Since contracts are incomplete and disputes may arise on interpretation or technical issues, the contracting parties could agree to specify clauses on dispute resolution mechanisms to handle these disputes. A dispute resolution procedure properly described in the contract (e.g. arbitration) is likely to be faster and less costly than going to a court to settle a controversy. Besides, a contract design allowing for dispute resolution procedures helps in mitigating the regulatory risk faced by the private-sector party, and thus reduces both the cost of capital and the cost-covering service charge level (Guasch, 2004).
As service disruptions can be very costly to the public-sector party, the speed of the dispute resolution mechanism plays a critical role. A sluggish mechanism could indeed be a disadvantage for the public-sector party if the dispute risks compromising the continuation of the service provision. Further, the private-sector party would benefit as well from a fast dispute resolution process since PPP contracts generally involve a large financial commitment and protracted disputes might create excessive financial distress.
Alternative dispute resolutions have also the advantage that the arbitrator (or conciliator, etc.) may be selected among experts in the field, which is helpful since PPP contracts often require sector-specific knowledge. However, it is desirable to avoid that the parties appoint the arbitrator themselves, since, as discussed by Iossa (2007), dispute resolution mechanisms where the decision maker is appointed by the parties in dispute may exhibit a decision bias in favour of the repeated player. Further, as emphasized by Medda (2007), strategic behaviour by the contracting parties can undermine the efficacy of dispute resolution mechanisms such as final offer arbitration, and inefficiently affect the risk allocation among PPP partners.
Whilst discussing the pros and cons of different dispute resolution mechanisms is beyond the scope of this paper, it is important to point out that the design of the dispute resolution mechanism is a key issue for the success of the contractual relationship, especially given the need to avoid costly service disruptions and the long-term nature of most PPP contracts. There have been instances (e.g. the PPP Arbiter for the London Underground PPP ) where it has been viewed as advisable to set up a permanent office, independent of the contracting parties, that has the authority to deal with all the contractual disputes between the parties in the contract.
The contracting parties should include clauses in the contract specifying a dispute resolution mechanism to handle disputes that may arise during the contract life. An alternative dispute resolution procedure, such as arbitration, is preferable to courts.
A simple dispute resolution procedure may involve three stages, with the contracting parties moving from one stage to the next if the former fails. The first stage is an internal consultation in 'good faith' between the parties trying to reach a mutually convenient agreement on a certain case. The second stage is an external consultation where the case is put before an appointed expert, or a conciliator, whose decision may or may not be binding. If either party disagrees with the expert's determination, the last stage envisages a PPP arbitration for a final and binding decision on the case. The contractual clause should clearly specify the procedure that will be followed for the appointment of the expert and of the arbitrator.
Despite the benefits of the three-stage procedure in terms of smoothing the conflict resolution process, the procedure may require too much time for certain pressing issues and give rise to transaction costs. To cope with pressing issues that require immediate decisions and may lead to an increase in costs, an extraordinary, fast-track procedure accelerating the three stages should be established in the contract.
In implementing external consultation and PPP arbitration, a number of issues should be addressed. Regarding the costs of undertaking such procedures, the contract should envisage a mechanism for appointing and compensating experts and PPP arbitrators. To encourage both parties to control transaction costs, it might be convenient that each party bear its own legal costs.
The contract should also envisage a mechanism for compensating experts and PPP arbitrators. Experts and PPP arbitrators should be appointed from panels or among distinguished professionals, thus avoiding affiliations that may lead to a conflict of interests, e.g. persons linked to the public-sector party, the private partner, competitors, or suppliers. In this regard, it is important to ensure transparency in the selection of experts and PPP arbitrators.
For the dispute resolution mechanism to attain its purpose effectively, the contract should facilitate any action and decision-making by the experts and PPP arbitrators. For instance, they should be entitled to access any document relevant for the case, to call the parties for hearings, to require written submissions from the parties, etc. Whether the information conveyed by the parties to them must be kept confidential or not is an issue that should be discussed on the basis of the specific circumstances of the dispute, but where possible confidentiality should be avoided. As discussed in the companion paper, transparency is key for reducing the likelihood of performance failure.
It is recommended to specify strict deadlines for the PPP experts and arbitrators' decisions and to require a written justification for any decision they make. Enforceability of decisions made by experts and PPP arbitrators is an essential requirement for the dispute resolution mechanism to work and be legitimate. In particular, the parties must be obliged to acknowledge and observe the decisions made by PPP arbitrators regarding compensations to be paid by one party to the other.
While the dispute resolution mechanism is underway, it may happen that the private-sector party attempts to avoid penalties resulting from construction delay or poor performance in service provision by arguing that these events are consequence of the yet unsettled dispute. However, the contract should not allow for lower payment deductions when a dispute has arisen.
In any case, if the private-sector party undertakes works to meet its contractual obligations while the dispute resolution mechanism is underway, but the final resolution makes these works redundant, then the private-sector party should be entitled to a compensation to be determined by the expert or PPP arbitrator.
More generally, the contract should specify which party is liable for any extra cost resulting from the final decision made in the dispute resolution procedure, e.g. economic costs of delaying service commencement, costs for rebuilding parts of the facilities, etc.
| Case Study: London Underground (UK) (Part VI) In order to handle disputes that may arise during the contract life, the PPP contracts included provisions to appoint a PPP Arbiter. The Arbiter can be called for to determine key financial terms of the PPP agreements at the periodic contract reviews every seven-and-a-half years. The Arbiter can also be appointed in the case that a specified circumstance makes it necessary for the parties to carry on an extraordinary contract review, e.g. a major cost overrun when upgrading a line. The difference between the Arbiter and an arbitrator is that the former has a continuum role and the ability to give guidance as well as directions under the contract terms, whereas an arbitrator is called for only in specific circumstances when the parties have reached a certain stage in the dispute resolution procedure. In the London Tube PPP case, the Arbiter did not escape from criticism. As there was no dispute to arbitrate during the first 20 months of the contracts, but the Arbiter Office enjoyed an annual budget of £1.6 million, some argued that it was being a costly procedure for resolving disputes. Sources: see London Underground (Part VII). |