2.  Operation provisions

Operation provisions are provisions that apply to the period wherein actual operations of the PPP project are underway. There are four contract provisions that should be closely examined: (1) insurance, (2) force majeure, (3) buy-out, and (4) events of default.

Insurance is defined as safeguards against loss of earning capacity of the project, considering that the lender is expected to be repaid from the revenues of the project. Major insurance required for a PPP project during construction include the constructor's all risk, third party liability, marine risk and business interruption risk. Major insurance during operations include operator's all risk, third party liability machinery breakdown and business interruption risk. Finally, in checking the insurance provisions of the PPP contract, LGUs should focus on four issues: (1) perils to be insured against must be specified; (2) the amount of coverage must be specified; (3) criteria for acceptable insurers must be defined; and (4) the proceeds must be used for the repair of the facility unless otherwise agreed to by the LGU.

The key issues in checking force majeure provisions in PPP contracts revolve around two issues: (1) identifying the exact conditions under which force majeure may be declared and (2) identifying the results of force majeure and their implications on parties' obligations. The first issue specifies risk allocation and is covered by previous discussions. The second issue refers to at least four events that occur as a result of force majeure:

●  There is a "cure period" during which time all parties attempt to resolve the force majeure problem;

●  There is a suspension of the performance of obligations, on both sides;

●  There is an extension of the completion date or the contract period;

●  The buy-out provision applies if force majeure extends beyond the "cure period".

Buy-out conditions are situations wherein the government buys the project from the private proponent, as on option or as a consequence of default. The payments will depend on the reason for the buy-out which should be provided for adequately in the contract. The LGU may for example exercise the buy-out option in the event of a natural calamity.

In the event of LGU default, the buy-out events should, at the very least, cover unrecovered capital costs incurred by the private partner. This amount is equal to or greater than the remaining debt plus interest outstanding plus book equity. A more complicated issue is quantifying the lost opportunity, i.e., the lost profits from the remaining years of operation. This situation may be avoided by agreeing on a fixed amount to represent lost profits in the event of a buy-out (such as 10%). A more sophisticated and controversial approach is to calculate the expected returns until the end of the contract period, and pay all or a fraction of this amount. In such a case, the schedule of payments may have to be agreed upon ahead of time.

Events of default define when a buy-out may be exercised. In case of failure or refusal to remedy the default the non-defaulting party may terminate or take over the project, or assign the contract to a third party. Events of default may be classified into three types: (1) actual breaches of contract; (2) anticipatory events which suggest an impending default such as a petition for insolvency or bankruptcy or any breaches in other major contracts; and (3) any changes in the assumptions of the agreement such as destruction of the project or changes in any of the major parties. Sample events of default are listed in Table 2-10.

Table 2-10: Sample Events of Default

Source: PPP Center PSP Manual, 2001

Default remedies commence upon occurrence of default. Examples of default remedies are: (1) assignment of the project to a third party; (2) termination of the project and take-over; and (3) set-off or compensation and cancellation of any other commitments. Other options are payment of liquidated damages and forfeiture of the performance bond.