Unprepared and Naïve
As the Covid-19 pandemic spreads and economics stagnate and operate in isolation, the impact of significantly reduced economic activity continues to negatively impact the viability of Public-Private Partnerships (PPPs). The Covid-19 pandemic is placing PPP Special Purpose Vehicles (SPVs) under considerable stress and is jeopardizing their economic and commercial viability due to lost revenue streams. This threat even extends to operators who might have felt naïve safe because they would be protected from force majeure risks to a certain degree by government subsidies, availability payments, and guarantees. However, governments are also facing financial challenges due to loss of tax revenue and as their treasury coffers shrink, they are in many instances increasingly unable to meet all their obligations due to the sudden onset and magnitude of the pandemic.
Appropriate Risk Sharing
A pillar of strength of well-structured PPPs is the appropriate sharing of risk. Ideally, risk responsibility is allocated to parties best able to address them when they occur. In instances of common risk, risk allocation and responsibility is unambiguous (e.g. construction risk would typically be allocated to the project team (private sector), while political risk would be allocated to the public sector). Unfortunately, force majeure has always been a grey area in relation to risk allocation and articulating responsible parties for failure by operators to meet obligations. Force majeure risk provisions – appears to have been a naïve cursory afterthought in most contract provisions because PPP stakeholders, it seems, seldom felt that there was a high probability that force majeure events would actually happen.
Vague Descriptions of Force Majeure Events
In many PPP contracts, force majeure provisions have ambiguous and vague descriptions of what constitutes a force majeure event.
For example – in the World Bank’s – Guidance on PPP Contractual Provisions (2017 edition) the following is written –
“Force Majeure Events include but are not limited to the following circumstances, provided that they meet the criteria set forth in Clause (1) above:
(a) plague, epidemic, and natural disaster, such as but not limited to, storm, cyclone, typhoon, hurricane, tornado, blizzard, earthquake, volcanic activity, landslide, tsunami, flood, lightning, and drought;
(b) fire, explosion, or nuclear, biological, or chemical contamination (other than caused by the negligence of the Private Partner, its contractors, or any subcontractor, supplier, or vendor);
(c) war (whether declared or not), armed conflict (including but not limited to hostile attack, blockade, military embargo), hostilities, invasion, the act of a foreign enemy, the act of terrorism, sabotage, or piracy[, in each case occurring outside the Country];
(d) civil war, riot rebellion, and revolution, military or usurped power, insurrection, civil commotion or disorder, mob violence, the act of civil disobedience [, in each case occurring outside the Country];
(e) radioactive contamination or ionizing radiation [, occurring outside the Country]; or
(f) general labor disturbance such as boycotts, strikes and lock-out, go-slow, occupation of factories and premises, excluding similar events which are unique to the PPP Project and specific to the Private Partner or to its sub-contractors [, and occurring outside the Country].
Attempts to create a comprehensive description of possible force majeure events have resulted in vague risk checklists and descriptions of events, instead of laser-focused descriptions. The vagueness is baffling. Looking at the above description, one might be forced to ask – Is Covid-19 a plague, an epidemic, a biological event, or a pandemic? This confusion has led to lawyers scrambling to find loopholes that protect their individual client’s interests, instead of the common interests of all partners in a PPP project.
Don’t Worry – the Lawyers Will Sort It Out
Unfortunately, the default argument in the past has been that we should not be worried about “minor details” as the lawyers would sort out should there be e remote possibility that an event of this nature should occur and that if it did occur it would be settled by mediation. I disagree. If we leave this to lawyers to mediate – between uncooperative partners – national economic recovery efforts will be stalled for years and the landscape will be littered with failed PPPs that could have contributed to economic recovery.
What is needed is a pragmatic approach that might even require project partners and stakeholders to throw the book (or contract) out of the window and seek alternative and innovative solutions that they might not have even considered in the past.
An Innovative Look
Whether we like it or not, the magnitude of the current impact of the Covid-19 pandemic will force the public and private sectors to take a hard and innovative look at contract provisions vis-a-vis force majeure clauses due to the magnitude of the current circumstances that were never expected. Not only is the magnitude overwhelming, but the frequency of occurrence is also unparalleled. There is a real danger that PPP partnerships will fragment like bad divorces, where one party walks away with all the spoils and another is left devastated.
This short-sightedness will only result in all parties losing out. Now is the time to be innovative, pragmatic, and practical with mediation leading to solutions that benefit both parties in the long term. Short-term recriminations and unhelpful allocations of responsibility and blame will only prove to be counterproductive. Punitive actions by the government sector will not be helpful either.
I have been rather astounded by the lack of concrete and unambiguous guidance on force majeure provisions in most international and national institutions’ guidelines and policy documents. It is a sad fact that force majeure risk allocation and mitigation guidance is weak at best. I have, over the last few days, managed to find some limited guidance that I will share below, but the available guidance needs improvement.
The APMG PPP certification book of knowledge states the following about force majeure in section 9.3.
“Force majeure events are a limited set of events that may arise during the term of the PPP contract through no fault of either party. These are best managed by a private partner. They are more severe than relief events, will typically last longer, and may result in termination of the PPP contract. They are, by definition, unusual and rare events, and the contract management team should deal with these as exceptions. The focus should be on avoiding termination by the private partner mitigating the effects and, if required, obtaining support from the lenders to defer payment until such time as the project is stable again.”
