Termination for PPP Company default is the final stage of a process which starts when a project is failing to perform in accordance with the requirements of the PPP contract. The PPP contract should set out the various circumstances which could trigger such termination. These will typically include failure to complete construction, persistent failure to meet performance standards and insolvency of the PPP Company. It should be noted that the PPP contract will also set out those circumstances in which failure to perform can not be used to trigger termination (the so-called "relief events").
Where the default by the PPP Company is caused by failure of one of its subcontractors (e.g. insolvency, poor performance, corruption), the PPP Company should have the contractual ability (in its subcontracts) to replace the non-performing subcontractor and seek termination damages from it. These damages should be backed (at least in part) by performance bonds or guarantees and set at a level which would allow the PPP Company to meet any additional costs associated with the replacement of the subcontractor.
Insolvency of the PPP Company is an important cause of default. This can occur where the PPP Company is no longer able to service its debt in line with the agreed schedule. In this case, lenders could choose to "accelerate" their debt (i.e. make the entire debt due and immediately payable). This would force the PPP Company into insolvency.
In the event of PPP Company default, the lenders should be allowed to step in to rescue the PPP project and protect their loan. The Authority should permit (and rely on) the lenders to take control of the PPP project in such circumstances. The lenders' right to step in is typically provided for in a direct agreement entered into between the Authority, the PPP Company and the lenders.
The PPP contract will be terminated only if lenders choose not to step in, fail in the step-in or choose to step out of the non-performing project. In these cases, it is reasonable to assume that the PPP Company's equity will be lost and no compensation will therefore be payable. Compensation would, however, normally be owed to the PPP Company's lenders (either directly or through the PPP Company). This is justified by the fact that the PPP project assets (or the rights over them) are transferred back to the Authority upon termination. This compensation is provided for either in the PPP contract, the applicable legal code or other agreements (e.g. where the public sector has agreed to guarantee the project's debt).
Termination payments for PPP Company defaults are a key issue in PPP contracts as they are fundamental to their bank-ability. Several methods can be used to determine the compensation payment that the Authority is obliged to make to the PPP Company / its lenders, including:
• repayment of all or a pre-specified part of the outstanding debt (to the extent that it has been properly used for financing the project assets);
• the depreciated book value of project assets (there are several variants of this general approach);
• the net present value of the expected future net cash out-flow that would have been payable by the Authority if termination had not occurred (i.e. the expected service fee less the costs that the Authority will have to incur as a result of the termination); and
• an open-market sale (i.e. the Authority re-tenders the PPP contract, selects a new PPP Company to continue with the contract and then pays the original PPP Company/its lenders the proceeds it receives from the sale).
Each of these methods has pros and cons. For example, it is often argued that the lenders should not be guaranteed full debt recovery upon termination as this would remove their incentives to conduct thorough due diligence and careful project monitoring. Also, the open-market sale method will not work well if there is no liquid market for PPP contracts. Finally, the net present value approach may be conceptually appealing, but forecasting future revenues and costs can be difficult and lead to disputes. This explains why the parties often adopt solutions that rely on simplicity and certainty of the outcome.
As a general principle, it is important to ensure that the public sector should not be financially incentivised to seek early termination. Equally, lenders should not expect to avoid financial losses at the undue expense of the public sector. The UK is a good example of arrangements that achieve a balanced outcome:
• Where there is a liquid market for similar PPP contracts, upon termination due to PPP Company default the Authority can opt to "sell" the remaining period of the PPP contract. The sum paid by the best bidder for such "sale" will be used to pay the compensation to the lenders of the original PPP Company. This is known as the "market-value compensation".
• Where there is no liquid market for similar PPP contracts, the compensation owed to the lenders will typically be deter-mined through the net present value of the future cash flow of the PPP contract over its remaining life (to which "rectification costs" are deducted) This is the so-called "fair-value compensation".