Negotiating and Implementing Relief Event Programs in P3 Projects

Ted Gibbs of The Walsh Group, Ltd. co-authored this article.

The primary vehicle for allocating design and construction risk in a public private partnership (P3) using the design-build-finance-operate (DBFOM) P3 model is the Relief or Supervening Event regime in the public private agreement.¹ A Supervening Event entitles the private partner to some financial or schedule relief from the public authority under the public private agreement (PPA).

The PPA will be consummated in a competitive request for proposal process including input from the public partner, private partner, and impacted participants including developers/equity providers, lenders, design-builders, and operation and maintenance service providers. This article focuses on the Supervening Events that can have an impact on these participants during the construction phase of the PPA. The Supervening Event issues addressed in this article include

• Voluntary changes or breaches by the public sector
• Right of way/land access
• Permits, environmental conditions, endangered species, archeological conditions and hazardous materials
• Weather
• Changes in law
• Labor shortages or strikes
• Other force majeure events
• Differing site conditions
• Utility delays

Before we get into the case law and sample contract terms for these issues, it is worth pausing to reflect on how the financial markets view these risks in terms of rating the financial risks associated with a P3 transaction. Moody’s has published a wide variety of risk and rating data based on P3 transactions and financing risks. Here is Moody’s risk factor summary from a P3 rating article published in 2016:

Supervening Events are largely meant to deal with Factors 1 and 2. The other factors are dealt with in the procurement and security package terms.

As it relates to Supervening Event risks, here is a modified version of Moody’s analogous risk allocation table:

Understanding these, and other, rating methodologies is critical to implement an effective P3 procurement and contract negotiation. It is therefore critical to engage an experienced team of financial, legal, and technical advisors to establish and structure the P3 procurement. With this background, we turn to the legal and contractual issues implicated in a U.S. P3 DBFOM model for dealing with the primary Supervening Event risks.

Basic contract sample language defining the sub-categories of Supervening Events is offered effectively by the Federal Highway Administration’s contracting guides. Here is FHWA’s sample term dealing with Compensation Events:

And here is FHWA’s sample contract provision dealing with Delay Events:

Right of Way/Land Access

As noted in applicable construction law reference documents, "where plans, specifications and conditions of contract do not otherwise provide, there is an implied covenant that the owner of the project is required to furnish whatever easements, permits or other documentation are reasonably required for the construction to proceed in an orderly manner."⁴ An owner interested in changing this “implied covenant” and shifting access risk to a private partner would: a) need to include language in the contract specifying the transfer; and b) understand that the risk profile would be much higher. Indeed, Moody’s advises that “[t]he most supportive risk allocations from a credit point of view are those where . . . the sponsoring government keeps the risks that cannot be easily controlled/priced by the private sector (such as land acquisition) and provides both for schedule relief and timely compensation for those risks.”⁵

Permitting and Environmental Risks

The Moody’s matrix notes that some permitting is best handled by the government (long lead time permits) and some by the private partner (construction permits). Leading construction lawyer Patrick O’Connor identifies the following environmental risks: asbestos, underground storage tanks, lead paint, contaminated soils, wetlands, coastal zone areas, brownfields, endangered species, storm water runoff, construction waste, PCBs, other hazardous materials, and indoor pollution.⁶

The critical point for Supervening Event management is that applicable permits and environmental regulations or conditions must be identified as early as possible and allocated to the party best positioned to manage the process of securing them. The tool for allocating responsibility between the public and private partners is typically the Supervening Event clause and related permit exhibits. And in simple terms, if the government fails to obtain permits on its list, then the private partner would be entitled to relief.

