Dozens of potential issues could materialize over the course of a long-term lease-from a precipitous decline in revenues after a natural disaster to an expensive lawsuit following a multi-car collision-posing risks to both the government and the private operator. (See Exhibit 4 on page 20.) The risks borne by the government will depend, in large part, on decisions made when the deal was formulated. States often see the transfer of risk to a private operator as an appealing element of long-term infrastructure leases. Risk and reward go hand in hand, however. The more risk the state is willing to assume, the larger the payoff the state will derive from the lease, because the private operator is left less vulnerable to potential costly events. In general, the party bearing the risks should also have greater control over what can be done to mitigate them. This factor, too, should be taken into account when structuring a deal.54 Contracts should generally identify and describe the different circumstances that might arise- and who bears responsibility for dealing with them. For example, both the Indiana Toll Road and the Chicago Skyway deals provide protections to the concessionaire if a future legislature takes some action that adversely affects them, such as providing replacement compensation if the action causes the value of the concession to the private operator to drop.55
Exhibit 4 | |||
RISKTYPE | DESCRIPTION | ALLOCATION | MITIGATION |
Policy / Political Constraints / Support | • Uncertainties regarding public policy and change in law • Regulatory uncertainties • Funding support | Public and private | • Persuasive and supported arguments for project • Early regulatory agency involvement • Public relations and citizen/policy maker education campaign • Community engagement and buy-in strategy |
Market Revenues | • Traffic and revenue below projections • Competing/alternative projects • Excessive capital maintenance • Insufficient revenues to fund ongoing operations and maintenance (O&M) | Public and private | • Investment grade traffic and revenue studies accepted by rating agencies • Adequate debt coverage ratios • Adequate reserves • Credit enhancement, insurance • Toll adjustment flexibility • Careful budgeting processes and O&M controls • Non-compete protections |
Operations & Maintenance Costs | • Excessive costs of operations • Excessive capital maintenance expenditures • Unpredictability of costs | Public and private | • Non-recourse financing • Minimum guarantees • Toll adjustment flexibility • Credit enhancement, insurance • Careful budgeting processes • Capital asset replacement assurances • Warranties, incentives and penalties • Financially viable private partners • Use of private O&M contract • Use of fixed price/guaranteed maximum pricing, with escalations and adjustments over time |
Liability | • Construction defects • Day-to-day operational • Subcontractor claims • Environmental | Public and private | • Warranties • Insurance • Well-thought out allocation of liability in contract based upon party best able to control and mitigate • Innovative insurance products |
SOURCE: Federal Highway Administration, December 2007 | |||
For private operators striving to generate profits on leased, tolled roadways, competition in the form of newly built, free roads nearby is not always welcome. States willing to commit to non-compete clauses in which they agree not to construct competing transportation corridors-roads or transit-can sometimes draw higher bids from private operators. The two deals often cited as the precursors to the Pennsylvania proposal, Chicago and Indiana, differ in this area. Chicago did not agree to a non-compete clause and is in fact expanding highways near the Skyway. But if Indiana builds a highway 20 miles or longer within 10 miles of the Toll Road, the state must compensate the private operator for lost revenue. Indiana opted for a shorter lease than Chicago; the state's acceptance of a non-compete clause may have helped keep its upfront concession payment high. (For more on Chicago and Indiana, see the sidebars on pages 6 and 7.)
The tensions between public and private interests can be seen in each party's desired level of flexibility. Understandably, the private operator often wants to minimize unknowns through the life of the lease by leaving as little opportunity for renegotiation as possible, while the government may prefer to include triggers-passing certain milestones in the contract, for example-that allow the parties to change the terms of the deal. To clarify both the true value of the agreement and the relationship the government and private operator will enjoy, these flexibilities and the process by which they will be resolved should be agreed upon prior to signing the lease.