The second approach was used in early accommodation, schools, and hospital projects, where contracts envisaged compensations, assets transfers, and payments. In particular, payments from the public-sector party to the defaulting private-sector party were calculated according to the stage in which the project was terminated: if termination occurred in the construction phase, payments depended on the capital costs net of rectification costs; if it occurred in the operation phase, payments were based on the net present value of future cash flows. Thus, the compensation approach embedded in the contracts attempted to overcome the shortcomings of the 'no compensation' approach, i.e. the risk of treating the private-sector party in an unfair way and the problem of excessive risk pricing.
However, the contractual procedures to value the assets to be transferred from the private-sector party and to calculate the payment to be made by the public-sector party typically involve large transaction costs. In practice, these procedures are difficult to negotiate and implement, e.g. there may be difficulties in verifying past capital expenditure, as well as disagreements between the partners in projecting future cash flows and assessing the impact of project termination.
Besides, the incentives for the major lenders to step-in and rescue the ailing project may be weakened to the extent that the payment made by the public-sector party upon the private partner default is high enough so as to fully repay senior debt. Lacking a stake in the project after debt repayment, lenders are unlikely to choose to step-in and continue the project.