Adverse Weather

Adverse weather conditions are one of the most common causes of construction delays and disputes. Weather conditions, while incapable of being predicted with absolute certainty, are predictable to a degree. Therefore, as a general rule, the risk of weather delays lies on the private sector partner. “In the words of one court: ‘[i]t is well-established … that supervening circumstances making the performance of a promise more difficult and expensive than originally anticipated is not enough to excuse the promisor.’”⁷

Changes in Law

Statutory or regulatory changes are another key concern for implementing long term P3’s and similar deals. Here is an instructive Illinois case law example:

In Robbins Resource Recovery Partners, L.P. v. Edgar, Foster Wheeler developed and operated a municipal recycling-and-solid waste-to-energy facility. The economic justification for the project was grounded in an Illinois law that required utility companies to enter into 20-year contracts to purchase electricity from qualified solid-waste-to-energy facilities at retail rates instead of at a federally set regulatory rate. As Foster Wheeler's project was nearing completion, the Illinois legislature amended its retail rate statute to cover only facilities that convert methane gas into electricity. While Foster Wheeler's facility met the requirements of the original law, the facility did not qualify for preferential rate treatment under the revised law. As a consequence, the economics of the facility were turned upside down and, eventually, Foster Wheeler abandoned the project after losing substantial sums of money.⁸

Labor Shortages or Strikes

It goes without saying that the private sector partner/developers will be responsible for providing the work and labor necessary to complete the construction improvements required in the public private agreement. Moody’s suggests that industry-wide labor strikes should give rise to relief event⁹; however, a general labor shortage is not generally considered basis for relief in favor of the private sector.¹⁰ Case law dealing with specific labor unrest on a project itself offers a number of lessons:

[a]s a general rule, delays and extra expense caused by strikes or labor unrest, including refusal of workers to cross picket lines, are excusable but not compensable. In other words, the contractor is able to avoid paying the owner for its delay damages but is not entitled to recover its own costs associated with the delay. This also holds true for extra costs incurred by the contractor to work around or through a strike. If labor unrest or a strike is reasonably foreseeable such that the contractor should have taken it into account when preparing its bid and entering into the contract, the delays associated with the labor problems may become the contractor's responsibility. Similarly, if the strike is caused by the contractor engaging in an unfair labor practice, the delay associated with the strike will not be excusable. Unfair labor practices committed by subcontractors may, however, be beyond the control of the general contractor and, therefore, may be excusable. The occurrence of a labor strike, even if unforeseen, will not give rise to a right of recovery under the government's differing site conditions clause. A long line of precedent has imposed a temporal limitation on the applicability of the Differing Site Conditions clause and the Changed Conditions clause.¹¹

Other Force Majeure Events

Force majeure is a French doctrine that is embodied in American case law in the equitable defense of impossibility. The concept is that courts will excuse performance if an unforeseen condition, outside the control of the parties, renders performance impossible. As a general rule, the doctrine will not apply where the parties allocate risks in the written contract.¹² Therefore, it is recommended the contract contain a robust force majeure clause to deal with as many contingencies as possible. Legal advisors to the developer should strongly consider circumstances that will give rise to right to terminate the public private agreement.

Here is the sample force majeure clause offered by FHWA:

Differing Site Conditions

Underground soil conditions are a major risk factor on any project requiring substantial earthwork or deep foundations. Techniques available for evaluating soil conditions have improved drastically in the last fifty to seventy-five years, and the public authority should be able to identify underground soil conditions. A conceptual challenge can arise in a P3 setting where the government wishes to transfer all or most risk but does not or cannot allow for the time, money, and expertise necessary to conduct a meaningful site investigation before awarding the contract. This is reflected in the Moody’s matrix, which places geotechnical conditions with the private sector, utilities with both parties, and archeological conditions with the public sector. As a practical matter in a vacuum, the site due diligence and investigation is better suited for the government to handle as a preliminary matter before even undertaking any procurement, whether P3 or otherwise. The data and baseline geotechnical reports can then be given to the prospective private partners during the procurement to enable the most effective pricing competition and risk.¹³

Utility Delays

Utilities are one type of underground condition that warrants special attention. There are a number of starting assumptions or issues. First, the government should possess or have access to information about existing utilities within the project site, raising the question whether the government will make that information available in the procurement and in such a way so as to allow reliance on the information by the private sector partners. Second, many states regulate or create special remedies against contractors that damage preexisting utilities. Both issues should be examined and dealt with in the Supervening Event clause.¹⁴