The PPP contract needs to set out the conditions under which the contract may be terminated early, in which case the ownership of the project assets typically reverts to the public sector. This includes who may terminate and for what reason, and what if any compensation payment will be made in each case.
There are three broad possible reasons for early termination: default by the private party, termination by the public party, whether due to default or for reasons of public interest, and early termination due to some external reason (force majeure). In each case, the government typically makes a payment to the private party, and takes over control of the project assets (which may be re-tendered under a new PPP contract). Contractually-defined termination payments typically depend on the reason for termination, as summarized in Table 3.2: Types of Early Termination and Termination Payments.
Some of these approaches to defining the termination payment-particularly when linked to the value of the project assets-require careful definition.
The following resources provide more guidance on termination causes, arrangements, and payments:
• EPEC Guide to Guidance [#83, pages 40-42] describes each of these causes of termination and the options for defining termination payments in each case
• A more detailed EPEC publication on termination provisions [#86] provides a review of current European practice and guidance on termination and force majeure provisions in PPP contracts
• Yescombe [#295] also describes termination causes and options for termination payments, in greater detail
• Ehrhardt and Irwin [#72, pages 46-49] note that many PPP termination clauses protect lenders from any losses (that is, do not allow the PPP company to go bankrupt)-they describe why this can cause problems, and how bankruptcy could be a realistic option
• Clement-Davies on PPPs in Central and Eastern Europe [#48, page 46] provides more information on lenders' step-in rights.
The standardized contracts listed in Table 3.1: Examples of Standardized PPP Contracts and Contract Clauses also provide further examples of termination clauses in practice.
Notwithstanding careful provisions in the contract, early termination is typically costly for both parties, and is a last resort when other avenues have been exhausted. As described in the EPEC Guide to Guidance [#83, page 40], this means the contractually-defined termination payments are important even if termination does not happen, since it defines the 'fallback' position of each party in any dispute resolution or renegotiation.
Early termination payments are usually tailored in such a way that debt providers always have an interest in keeping the contract alive and services operational, thereby inducing them to 'step-in' before issues of poor performance lead to default by the private party.
Table 3.2: Types of Early Termination and Termination Payments
| Termination | Typical Triggers | Defining Termination Payment |
| Private party default | ■ Failure to complete construction ■ Persistent failure to meet performance standards ■ Insolvency of project company Lenders are typically given 'step-in rights' to enable them to remedy problems due to an under-performing contractor-termination only occurs if this is ineffective, or if lenders choose not to do so | Termination payments are typically defined to ensure equity-holders bear the burden of default. Lenders may also be exposed to some possible loss-to strengthen their incentives to rectify problems-although this can affect bankability. Options include: ■ Full value or a specified proportion of outstanding debt ■ Depreciated book value of assets ■ Net present value of future cash flows (subtracting costs of termination) ■ Proceeds of re-tendering the concession on the open market-thereby also overcoming the possible difficulty of finding budget space for termination payment obligations that realize unexpectedly |
| Public party default | Public party fails to meet its obligations under the contract | A fair contract should ensure the private party does not lose out if the public party chooses to default. Termination payments in this case are typically set to the value of debt plus some measure of equity, and may also include lost future profits (if any) |
| Termination for public interest | Many PPP or public procurement laws allow the contracting entity to terminate for reasons of public interest | Typically should be the same as for public party default, otherwise creates perverse incentives to voluntarily terminate instead of default (or vice versa) |
| Prolonged force majeure damage | Should be carefully defined in the contract, and limited to uninsurable, prolonged force majeure events that preclude performance of obligations | Typically in between the two options above, since neither party is at fault |
