

1. Introduction

Many recent rail projects have But the PPP model is known to be This creates some very significant been delivered as Public Private inflexible when it comes to making challenges for government, Partnerships (PPPs) including changes to a project. It is inflexible which can impair government‘s Stage 1 of the Sydney Metro, and because PPP contracts are long ability to obtain value for money light rail projects in the Gold Coast, term in nature, and involve on the extension. Canberra and Sydney. many more parties than more traditional publicly funded This paper unpacks the challenges In each case, it was expected that contract delivery models. associated with extending a rail the system would be extended network that is being operated during the term of the PPP contract. On each of the projects previously under a PPP contract. It considers Indeed, stage 2 of the Gold Coast referred to, customers will want the measures that governments light rail project opened in 2017, and the extension to be operationally can implement in response to a detailed business case for Stage 3 integrated with the part of the these challenges, and their likely is being developed. Likewise, network covered by the PPP effectiveness. The paper also Stage 2 of the Sydney Metro project contract. Customers will not want considers whether alternative is under construction, a business to switch vehicles at the point contractual models might provide case for the second stage of the where the extension joins on to better value for money over the Canberra light rail project is under the network covered by the PPP longer term, once the cost of consideration, and future extensions contract. To achieve this outcome, extensions are taken into account. to the Sydney light rail system from the relevant government must Kingsford to Maroubra, Malabar or secure the agreement of the La Perouse have been proposed. multiple parties involved in the PPP.

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2. The PPP model

2.1 Australian PPP bears the risk of demand by users The service payment PPP model was models (and consequently, revenue from preferred for each of these projects In Australia, the PPP model is user charges), being less than what because private sector investors and generally used to describe contracts was forecast. In the case of service lenders had lost their appetite for that incorporate two key features: payment PPPs, demand risk is demand risk on greenfield transport typically borne by the government. projects, mostly as a result of the • the bundling of design, failure of numerous toll roads to construction, maintenance and Of course, there are many variants achieve their patronage forecasts. potentially other services into a to these two basic models. Indeed, The service payment PPP model was single contract; and demand risk can be allocated also preferred over a user-charge differently under either model. model because user charges would • the use of private sector finance. only cover a portion of the operating There are two basic PPP models There have been periods when costs in any event. Government that are applied to infrastructure user-charge PPPs have dominated also wanted to control fares, service projects in Australia. The feature the Australian PPP landscape. levels, and the development of the that distinguishes one model from Most Australian toll roads were surrounding transport network, the other is the primary source delivered under a user-charge PPP which was more easily achieved if of revenue used to repay the model. The user-charge PPP model government bears the demand risk. private sector finance. In one case, was also applied to a number of rail the primary source of revenue infrastructure projects including The challenges discussed in is charges imposed on users of the Adelaide – Darwin railway, the this paper apply equally to both the infrastructure. These PPPs Brisbane Airport rail link, and the user-charge PPPs and service are known as ‘user-charge PPPs’. Sydney Airport rail link transactions. payment PPPs. In the other case, the primary source of revenue is a service However, in more recent years, Before covering the challenges (or availability) payment from the it has been the service payment associated with extending a rail government, which are known as PPP model that has dominated, project being operated under a PPP ‘service payment PPPs’. including in relation to road and contract, we will explain in more rail infrastructure. It is the service detail the PPP model that has been A key difference between the two payment PPP model that is being applied to recent rail projects, and models is who bears demand used on the rail projects mentioned the reasons why government may risk. In the case of a user-charge in the introduction. have chosen to use the PPP model PPP, the private sector typically for these projects. FLEXING PPPs

2.2 Overview of PPP model used on recent rail projects The basic contractual structure that was adopted for Stage 1 of Sydney Metro and the light rail projects in the Gold Coast, Canberra and Sydney is shown in figure 1.

FIGURE 1: BASIC PPP STRUCTURE FOR RECENT RAIL PROJECTS

Government

PPP Contract

Debt Equity Debt Financiers SPV Equity Investors

D&C Contract O&M Contract

D&C Joint Venture Operator

In each case, the relevant between one or more major civil • an Equity Subscription Agreement government agency entered into a engineering contractors and, in the with each Equity Investor, under PPP contract with a special purpose case of each light rail project, a light which each Equity Investor agrees vehicle (SPV) established by the rail vehicle and systems supplier (the to contribute a fixed amount of successful bidder. The PPP contract D&C Joint Venture). In the case of equity into the SPV; and requires the SPV to finance, design Sydney Metro Northwest, the rolling • a Loan Facility Agreement with and construct the rail system stock and rail systems supplier was the Debt Financiers, under which (including the rolling stock) and then a subcontractor to the D&C Joint the Debt Financiers agree to lend to operate and maintain it through Venture, rather than a member of it. a capped amount to the SPV. to the expiry of the PPP contract. This difference is not material to the In return, the government agency analysis that follows. The SPV uses this finance (and the agreed to pay a capital contribution capital contributions it receives during the construction phase, The SPV also enters into an from the government agency and monthly service payments Operation and Maintenance (O&M) under the PPP contract) to pay the during the operation phase. contract under which it subcontracts monthly progress payments due The government agency was also its obligation to operate and to the D&C Joint Venture under the responsible for providing access to maintain the rail system to an D&C contract. site during the construction phase, Operator. The Operator either and a lease or licence of the project performs the maintenance activities When construction is completed site during the operations phase. itself, if it has the capability to do so, and operations commence, the SPV or it subcontracts these activities receives monthly service payments The SPV enters into a fixed to the rolling stock and systems from the government agency under price Design and Construct supplier and perhaps one or more the PPP contract, which it uses to: (D&C) contract, under which it members of the D&C Joint Venture. subcontracts its obligation to • pay the fee payable to its design and construct the rail system The SPV raises the finance it needs Operator for the provision of (including the rolling stock) to to fulfil its contractual obligations by the operation and maintenance an unincorporated joint venture entering into: services under the O&M contract;

