Circumstances change over the life of a long-term contract. For example, if demand grows faster than expected, the PPP facility may need to be enlarged before the current concession ends; or if the original user-fee schedule proves inadequate, it may need to be changed. In those cases, one would like to grant the PWA flexibility to change the contract and, perhaps, even terminate it unilaterally. But, of course, this would also facilitate regulatory takings. Not surprisingly, many contract clauses restrict discretion to protect the private concessionaires.
The tension between protection against regulatory takings and the costs of inflexibility can be illustrated with the two main U.S. PPP concessions during the 1990s. In 1995, the California Department of Transportation (Caltrans) contracted a four-lane ten-mile segment of SR91 between the Orange County- Riverside County line and the Costa Mesa Freeway (SR55) to a private firm, California Private Transportation Corporation (CPTC) for thirty-five years. Motorists use the express lanes to avoid congestion in the nontolled lanes, paying up to almost $11 for a round trip. The firm that was awarded the concession was allowed to raise tolls freely to relieve congestion, which it did several times. By the late 1990s, 33,000 daily trips brought the express lanes to the brink of congestion at peak time, turning the concession into a financial success. At the same time and for the same reasons, users in the nontolled public lanes were suffering extreme congestion, and an expansion became urgent. Nevertheless, the contract included a noncompete clause, which prevented Caltrans from raising capacity of SR91 without CPTC's consent during the thirty-five years of the concession. Caltrans tried to go around the clause, arguing that expansions were necessary to prevent accidents, but CPTC fled a lawsuit to prevent that move. The settlement stated that noncompete clauses were meant to ensure the financial viability of CPTC and restrict Caltrans's right to adversely affect the project's traffic or revenues. Consequently, auctions no new lanes could be built.
Protracted negotiations ensued and eventually the Orange County Transportation Authority (OCTA) was empowered to negotiate the purchase of the tolled lanes. Unfortunately, the value of the toll road was controversial because, strictly speaking, it should have been the present value of profits from the SR91 express lanes if the franchise had continued as originally planned. Even though the lanes cost $130 million to build, the company initially set a price of $274 million in a controversial (and ultimately unsuccessful) attempt at a buyout by a nonprofit associated with Orange County. After several years of negotiations, while frustrated commuters on the SR91 were stuck in traffic, OCTA bought the express lanes in January 2003 for $207.5 million. The purchase was enabled by the California legislature, which gave OCTA authority to collect tolls and pay related financing costs, and eliminated noncompete provisions in the franchise agreement for needed improvements on SR91.
In this case, the noncompete clause proved inefficient, and one might believe that Caltrans made a mistake by including it in the original contract. But consider the fourteen-mile Dulles The SR91 freeway example shows that inflexibility may be costly, while the Dulles Greenway example suggests that inflexibility may be justified. Both examples highlight the importance of designing contracts that facilitate good faith renegotiations while deterring bad faith renegotiations, a topic we return to below.
The tension between protection against regulatory takings and the costs of inflexibility can be illustrated with the two main U.S. public-private partnership concessions during the 1990s.
Greenway that was designed as a greenfield build-operate-transfer facility that would become the property of the state of Virginia after forty-two and a half years.
Virginia's general assembly authorized private development of toll roads in 1988. A group of investors thought that a toll road linking Washington's Dulles International Airport and Leesburg, Virginia, would be a promising investment. Their expectations were based on the prospect of residential and commercial growth in the area, which was expected to increase congestion on existing arterial roads serving the corridor. To finance the Greenway, investors put up $40 million in cash and secured $310 million in privately placed taxable debt. Loans were to be repaid with toll revenues. Investors underestimated how much users disliked paying tolls, and initial revenues were much lower than forecasted. Furthermore, investors did not count on the Commonwealth of Virginia widening the congested Route 7, which serves the same users. Two independent consulting companies had predicted that when the road opened in 1996, with an average toll of $1.75, there would be a daily flow of 35,000 vehicles. In practice, however, the average number of vehicles per day turned out to be only 8,500, one-fourth of the initial estimates. After tolls were lowered to $1.00, daily ridership increased to 23,000, still far below predictions. Bonds that were issued to finance the project were renegotiated and some of the initial investors wrote of their equity. After refinancing and an extension of the franchise term to sixty years, the project became financially viable