| Key References: Designing PPP Contracts | |
| Reference | Description |
| European PPP Expertise Centre (2011) The Guide to Guidance: How to Prepare, Procure, and Deliver PPP Projects, Luxembourg | Section 2.2.5 on "prepare the draft contract" briefly describes typical contract content; Box 3 provides more detail on defining payment mechanisms Section 4 on Project Implementation describes dealing with change within the contract, dispute resolution, and termination |
| World Bank (2009) Toolkit for Public Private Partnerships in Roads and Highways | Module 4: Laws and Contracts section on "contracts" describes PPP contract types, and describes typical contract contents and provisions, including sample "boiler plate" clauses. The section on "agreements, bonds and guarantees" describes other common elements of the contractual structure, including agreements with lenders |
| Infrastructure Australia (A) (2011) National PPP Guidelines: Roadmap for applying the Commercial Principles; (B) (2008) National PPP Guidelines: Commercial Principles for Social Infrastructure (Vol.3); (C) (2011) National PPP Guidelines: Commercial Principles for Economic Infrastructure (Vol.7) | Set out why and how key risks and responsibilities should be allocated in the contract, for social infrastructure (government pays) and economic infrastructure (user pays). The roadmap document describes the process of developing the contract, and provides guidance on deciding which set of commercial principles to use |
| World Bank (2011) PPP Arrangements / Types of Public-Private Partnership Agreements, http://ppp.worldbank.org/public-private- partnership/content/agreements | The PPP in Infrastructure Resource Center hosts a collection of actual PPP contracts and sample agreements for a range of contract types and sectors |
| Farquharson, Torres de Mästle, and Yescombe, with Encinas (2011) How to Engage with the Private Sector in Public-Private Partnerships in Emerging Markets, World Bank/PPIAF | Chapter 4 on "selecting projects" includes a section on specifying output requirements, and defines and provides examples of "SMART" output specifications |
| Hong Kong Efficiency Unit (2007) A User Guide to Contract Management, Hong Kong, China | Guide to contract management, in the context of outsourcing services. Includes several sections relevant to designing PPP contracts, including developing service specifications, and dealing with termination and dispute resolution |
| United Kingdom, MOD Private Finance Unit (2010) Output-Based Specifications for PFI/PPP Projects: Version 0.2 Consultation Draft, London | Provides detailed guidance on output-based specification, and a process for developing the specification for a PPP project |
| Iossa, Spagnolo & Vellez (2007) Contract Design in Public-Private Partnerships, World Bank | Provides guidance on several elements of contract design, including risk allocation, designing the payment mechanism, building in flexibility and avoiding renegotiation, contract duration, and other contractual issues to do with dealing with change |
| United Kingdom, Her Majesty's Treasury (2007) Standardization of PFI Contracts: Version 4, London | Provides detailed guidance and standard wording where appropriate on every aspect of the PPP contracts used for United Kingdom PFI PPPs (predominantly user-pays). The website http://www.hm-treasury.gov.uk/ ppp_standardised_contracts.htm provides additional materials, including marked up versions showing changes made to previous versions |
| Kerf, Gray, Irwin, Levesque, Taylor & Klein (1998) Concessions for Infrastructure: A guide to their design and award, World Bank Technical paper no. 399 | Section 3 "Concession Design" provides detailed guidance on designing PPP contracts, focusing on contracts in which the private party provides services directly to users. Topics covered include allocating responsibilities, price setting and adjustment, performance targets, penalties and bonuses, termination, dealing with unforeseen changes, and dispute settlement |
| 4ps (2005) Review of Operational PFI and PPP Projects, London | Summarizes the results of interviews with stakeholders in operational PPP projects in the United Kingdom. Includes sections with lessons learned on output specification, payment mechanisms, and contract flexibility |
| South Africa, National Treasury (2004) PPP Manual Module 6: Managing the PPP Agreement, Johannesburg | Module 6 of the manual, on "managing the PPP Agreement" briefly outlines how performance requirements, monitoring and enforcement mechanisms should be established. The Standardized PPP Provisions set out and explain key provisions across all elements of the PPP Contract |