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• meet its interest and principal According to the Full Business Case default or insolvency if failing to repayment obligations to the for the Canberra light rail project,1 do so would reduce the value of Debt Financiers under the the PPP model was considered to their existing investment or loan. Loan Facility Agreement; and provide the best value for money The additional resources provided outcome because of: by investors or financiers may be • if surplus funds exist after making sufficient to solve the problem, in the above payments, distribute • the heightened degree of risk which event government is shielded the surplus to the Equity transfer and cost certainty it from the risk. It is only when the Investors as a return on their offered over other delivery investors or financiers are unable equity investment. models; and or unwilling to provide further The service payment payable by resources to solve the problem that • the greater scope for innovation the government agency under the the risk shifts back to government. it offered, compared to other PPP contract is performance-based, delivery models.2 meaning it is reduced in accordance The bundling of design, construction, with an agreed formula in the event The Capital Metro Authority operation and maintenance the passenger services are not considered these features to be obligations into a single PPP contract provided to the required standards particularly important for its project also eliminates the interface risk (for example where services because of the ACT Government‘s that government bears when it run late). lack of familiarity with rail projects of enters into separate D&C and O&M that size and complexity.3 contracts. However, government can As already mentioned, fares are also eliminate this risk by bundling set, collected and retained by But much of the risk that is allocated these obligations into a single DBOM government on each project. to the private sector under the PPP contract, or by ensuring that its The SPV has no entitlement to contract can also be allocated to contractor under each of the D&C the fare revenue collected. the private sector under a publicly and O&M contracts is the same entity. funded D&C and O&M contracts, or a Further details of the contracting Design, Build, Operate and Maintain The heightened cost certainty structures for Sydney Metro (DBOM) contract. The additional risk arises from the bundling of all Northwest, and the light rail projects transfer that a privately financed necessary components of the in Sydney, the Gold Coast and PPP can achieve relative to publicly project into a single contract with Canberra light rail, are provided funded models boils down to the a fixed price (service payment). in the case studies at the end of risk of default by or insolvency of With more traditional contracting this paper. the D&C contractor or Operator.4 methodologies, different Under the PPP model, the private components of the project are 2.3 Why was the PPP finance provided by the SPV‘s delivered under separate contracts. model chosen for equity investors and debt financiers The costs of some of these contracts each project? provides government with a buffer is often not know at the time the The main reason the PPP model was against the risks of contractor government, by signing the first chosen for each project was a belief insolvency, and default for which contract, commits to the project.5 that the PPP model would deliver the contractor‘s liability is capped or a better value for money outcome excluded. In particular, government The greater scope for innovation compared to any alternative delivery is partially protected under a PPP, on a PPP is often said to arise from model. In each case, the decision because the equity investors and government‘s focus on outcomes was made at a point in time, based debt financiers will generally invest and the use of an output/outcome on the information available to the additional resources in solving specification. However, the same relevant government. problems caused by contractor outcome focussed approach can

1 Capital Metro Full Business Case, pin. Available at https://www.tccs.act.gov.au/__data/assets/pdf_file/0010/887680/Light-rail-Capital-Metro-Business-Case-In-Full.pdf

2 “a comparison between the project’s public sector comparator and PPP proxy” was also given as a reason for recommending the PPP model, but this is

simply another way of expressing the risk transfer point. See p16 of the Capital Metro Full Business Case.

3 Capital Metro Full Business Case, pin.

4 Hayford, O, Public Private Partnerships — Improving the Outcomes, 2017, at p11.

5 WestConnex is a good example of this scenario.

7 FLEXING PPPs

be applied to the specifications for 2.4 PPPs are not as Another reason PPP contracts are a traditional government funded flexible as other less flexible than more traditional D&C contract. In truth, the greater contract delivery contracting methodologies is their innovation seen on PPP contracts is models long term nature. The long term is probably due to the involvement of As Figure 1 (in section 2.2) driven by a desire to incorporate the Operator in the bidding process, demonstrates, a PPP is not a simple a fixed price operation and which could also be achieved under two-party, ‘principal and contractor‘ maintenance period of sufficient a DBOM contract. arrangement. Rather, there are five length to motivate the SPV to separate private sector roles with optimise the trade-off between It is not possible to report on exactly a significant financial interest in lower design and construction costs why it was thought that the PPP the project. Each role has different resulting in higher operating and model would provide the best value interests, rights and obligations maintenance costs. Each of the PPP for money for Sydney Metro Stage 1, in relation to the project, so the contracts considered in this paper Sydney light rail and Gold Coast light commercial interests of the private has an operation phase of at least rail projects, as the procurement/ sector parties are not aligned. 15 years, on top of the construction delivery model strategies for those Further, most roles, such as the phase. Although 15 years is projects are not publicly available.6 D&C Joint Venture, the Equity considerably shorter than the Investors and the Debt Financiers 30+ year term associated with most One would reasonably expect that typically comprise several different PPP contracts, it still means the option the reasons mentioned above would companies, each with its own of simply waiting for the current have also applied to these projects. unique objectives. contract to expire and then going Additional reasons as to why it was out to tender with a new contract thought that the PPP model would As a general rule, before the SPV incorporating the desired changes be appropriate might have included: can agree to any changes to its PPP won‘t be available to government until contract with the government, the late in the contract term. • improved scoping and risk SPV must first obtain the agreement assessment by government that of its Equity Investors, its Debt 2.5 Delivery model tends to occur for PPP projects; Financiers, the D&C Joint Venture analysis for and the Operator, if the change to Canberra light rail • additional rigour that the use of the PPP contract will increase the The full business case for Canberra private finance brings, due to due obligations or otherwise adversely light rail includes a detailed analysis diligence and monitoring from the affect the interests of these parties. of potential delivery and packaging lenders and equity investors; options. Packaging options involving • improved service outcomes due Negotiating a deal that enables separate contracts for operations to proper planning and allowance the SPV to obtain the agreement (or operations and maintenance) for maintenance costs; and of all of these parties is a major were considered, but the option of challenge for any government bundling the design, construction, • industrial relations reform, that wishes to extend or otherwise operations and maintenance of via the private sector make a significant change to a the rail infrastructure and vehicles provision of operations and PPP contract after it is signed. into a single package was preferred maintenance services. because it mitigated interface risks The downsides associated with PPPs This is the primary reason why PPP between packages. This was ‘seen as would have also been taken into contracts are less flexible than more important and relevant for the ACT, account, including: traditional contracting methods. which does not have existing light The involvement of private sector rail operations or large construction • the reduction in flexibility; and finance significantly constrains markets (unlike Melbourne and the ability of government to make Adelaide where packages have been • the cost of using limited recourse changes to the PPP arrangement procured separately)’.7 private sector finance. after it has been signed.