There are important takeaways from this statement that should be highlighted. They are;
- Limited, unusual, and rare events
- They last longer and could result in the termination of the project
- Force majeure clauses should focus on avoiding termination by the private sector mitigating the effects with support from lenders
Comments: Due to the magnitude, the sudden onset of the impacts of the Covid-19, and expected duration, I believe that the private sector might be unable to mitigate the impacts with support from lenders and that governments will need to step up to ensure that projects are not unnecessarily terminated. A terminated project will be more difficult to restart than resuscitating a stalled project.
Inter-American Development Bank
In the IDB book “Bringing PPPs into the Sunlight – Synergies now and Pitfalls Later” the Chilean policy on force majeure is stated in the following way –
“…the works will be carried out at the concessionaire’s entire risk, and the concessionaire will provide any necessary disbursements stemming from an unexpected event, force majeure, or any other cause. The Treasury will not be responsible for the consequences derived from the contracts entered into by the concessionaire with contractors or suppliers. However, the Treasury shall pay for damages caused by unexpected events or force majeure if this is established at the procurement stage.” (Chile, n.d.) –
In the Chilean example, the following is highlighted:
- Works will be carried out at the concessionaire’s entire risk
- The concessionaire will provide any necessary disbursement
- The treasury will pay damages caused by a force majeure event if stated in the procurement and contract award documents
Comments: In this example, it is assumed that the concessionaire will be on its own unless something was specifically stated in the procurement and award documents regarding a pandemic-type event. In hindsight, of the current pandemic crises and the potential impacts of the pandemic on multiple PPP projects within a country, it is more likely that there will be a widespread national collapse of PPP projects if a government does not explore ways to collaboratively find solutions for project debt collaboratively with its overstretched private sector partners, even if this was not stated in the original contract terms.
The Caribbean PPP Toolkit
In the Caribbean Public-Private Partnership Toolkit, the following is stated –
“Accordingly, the financial consequences resulting from the occurrence of a Force Majeure event should be shared. In the allocation of Force Majeure risk, the parties will need to look at the availability and cost of insurance, the likelihood of the occurrence of Force Majeure events, and any mitigation measures which can be undertaken. For example, although the government may be best placed to bear the consequences of some common natural disasters, the concessionaire should be able to obtain insurance for most of this risk. If the government is best able to manage Force Majeure risk, for example, because it is involved with disaster risk management activities, or if the government is the only party able to bear such risk, given its size and the difficulty of obtaining adequate insurance, then allocation to the government may be justified. “
On page 246 of the toolkit the following statement is made – When budgeting for contingent liabilities, – “Nothing—may be appropriate for very low-probability risks (such as force majeure).” In retrospect, this seems to be rather shortsighted.
On page 347 the following is stated – The procedure to be followed to establish the level of relief is similar to Force Majeure procedures. Moreover, both parties would typically have the right to terminate the PPP Contract in the event of a MAGA (Material Adverse Government Action) lasting longer than a defined period of time (generally between 6 to 12 months).
The following is noteworthy:
- Consequences should be shared
- There seems to be an assumption that budgeting for contingent liabilities is not that important because of the low probability of force majeure events
- MAGA events will give both the public and private sectors the right to terminate projects
Comments: Although risks should be shared, the question arises whether the potential termination of so many projects simultaneously and the collective impact that it will have on economies’ economic recovery is even an option if contingent liabilities were not equitably negotiated.
I see a glaring omission in generic force majeure contractual provisions. It seems that contracts provisions have been rather vague concerning descriptions of what a force majeure event is, and naivety concerning the magnitude and duration of events, and allocation of responsibility exists. It seems that in most instances the assumption of responsibility is heavily predisposed to the private sector as public sector PPP project initiators really did not contemplate a global plague scenario and assumed that the private sector would have the resources to ride out force majeure event. This is most certainly not the current case and more concrete language will be needed in the future to articulate these risks better.
The glaring current realities are going to require parties entering into project rescue agreements to embrace collaborative responsibility; adopt a strategic attitude that projects cannot fail, and accept that both parties will need “marriage counseling” to rescue their projects through innovative mediation that results in win-win outcomes for all parties. It is my belief that the only PPP projects that should be allowed to fail, are those that were ill-conceived from the beginning and did not offer value for money from the onset of their planning.
The question remains – “Do we allow widespread project failures through shortsighted decisions, or do we collaboratively and innovatively seek solutions?” In the long run, I believe the Covid-19 pandemic is going to require a comprehensive revision of how force majeure contract provisions have been approached in the past, as it is likely that events of this nature and magnitude will reoccur in the foreseeable future. Hopefully, PPP project sustainability and resilience measures will lead the debate on the drafting of new force majeure policy and contract provisions.
Interesting Force Majeure References:
In the IDB book “Bringing PPPs into the Sunlight – Synergies now and Pitfalls Later”
Caribbean Public-Private Partnership Toolkit
World Bank’s – Guidance on PPP Contractual Provisions (2017 edition)