| United Kingdom, Scottish Government (2004) Output Specifications: Building our Future - Scotland's School Estate, Edinburgh | Sets out model output specifications for schools PPP projects as well as some guidance on key issues in defining output-based specifications |
| United States, Federal Highway Administration (2011) Key Performance Indicators in Public-Private Partnerships: A State-of-the-Practice Report, Washington, D.C. | A state-of-the practice description of domestic and international practices for key performance indicators in PPPs, based on a comprehensive literature review and eight case studies from Australia, British Columbia, the United Kingdom and the United States |
| World Bank (2006) Approaches to Private Sector Participation in Water Services: A Toolkit | Section 6.3: designing risk allocation rules describes several aspects of PPP contract design for user-pays PPPs-including payment mechanisms, and termination clauses. Section 7 on developing institutions to manage the relationship includes a discussion on dispute resolution |
| Tim Irwin (2003) Public Money for Private Infrastructure: Deciding When to Offer Guarantees, Output-Based Subsidies, and Other Fiscal Support, World Bank Working Paper No. 10 | Describes different payment mechanism for subsidies to infrastructure projects-including output-based payments and upfront capital subsidies-and how the government can decide which is most appropriate |
| Yescombe, E. R. (2013) Public-Private Partnerships: Principles of Policy and Finance, 2nd edition, Elsevier Science, Oxford | Chapter 13: Service-fee mechanism describes the different possible payment mechanisms (focusing on government-pays PPPs) and their implications for risk allocation and bankability. Chapter 15: Changes in Circumstances and Termination describes mechanisms to deal with changing costs and risks (compensation and relief events), step-in and substitution, and termination payment provisions for different causes of termination |
| United Kingdom, Scottish Government (2007) Briefing Note 1: Payment Mechanisms in Operational PPP Projects, Edinburgh | Describes experience with defining and implementing government-pays payment mechanisms in PPPs |
| Hong Kong Efficiency Unit (2008) An Introductory Guide to Public Private Partnerships (2nd ed), Hong Kong, China | Section 9: Changes of Circumstance provides guidance on the types of changes that the PPP contract should be able to deal with |
| Jadresic, A. (2007) Expert Panels in Regulation of Infrastructure in Chile (Working Paper No. 2) World Bank | Describe the expert panel approach used in Chile to deal with regulatory conflict. Section 6 focuses on the use of expert panels in public works concession contracts |
| David Ehrhardt & Tim Irwin (2004) Avoiding Customer and Taxpayer Bailouts in Private Infrastructure Projects: Policy towards Leverage, Risk Allocation, and Bankruptcy, World Bank Policy Research Working Paper 3274 | Describes the problems associated with protecting lenders from losses in case of termination due to private party default, and provides some policy suggestions for alternatives |
| Clement-Davies, C. (2007) Public-Private Partnerships in Central and Eastern Europe: structuring concessions agreements, in European Bank for Reconstruction and Development (eds.) Law in Transition 2007: Public Private Partnerships, Legal reform in Russia (38-50) London | Discusses some of the main issues in developing concession agreements in transition countries-including risk allocation, tariff structure, performance standards, dealing with change, termination and step-in rights for lenders |
| Juan Carlos Cassagne (1999) El Contrato Administrativo, Buenos Aires, Argentina: Lexis-Nexis Abeledo-Perrot | Provides a detailed account of public contracts, and a framework for creating them-guidance that can also be applied to designing PPP contracts. Focuses on the role of a public contract, procedures for public contracting, the effects of executing a contract, public participation in public contracting and the procedures for terminating a contract |
| Cassagne, Juan Carlos & Gaspar Ariño Ortiz (2005) Servicios Públicos: Regulación y Renegociación, Buenos Aires, Argentina: Lexis-Nexis Abeledo-Perrot | Describes regulatory reform in public services, including achieving regulation through effective PPP contracts. Includes guidance on mechanisms for tariff changes, and for dispute resolution |
| Souto, M. J. (2004) Direito Administrativo das concessões, Rio de Janeiro, Brazil: Lumen Juris | Describes the legal framework for concessions in Brazil, and its implications for PPP contract design |