6 Whilst a high level summary of the business case for the Sydney particular procurement model, as the investment decision was light rail project has been

published, it doesn’t recommend a made before the procurement model decision on that project.

7 Capital Metro Full Business Case, p115.

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The full business case states that price project via a PPP contract with apply the funds that it would certainty, risk transfer, innovation and a 15-year operations phase generate from selling its electricity incentive were the primary drivers was announced in June 2012.10 distribution assets (the ‘poles and for the decision on procurement At this time, it was expected that wires’) to the extension of the metro model, and that time to market and government funding for the south of Chatswood, if it secured flexibility were considered potentially proposed extension of the Metro a mandate from voters at the lesser drivers.8 It also stated that the network south of Chatswood would March 2015 election.12 This meant fully integrated model “can address only become available towards that it was now almost certain, future flexibility contractually: i.e. the the end of the PPP contract‘s rather than remotely possible, potential inclusion of break points proposed 15-year operations that during the term of the PPP in the operating contract to change phase. Accordingly, it was thought contract, government would need operator; competitively bid pricing on that a new contract to operate to negotiate with NRT to try to reach changes to frequency/route extensions.“ 9 and maintain the extended metro agreement on commercial terms The need for future flexibility in relation system in a fully integrated manner for the operation of the extended to extensions, and the challenges could be competitively tendered at metro system. Accordingly, associated with obtaining under the this time, which would ensure that a more detailed augmentation fully integrated PPP model, may have NSW taxpayers obtained the best regime was added to the PPP been under-estimated. value for money outcome from the contract to assist government with operator of the extended metro. these negotiations. 2.6 A late change to extension plans It was not until June 2014, 2.7 The challenge of on Sydney Metro the same month that Northwest extensions Northwest Rapid Transit (NRT) was announced It is contemplated that there will The decision to procure the as the preferred bidder for the be linear extensions to each of the operations, trains and rail systems PPP contract,11 that the Baird projects considered in this paper. for the Sydney Metro Northwest Government announced it would

8 Capital Metro Full Business Case, pw.

9 Capital Metro Full Business Case, pg.6.

10 https://www.sydneymetro.info/sites/default/files/document-library/media%20release2062012_0.pdf

11 http://www.transport.nsw.gov.au/newsroorn/media-releases/major-milestones-reached-north-west-rail-link-preferred-operator-selected

12 http://www.transportnsw.gov.au/newsroorn/media-releases/rebuilding-nsw-government-declares-war-congestion;

http://www.transport.nsw.gov.au/sites/default/files/b2b/med ia/Rebuilding%2oNSW962o-%2oMassive%2oinvestment%2ofor%2oregional%2oNSW.pdf

9 FLEXING PPPs

Customers are likely to want the a. terminate the PPP contract early – Faced with these options, the extension to be operationally which is very expensive; or government will choose to pursue integrated with the part of the Option 1, i.e. negotiate amendments b. get the SPV to terminate its network covered by the PPP to the PPP contract to enable the O&M contract with the existing contract. It‘s unlikely customers will incumbent Operator to operate Operator and enter into a want to have to switch vehicles at both the original line and extended new O&M contract with a the point where the extension joins line as a fully integrated service, new Operator – which is less on to the network covered by the unless the commercial terms expensive, but very difficult PPP contract. demanded by the SPV or the to achieve. Operator are so extreme that it is To achieve this outcome, either Option 2a is very expensive because cheaper to switch to Option 2. the incumbent Operator needs to PPP contracts generally require operate both the original line and government to pay a termination This is an unenviable negotiating extended line as a fully integrated payment for early termination position for the government. service, or a new Operator needs to sufficient to enable the SPV to: Unfortunately, it is the inevitable be engaged to operate both lines consequence of entering into as an integrated service – it‘s not • repay its debt (including hedge a PPP contract. possible to have a different Operator break costs and the like); on each part of the network. The solutions to this challenge fall • fully compensate its Operator into two basic categories: for early termination of the This leaves government with O&M contract (including profits two basic options. • The first is to try to build foregone); and additional flexibility into the PPP Option 1: Strike a deal with • give its equity investors a return arrangement. This is what has the incumbent Operator (and on their equity investment.13 occurred, to varying degrees, on its SPV). It‘s not possible for each of the projects considered Option 2b is less expensive, as it government to deal directly with by this paper. However, for is only the incumbent Operator the incumbent Operator (and cut reasons explored later, there is that needs to be compensated for out the SPV), as the Operator will only so much that can be done early termination (rather than the need to reach agreement with the in this regard, given the inherent SPV). However, this is very difficult SPV on consequential changes features of the PPP model. to achieve as it involves great risk to the operational performance for the SPV and its Equity Investors • The second solution is to consider regime in the O&M contract. and Debt Financiers, who will bear an alternative delivery model for The SPV won‘t agree to these the risk of poor performance by the initial project. changes with the Operator unless the new Operator. These parties corresponding changes are made to will want to be protected against the operational performance regime this risk if they are forced by in the PPP contract between the government to switch Operators, SPV and government. which would completely undermine the PPP contract‘s allocation of Option 2: Terminate the existing operational performance risk to the Operator, and engage a new SPV, and the value for money this Operator to operate both the provided to government. existing railway and the extension. To do this, government will need to either:

13 The level of return the equity investors receive varies between projects. For some projects (Sydney Metro, Gold Coast light rail, and Sydney light rail

(pre-completion)), they receive the return they expected to receive on their equity investment when the PPP contract was signed. On others

(Canberra light rail, Sydney light rail (post completion)), they receive the fair market value of the equity as assessed by an independent expert.

