BackOpinion | Force major changes to 'force majeure' clause in infrastructure PPPs
Central and state authorities interpret force majeure events in terms of definition and impact inconsistentlyStandardising provisions in PPP contracts will help attract equity investors and lenders
PremiumThe novel coronavirus pandemic and the 40-day lockdown presents a great opportunity to induce clarity into the force majeure clause in public private partnerships (PPPs) in infrastructure.
Today, a raft of questions need clear-cut answers: What does force majeure include? What is the compensation to be paid if it is invoked? What are the lacunae in contracts that need correction so that stakeholder interest is balanced?
Before answering, let’s first understand how private developers in typical PPP infrastructure projects are affected currently.
In general, the disruption in construction work and operations of ready infrastructure projects along with mass exodus of migrant labour will prolong the rebound to steady state by a few more months, with the lockdown extended to May 3, 2020.
Illustratively, an operational build-operate-transfer (BOT) road project will now be facing:
1. Material loss of traffic volume, and then low traffic after the lockdown, hurting cash flows
2. Hit to maintenance activities, which will attract penalties for projects not adhering to performance-based output parameters specified in the concession agreements
3. Negative impact on project cash flows, even if moratorium on principal and interest servicing during the lockdown is opted for by the developer, as the interest accrues, thereby impacting project economics even if the concession period is extended
4. Increased financial stress if a developer has issued bonds, as the Reserve Bank of India’s measures do not allow moratorium for outstanding bond exposures
5. Change in volume and composition of traffic after lockdown, depending on extent of impact on the economy on specific road stretches, impacting project economics
In addition, BOT (annuity) toll road projects may face delays in receipts as routine/periodic maintenance activities are affected by shortage of manpower for carrying out the upkeep of these assets.
And under-construction projects will experience time and cost overruns, which will need additional debt and equity funding.
For other infrastructure sectors (such as airports), continued lockdown or delay in normalcy will impact balance sheets sans regulatory support.
What does force majeure include?
In concession agreements, force majeure is about unforeseen circumstances beyond reasonable control of the parties involved.
Compensation in the case of Covid-19 pandemic could be determined by the duration and after-effects of the lockdown such as: supply chain issues, restrictions on movement of freight and people, depressed investor sentiment, and gradual return of labour to work in construction projects.
Private developers can also claim relief under ‘change-in-law’ provision of the concession agreement, in the event that a governmental order or change in applicable law makes the contract performance unfeasible or impossible. Covid-19 has resulted in numerous governmental laws, orders, etc., which may impact contract performance, thus necessitating additional relief under such clause.
But the track record on settling this is far from satisfactory. Two steps are essential to change the paradigm:
1. Standardise force majeure clauses in PPP contracts
Central and state authorities interpret force majeure events in terms of definition and impact inconsistently. Therefore, standardising provisions in PPP contracts will help attract equity investors and lenders. Moreover, they need to clearly define processes that the balance interests and rights of all stakeholders.
Such clauses must do four things:
1. Spell out the circumstances under which private parties are granted relief
2. Define the process to be followed for timely invocation of the clause by parties by notifying the counterparty of the event’s occurrence and explaining its direct impact on contract performance
3. Define cost components such as debt servicing and operations and maintenance expenditure that private developers incur during this period that the authority will compensate and,
4. Set a predefined time limit of say, 6-12 months on a prolonged force majeure situation, after which the parties may mutually terminate the contract.
Issues relating to the post-force majeure period also needs to be factored into the clause, as the effects may continue long after the event is over.
Appoint a commission to assess lockdown impact
To be sure, the pandemic will have a prolonged impact. For example, in toll roads, traffic will remain thin much beyond the lockdown, especially on trunk routes. This will not only impact traffic at key originating points but will also feeder traffic into other regions, thus prolonging the ramp-up period to reach pre-lockdown levels of toll revenue.
Robust mathematical tools could be deployed to assess the indirect macroeconomic effects of the pandemic, which has both supply and demand-side repercussions. This should ideally be done by sector specific regulators, or in their absence, by a commission appointed to develop an effective response.
This will help define the duration of economic damage and financial support needed.
Force majeure provisions and responses are central to driving equitable risk-sharing between the public contracting authority and the private developer.
While it is reasonable for the public authority to be concerned with continuity in the provision of public service rather than terminating the PPP arrangement, spelling out provisions in the contract to set the boundaries of negotiation when such events occur is equally important.
The author is Senior Director, CRISIL Infrastructure Advisory. The views expressed in this column are his own
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