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3. Building additional flexibility into PPPs

3.1 A variation power PPP contract clearly states that the However, there will be many can provide some government can direct the SPV significant elements for which flexibility to build and operate a significant this won‘t be possible, such as the The most obvious way to build extension to a railway, the courts will operation and maintenance of flexibility into a PPP contract is to give effect to this. the extra trains and the extended include a broad power to order network. The pricing for these variations in the contract, similar to This explains why the variation elements can only be agreed or the variation power found in most power in the Canberra light rail PPP determined once the scope of construction contracts. contract expressly permits the ACT the work is known. Government to direct the SPV to This power allows the government build, operate and/or maintain all For these elements, the best to direct changes to works and or part of an extension to Canberra government can get is: services that are to be provided light rail system. It also explains the under the contract, on the basis that inclusion of similar powers in the • a commitment from the SPV to government will compensate the Sydney light rail PPP contract. negotiate the price and other SPV for any additional costs or loss consequences after government of revenue arising from the change. But having an express power to has worked out what it wants; and order variations of this nature only • a right to have the price and other However, the law ordinarily implies gets you so far. The real challenge consequences determined by an a limitation of reasonableness on for government is getting certainty independent expert if the parties this power. The courts have said and value for money on the price can‘t reach agreement. that extent of variations ordered and other consequences of must be reasonable having regard exercising the power. Whilst the right to have the to the extent of the additional work, price and other consequences the time at which it is ordered, It is usually not possible to obtain determined by an expert in the and any changes in circumstances a fixed price for the construction, event the parties can‘t reach since the date of the contract.14 operation and maintenance of agreement seems a reasonable The courts have also said that the a potential extension as part of solution, it would be high risk for changes cannot go beyond what the competitive bidding process government to order the variation the parties ought reasonably to for the original PPP contract, as before the price is agreed or have contemplated at the time the government does not know, at determined, given the massive contract was signed.15 the time when bids are submitted, costs involved and the possibility exactly what it wants in relation that the price determined by the Accordingly, a normal contractual to the extension, or when it will expert could be many millions power to order variations would not require it. of dollars different to what permit a government to direct the government expected. SPV to build or operate a significant It may be possible to secure fixed extension to a railway system. prices for certain elements of the On some projects, such as Sydney extension, such as the supply of light rail,16 government also has the But like all implied terms, this extra trains. This was achieved on option of waiting for the expert‘s implied limitation of reasonableness each of the projects considered in determination before making a final can be overridden by clear words this paper. decision on whether to proceed with to the contrary. Accordingly, if the the variation. But other projects, such as Canberra light rail,17 14 Wegan Constructions Pty Ltd v Wadonga Sewerage Authority [1978] VR 67; have no such option.

15 Bush v The Trustee of the Town & Harbour of Whitehaven (1988) 52JB392. Bush v ... (1988) 52 JB 392

16 Sydney Light Rail Project Deed, clause 29.12

17 Capital Metro Project Agreement, clause 33.

11 FLEXING PPPs

Even where the option of waiting for Getting the SPV to run a competitive These rights are really difficult to the expert‘s determination before tender process for the design and obtain, even if government offers making a final decision does exist, construction of the extension can to fully compensate the party it is unlikely to be an attractive also be challenging if members of being taken out, as the knock-on pathway for government, given the the SPVs original D&C Joint Venture consequences for those remaining additional time involved, and the hold significant equity in the SPV. in the transaction could be damage that the dispute resolution very significant. process could cause to the parties‘ 3.3 Rights to take out long-term relationship. non-consenting That said, they have been obtained to parties varying degrees on some, but not all, 3.2 Variation works can As mentioned earlier, the main of the projects discussed in this paper. be competitively reason changes are difficult to tendered implement on PPPs is the large Even if obtained, they can end up One way of injecting some number of parties that need to being very expensive to exercise, competitive tension into the pricing agree to the change. particularly if interest rate swaps and of the variation works is to require the like are “out-of-the-money“ at the SPV to competitively tender the The only way to overcome this is the time government elects to break relevant work. to give government the ability to these early by taking a party out. remove non-consenting parties This is what occurred for Stage 2 from the transaction. In particular, 3.4 There is a limit to of the Gold Coast light rail project, government could attempt to the flexibility that where the SPV ran a competitive include provisions in the PPP can be achieved tender process for the design and contract that give government: Whilst it is possible to build extra construction of the extension. flexibility into a PPP, there is only so • the right to require SPV to replace much that can be done given the Unfortunately, it‘s generally not the Operator; inherent features of the PPP model. possible to apply this approach So let‘s turn to the second solution. • the right to buy-out to the operation or maintenance non-consenting debt of the extension, given the need financiers; and for operations to be integrated with the operations of the SPVs • the right to buy-out the existing Operator. equity investors. WWW.DLAPIPER.COM

4. Alternative delivery models

The second solution is to consider The Newcastle and Parramatta light The operating franchise contract for an alternative delivery model for the rail projects provide some insight the Newcastle project incorporates a initial project. into what is possible in this regard, performance based service payment as do the Melbourne train and regime, similar to that found in a The objective of the second solution tram franchises. PPP contract. But the term is shorter is to come up with a contracting which provides more frequent model that provides as many of On the Newcastle light rail project, points at which a new operating the benefits of the PPP model as is Transport for NSW has entered franchise contract, covering the possible, without the associated lack into three separate contracts of operation of an expanded network, of flexibility. significance. The first two cover can be competitively tendered. the design and construction of the To do this, you need to eliminate light rail system and the supply of A similar approach applies in the causes of the lack of the light rail vehicles. Once built, Melbourne, where the process of flexibility, namely: these assets will be leased to, and re-tendering the operating franchise operated and maintained a private contract every seven years provides • the large number of parties sector operator that Transport regular opportunities to obtain during the operation phase; and for NSW has separately engaged competitive pricing for the operation under a short term operating and maintenance of network • the long-term nature of the franchise contract. infrastructure changes. operating phase.

13 FLEXING PPPs

Transport for NSW has adopted a price D&C contract with an output There is no reason why government similar model for the Parramatta specification provides a similar cannot tender the build and light rail project. Initially it was risk allocation and opportunity operation phase contracts in intended for the project to be for innovation as a PPP contract. parallel. The preferred operator procured as a single package Alternatively, other forms of build could be selected shortly before under a DBOM contract. However, phase contract (i.e. alliance, managing the selection of a preferred build following industry consultation contractor, delivery partner model phase contractor, and involved in it was decided that it would be etc) can be used if government has a the finalisation of the build phase procured via two main packages, different risk appetite or objectives, contract. Indeed, the operator could plus some early and enabling especially if there is no private finance be selected on the understanding works packages. The two main during the build phase. that it will enter into and administer packages are: the build phase contract, and If government wants the rigour manage the interface risk between • the Construction Package – that private finance brings to be the two contracts. covering the track, road works applied to the build phase, this and stop platforms; transport can be achieved, at least in part, by The build phase contracts for interchanges at Westmead, holding back payment of a significant subsequent extensions can be Parramatta CBD and Carlingford; component of the build price until competitively tendered when and pedestrian zones along all commissioning tests have been government is ready to proceed, Church and Macquarie Streets passed and build phase defects have thereby ensuring value for money in in the Parramatta CBD; and been closed thereby requiring the relation to build phase costs. SPV or its D&C contractor to finance • the Supply and Operate Package, these costs in the meantime.18 Eliminating the use of private finance which includes: during the operation phase avoids • the supply of the light rail Maintenance responsibilities can the need to obtain the agreement of vehicles and rail systems; also be incorporated into the equity investors and debt financiers build contract. The maintenance (or to incur the cost of buying • the design and construction of term can be aligned with the term them out) when the operating the stabling and maintenance of the initial operating franchise franchise agreement is amended to facility and the above ground fit contract, but with an option for the incorporate the extension. out of the light rail stops; and maintenance term to be extended • operation and maintenance of out to, say, 15 years, to drive a If the opening of an extension is the network for 8 years, with an whole of life approach to the timed to coincide with the expiry of option to extend for a further assets. Alternatively, maintenance the Operating Franchise Agreement, 10 years. responsibilities can be included in the need to obtain the agreement the operating franchise agreement, of the incumbent operator can also Under these alternative non-PPP as occurred for Newcastle be avoided. models, the build phase contract(s) and Parramatta. can actually take many forms. A fixed

18 Limited recourse finance will bring more rigour than finance raised by the build phase contractor on a corporate finance basis, but limited recourse

finance will also be more costly. WWW.DLAPIPER.COM

5. Which is best?

There are a number of benefits However, the PPP model creates At the end of the day, the decision associated with the PPP model significant challenges when it comes probably turns on the likelihood that can‘t be fully replicated by the to securing best value for money on of there being an extension, the alternative models that we have extensions. Whilst there are things relative size/cost of the extension, suggested. The main ones are: that can be done to reduce these and the level of confidence that challenges, they can‘t be eliminated government has regarding its • more rigour from involvement without destroying the positive capacity to negotiate a good deal of private sector finance over features of the PPP model. on the extension with its incumbent longer term; contractors. Governments had Accordingly, if extensions are high levels of confidence going • higher cost certainty for contemplated during the term of into Sydney Metro Stage 1 and the initial project; and the proposed PPP contract, serious light rail project in the Gold Coast, • debt and equity provide a buffer consideration should be given to Canberra and Sydney. But the more against risk of default/insolvency alternative delivery models. Even recent delivery model decisions for of the operator. though the alternatives discussed in the Parramatta and Newcastle light this paper are less likely than a PPP rail projects suggest some lessons These benefits certainly make it to provide the best value for money may be being learned. more likely that a PPP will deliver outcome for the initial project, the best value for money outcome they may provide the best longer for the initial project. term outcome, once the cost of extensions are taken into account.

15 FLEXING PPPs

Case studies

Sydney Metro Northwest

On 20 June 2012, the NSW Government announced Sydney‘s Rail Future, its long-term plan to increase capacity on Sydney‘s heavy rail network to support a growing population and improve customer experience. The NSW Government committed to deliver the Stage 1 of Sydney Metro (also known as Sydney Metro Northwest) as the first of the new rapid transit rail services to connect Sydney‘s global economic corridor with high growth employment and residential centres. Together, these three packages of In return, TfNSW has agreed to: work will deliver the Sydney Metro The Sydney Metro Northwest Northwest between Cudgegong • procure the construction of the was procured in three major Road, Rouse Hill and Chatswood. Tunnels and Stations Civil Works contract packages: and the Surface and Viaduct Civil Each contract package was Works, on time and in accordance • The Tunnels and Stations competitively tendered. with the relevant contract Civil Works package, which The Operations, Trains and Systems specifications; was delivered by Thiess Pty (OTS) package was the final package • undertake specified works in Ltd, John Holland Pty Ltd and to be tendered. connection with the conversion Dragados Australia Pty Ltd (the of the existing railway between TSC Contractor) under a D&C NRT, the counterparty to the PPP Chatswood and Epping; contract between Transport contract, is a special purpose vehicle for NSW (TfNSW) and the TSC established by the successful bidder • pay a capital contribution Contractor, valued at $1.15 billion. for the OTS package. The owners during the construction phase, of NRT are MTR Corporation monthly service payments • The Surface and Viaduct Civil (20 per cent), Leighton Holdings during the operations phase, Works package, which was (10 per cent), Plenary Group and a ‘conditional debt pay down delivered by Salini Impregilo (10 per cent) Marubeni (20 per cent) amount’ between year two and S.p.A and Salini Australia Pty Ltd and the Aria Investments Trust (10 per year four of the operations phase, (the SVC Contractor) under a D&C cent), Palisade‘s Australian Social provided certain conditions are contract between TfNSW and SVC Infrastructure Fund 2 (l0 per cent) and met; and Contractor, valued at $340 million the Partners Group (20 per cent). • acquire the land required for the • The Operations, Trains and project site and provide NRT with Systems package, which is being The PPP contract requires NRT to access to it. delivered under a PPP contract finance, design and construct the between TfNSW and NRT Pty Ltd rail systems and the trains, and then in its own capacity and as trustee operate and maintain the metro of the NRT Unit Trust (NRT), system for an expected period of valued at $3.7 billion.19 15 years.

19 A copy of the operative provisions of the PPP contract is available at this link: https://www.transport.nsw.gov.au/system/files/media/documents/2019/

North-West-Rail-Link-OTS-Project-Deed-amended.pdf Other parts of the PPP contract and other contracts relating to the North West Rail Link (now

known as the Sydney Metro Northwest) can be accessed at this link: https://www.transport.nsw.gov.au/industry/contracts-awarded/transport-projects.

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FIGURE 2: PROJECT STRUCTURE — SYDNEY METRO NORTHWEST PPP

Government

PPP Contract

Debt Equity Debt Financiers SPV Equity Investors

D&C Contract O&M Contract

D&C Contractor Operator

System Subcontractor

NRT subcontracted its obligation UGL Rail Services Pty Ltd (SJV) – John Holland Sydney NRT to design and construct the further subcontracted the design Pty Ltd (20 per cent holding) rail systems and trains to an and manufacture the trains and and UGL Rail Services Pty Ltd unincorporated joint venture communications based train control (20 per cent holding). between MTR Corporation (Sydney) systems to Alstom Transport NRT Pty Ltd, John Holland Pty Australia Pty Ltd. The Operator, in turn, engaged Ltd, CPB Contractors Pty Ltd and Alstom Transport Australia Pty Ltd UGL Rail Services Pty Ltd (together, NRT subcontracted its obligation to provide certain maintenance the D&C Contractor). to operate and maintain the metro support for the trains and system to Metro Trains Sydney Pty communications based train Two members of the D&C Ltd (the Operator). The Operator control systems. Contractor – MTR Corporation is owned by MTR Corporation (UK) (Sydney) NRT Pty Ltd and NRT Ltd (60 per cent holding),

17 FLEXING PPPs

Augmentation — Sydney Metro City and Southwest

The draft PPP contract issued with other than agreed‚ non-contestable parties can‘t reach agreement on the RFI included a short clause components (i.e. supply of the terms on which NRT will be that provided a framework under trains, supply of signalling and involved in the design, construction, which future extensions of the train control systems (CBTC) operation and/or maintenance of network (referred to in the contract and operation and maintenance the augmentation, TfNSW cannot as ‘augmentations’) could be services), but the parties are free force NRT to participate. discussed and potentially agreed to depart from these. by the parties.20 If TfNSW forms the view that it is The regime includes fixed unlikely that the parties will reach When the Baird Government prices (subject to escalation and agreement on the terms of the announced that the future extension adjustment for specified events) for augmentation, TfNSW can exercise south of Chatswood, under Sydney the supply of additional trains, and its right to terminate the PPP Harbour, through the CBD and for the supply of CBTC systems for contract for its convenience,23 in on to Bankstown21 would proceed trains and stations, provided TfNSW which event TfNSW must pay an earlier than originally planned if the orders them before a specified early termination payment that Government secured a mandate at date. It also includes an ‘O&M target enables the NRT to prepay its the March 2015 election to privatise price‘ for the operation and debt (including hedge break costs its electricity distribution assets, maintenance for the augmentation and the like); fully compensate its TfNSW and NRT negotiated a more which was prepared based on a Operator for early termination of detailed regime by which the parties list of assumptions regarding the the O&M contract (including profits could work together on the project augmentation. The intention is that foregone); and give its equity definition, planning, development this O&M target price will form investors the return expected to and delivery of this augmentation.22 a benchmark (or starting point) receive on their equity investment from which an O&M price can be when the PPP contract was signed.24 The regime does detail a number of negotiated and agreed. principles that the parties intended TfNSW also has the right to take would be incorporated into any final Whilst 58 pages are dedicated control of NRT by purchasing all agreement, such as an obligation to this more detailed regime, of the equity in NRT in certain on NRT to competitively tender all it fundamentally remains an circumstances if the terms of the components of its scope of work agreement to negotiate. If the augmentation are not agreed.

20 See clause 33.

21 The extension is now known as the Sydney Metro City and Southwest project.

22 This more detailed augmentation regime is contained in Schedule 46 of the PPP contract.

23 NWRL OTS Project Deed, Schedule 46, clause 20.

24 NWRL OTS Project Deed, Schedule 31, clause 4.

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Canberra light rail

The 12 kilometre light rail project PC Pty Ltd in its personal capacity In return, the ACT has agreed to pay between Gungahlin and the and as trustee for the Metro Trust a capital contribution of $375 million city centre of Canberra is being (Canberra Metro) – a special purpose upon completion of construction, designed and constructed under vehicle established by the successful and monthly availability payments a PPP contract.25 The PPP contract consortium. during the operations phase. also provides for the operation and The net present cost of the forecast maintenance of the light rail system The owners of Canberra Metro availability payment is $520 million. over a 20-year period. are John Holland Pty Ltd, Pacific The ACT must also obtain necessary Partnerships, Mitsubishi Corporation development and works approvals A tender process was conducted and Aberdeen Infrastructure for the works, and provide Canberra to ensure value for money was investment. Metro with access to the project site. achieved with respect to the award of the PPP contract. The PPP contract requires Canberra Metro to finance, design and The Australian Capital Territory (ACT) construct the light rail system, entered into the PPP contract on and then operate and maintain it 17 May 2016 with Canberra Metro for a 20-year period.

FIGURE 3: PROJECT STRUCTURE — CANBERRA LIGHT RAIL

Government

PPP Contract

Debt Equity Debt Financiers SPV Equity Investors

D&C Contract O&M Contract

D&C Joint Venture Operator

LRV Supplier Deutsche Bahn

Canberra Metro has subcontracted The D&C Joint Venture has, in turn, venture company owned its obligation to design and subcontracted the design and by John Holland Pty Ltd and construct the light rail system manufacture of the light rail vehicles Pacific Partnerships Pty Ltd. (including the vehicles) to an to Construcciones y Auxiliar de unincorporated joint venture Ferrcarriles S.A. (CAF). The Operator has, in turn, between John Holland Pty Ltd and engaged Deutsche Bahn CPB Constructions Pty Ltd (together, Canberra Metro has subcontracted Engineering and Consulting to the D&C Joint Venture). The fixed its obligation to operate and assist it with the operation and price payable to the D&C contractor maintain the light rail system maintenance of the light rail system. is $508 million. to Canberra Metro Operations Pty Ltd (the Operator), a joint

25 A copy of the PPP contract is available at: https://tenders.act.gov.au/ets/contract/view.do?id=42390&returnUrl=%252Fcontract%252Flist.

do%253F%2524%257Brequest.queryString%257D

19 FLEXING PPPs

Future stages direct Canberra Metro to design, As mentioned in section 3.1 of this construct, operate and/or maintain paper, it would be a courageous The ACT Government has mapped all or part of a ‘future stage‘ move for the ACT to direct out the future potential light rail pursuant to the ACT‘s contractual Canberra Metro to implement network. The current master plan is power to order variations; and a future stage as a variation in shown below. circumstances where the parties • procure the design, construction, are unable to reach agreement In September 2016, the ACT operation and/or maintenance on the variation costs and other Government announced that of any future stage by a third consequences of the variation, the Woden to city corridor would party (including Capital Metro‘s as doing so would leave the be the next stage of Canberra‘s contractors), but the ACT must Territory liable to pay whatever the light rail network. compensate Canberra Metro for expert determines, which could be any ‘unreasonable interference‘ well in excess of what the Territory The ACT Government has advised that caused by such third parties. expected or budgeted for. Stage 2, to Woden, will be physically connected to Stage 1, and that If the ACT wants the Stage 1 vehicles Accordingly, the PPP contract also the contract methodology will be to be able to operate on Stage 2, allows for the ACT to terminate the developed during preparation of the second option ceases to be PPP contract for its convenience. the business case.26 It has also said viable solution, for the reasons If it does so, the ACT must pay that there would be logical benefit explained in section 2.7 of this paper. Canberra Metro a termination for in running Stage 1 vehicles from convenience payment equal to Gungahlin through the city to Woden. If the ACT exercises its contractual Capital Metro‘s outstanding project power to order variations, and the debt, plus the fair market value of The PPP contract includes a parties are unable to reach Canberra Metro‘s equity, plus any clause dealing with ‘future stages’. agreement on the variation costs or other reasonable costs incurred by The clause allows the ACT to: other consequences of the variation, Canberra Metro as a result of the Capital Metro may refer the dispute termination (including subcontract to expert determination. break costs). This amount is unlikely to represent value for money.

26 Light Rail Stage 2: Frequently Asked Questions, ACT Government and Transport Canberra, available at https://s3.ap-southeast-2.amazonaws.com/hdp.

au.prod.app.act-yoursay.files/9014/9359/7087/TC_FAQ_stage_2.pdf

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Gold Coast light rail

The Gold Coast light rail project maintain it through to the expiry of regulating the use of GCCC land, between Gold Coast University the PPP contract on 31 May 2029. GCCC design review rights, works to Hospital and Broadbeach was In return, the State agreed to pay be returned to GCCC, conditions to delivered and is now being a capital contribution during the be imposed by GCCC on adjoining operated, under a $1.2 billion, construction phase, and monthly developments, and changes to 18 year PPP contract. service payments during the traffic signalling priority. operation phase. The State was also A tender process was conducted responsible for providing access to The Operator Franchisee to ensure value for money was site during the construction phases, subcontracted its obligation to achieved with respect to the award and a lease of the project site during design and construct the light of the PPP contract. The State the operations phase. rail system (including the light rail entered into the PPP contract on vehicles) to an unincorporated 5 May 2011 with GoldLinQ Pty Ltd The State takes ticket revenue risk, joint venture between Bombardier (the Operator Franchisee) – a special sets ticket prices, and retains the Transportation Australia Pty Ltd purpose company established by ticket revenue. Consistent with and McConnell Dowell Constructors the successful consortium. this, the State is responsible for (Aust) Pty Ltd (the D&C Contractor). the electronic ticketing system. The owners of the Operator The State entered into a separate The Operator Franchisee Franchisee are Aveng Australia agreement with the Translink Transit subcontracted is obligation to Holdings Pty Ltd, International Authority in relation to ticketing operate and maintain the light rail Public Partnerships (Aust) Ltd, and fare collection arrangements. system to KDR Gold Coast Pty Ltd Keolis SA, Marubeni Corporation, The Operator Franchisee must take (the Operator), a company owned and the Plenary Group.27 all necessary steps to minimise by Keolis SA and Downer EDI Ltd. fare evasion. The Operator, in turn, subcontracted The PPP contract requires the its obligation to maintain the Operator Franchise to finance, The State also entered into a light rail vehicles to Bombardier design and construct the light rail separate agreement with the Transportation Australia Pty Ltd. system and then to operate and Gold Coast City Council (GCCC),

27 GoldLinQ web page, visited on 19 June 2017: http://www.goldlinq.com.au/board.html. It seems that Palisade has sold down its 16.7% interest.

21 FLEXING PPPs

FIGURE 4: PROJECT STRUCTURE — GOLD COAST LIGHT RAIL

CGGG and State GCCC State

PPP Contract

Debt Equity Debt Financiers SPV Equity Investors

D&C Contract O&M Contract

D&C Contractor Operator

Future stages Whilst the Operator Franchisee additional light rail vehicles, to It was always contemplated that acknowledged in the PPP contract be manufactured by Bombardier the light rail system would be that it had no right to participate in Transportation) would cost extended north of Gold Coast future stages of light rail network, taxpayers $420 million.29 However, University Hospital/Griffith the reality was always going to no details were made publicly University, to connect to the be quite different, as subsequent available regarding the additional existing heavy railway at Helensvale, events have shown. costs that the Government will incur and south of Broadbeach in connection with the operation to Burleigh Heads and then to In 2015, the Queensland and maintenance of the extension Coolangatta. These extensions Government announced that it was by the incumbent Operator were contemplated in the Concept progressing with the extension to Franchisee and its incumbent Design and Impact Management Helensvale. It asked the Operator Operator. Plan (CDIMP), published in Franchisee to commence a 2009, two years before the PPP procurement process for the Whilst the design and construction contract was signed. The CDIMP design and construction of the costs for the extension have been contemplated that the extensions extension. Three contractors determined by a competitive from Gold Coast University Hospital/ submitted detailed tenders for the tender process, the operating Griffith University to Helensvale, and D&C contract. CPB Contractors and maintenance costs have from Broadbeach to Burleigh Heads was announced as the preferred not. And although the operating would be delivered between 2016 contractor in March 2016, performance regime for Stage 1 and 2026, i.e. during the term of and construction commenced would have provided a benchmark the PPP contract. It contemplated shortly after. for Stage 2, the Operator Franchisee that the extension from Burleigh would have been in a strong Heads to Coolangatta would The Queensland Government negotiating position for those aspects occur after 2026.28 indicated that the design and of the Stage 2 performance regime construction of the 7.3 kilometre that needed to be negotiated. extension (including four

28 Gold Coast Rapid Transit Concept Design Impact Management Plan, Volume 2 Chapter 5, p7.

29 Gold Coast Light Rail — Stage 2 Newsletter, April 2016. Available at:

https://www.tmr.q1d.gov.auf/media/Projects/G/Gold-Coast-Light-Rail-Stage-2/GCLR2-April-Newsletter.pdf?la=en

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Sydney light rail

The new CBD and South East Light 17 December 2014 with the ALTRAC • a ‘conditional debt pay down Rail (CSELR) from Circular Quay Light Rail Partnership (ALTRAC) – amount‘ between year two and along George Street to Central a special purpose partnership year four of the operations phase, Station to Moore Park, then to established by the successful bidder. provided certain conditions are Kingsford via Anzac Parade and met; and Randwick via Alison Road and The owners of ALTRAC are First State • bonus payments for early High Street is being delivered by Superannuation Scheme (62.5 per completion, if applicable. two major contracts: cent), John Laing PLC (32.5 per cent) and Accoina SA (5 per cent).30 The estimated net present value • a limited ‘early works’ package, of the service payments over that is being delivered by Laing The PPP contract31 requires ALTRAC 19.1 years is $2.204 billion.32 O‘Rourke Australia Construction to finance, design and construct Pty Ltd under a ‘managing the CLELR and then to operate TfNSW is also responsible for contractor‘ contract; and and maintain it together with the obtaining the planning approval existing Inner West light rail system required for the project and • a main works package, that is through to the expiry of the PPP providing access to the project site. being delivered as a PPP contract. contract on 16 March 2034. In The Main Works PPP covers design, return, TfNSW has agreed to pay: ALTRAC subcontracted its obligation construction, services relocations, to design and construct the light operation and maintenance of the • a monthly O&M payment for rail system (including the light rail 12-kilometre project, as well as the operation and maintenance vehicles) to an unincorporated joint the operation and maintenance of of the existing Inner West light venture between Alstom Transport the Inner West Light Rail network, rail system (during the IWLR Australia Pty Limited and Acciona from Central to Dulwich Hill. operations phase); Infrastructure Australia Pty Ltd (the D&C Contractor). • monthly service payments during A tender process was conducted the full operations phase upon to ensure value for money was ALTRAC has subcontracted is its completion of the CSELR; achieved with respect to the award obligation to operate and maintain of the PPP contract. TfNSW entered the light rail system to Transdev into the PPP contract on Australia Pty Ltd (the Operator).

FIGURE 5: PROJECT STRUCTURE — SYDNEY CBD AND SOUTH EAST LIGHT RAIL

Government

PPP Contract

Debt Equity Debt Financiers SPV Equity Investors

D&C Contract O&M Contract

D&C Contractor Operator

30 Sydney Light Rail Project deed, Schedule A7.

31 A copy of the Sydney Light Rail Project Deed is available at: https://www.transport.nsw.gov.au/sites/default/files/media/documents/2017/slr-project-

deed-redacted.pdf

32 Sydney Light Rail Public Private Partnership Contract Summary, p18. Available at: https://www.treasury.nsw.gov.au/sites/default/files/2017-02/Sydney_

Light_Rail_PPP.pdf

23 FLEXING PPPs

Extensions TfNSW‘s contractual power to order • a variation that requires ALTRAC The PPP contract also establishes variations allows TfNSW to order: to operate and maintain a framework by which an additional light rail vehicles for augmentation (which is outside the • a variation that requires ALTRAC the Sydney light rail purchased by scope of TfNSW‘s power to order to operate and maintain any TfNSW from a third party (CAF). variations) can be discussed and extension to the Sydney light potentially agreed upon by the However, the variation costs rail designed and constructed parties. The framework is based on that TfNSW must pay for these by TfNSW; the equivalent framework that was variations have not yet been agreed. negotiated on the Sydney Metro • a variation that requires ALTRAC Rather, they must be negotiated Northwest, and fundamentally to operate over, but not maintain, and agreed having regard to various remains a non-binding agreement any extension to the Sydney light principles set out in schedules to the to negotiate. rail designed, constructed and PPP contract.33 maintained by TfNSW; TfNSW cannot force ALTRAC to The PPP contract includes fixed • a variation that extends the Sydney implement an augmentation, prices (subject to escalation light rail by no longer than 20 per without ALTRAC‘s agreement. and adjustment for specified cent of its length and requires events) for the supply of between ALTRAC to design, build, operate If TfNSW forms the view that it four and 16 additional CESLR and maintain the extension; is unlikely the parties will reach vehicles, provided TfNSW orders agreement on an augmentation, • a variation that requires ALTRAC to them before 1 March 2024. TfNSW may terminate the PPP operate and maintain additional The fixed price doesn‘t cover contract for convenience or light rail vehicles for the Sydney operations or maintenance of the purchase the equity in ALTRAC.34 light rail purchased from ALTRAC‘s additional vehicles. LRV supplier (Alston); and

For further information contact:

Owen Hayford Partner, Sydney Infrastructure and Construction +61 (2) 9286 8364 [email protected]

33 Schedule D4 (Net Financial Impact) and Schedule D5 (Pre-Agreed Options)

34 Schedule D9, clause 20

FLEXING PPPs

Our broader infrastructure and construction team

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Alex Regan Richard Edwards Partner, Sydney Partner, Perth Finance and Projects Litigation and Regulatory [email protected] [email protected]

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