There are essentially three different options the Contracting Authority should consider in respect of equity compensation. These are all likely to lead to different outcomes so the Contracting Authority should be guided by the key considerations in Section 4.2, as well as by the circumstances of the PPP Project. See Section 4.7, Sample Drafting 4, Schedule, Clause (1)(d).
(a) Original Base Case Approach (Option 1(a)): in this approach, the amount payable is determined by reference to the Original Base Case. The Contracting Authority pays a sum which, when taken together with all amounts already paid to the Equity Investors before the date on which the PPP Contract is terminated, will ensure that the Equity Investors recover Base Case Equity IRR.
The key benefit of this approach lies in its easy implementation and certainty and the fact that it leaves less room for dispute than other approaches.
A material drawback, however, is that this option assumes that the Private Partner has been performing as planned in the Original Base Case - it does not take into account the actual performance of the Private Partner under the PPP Contract. From the Contracting Authority's perspective, this may over-compensate the Private Partner if it has been performing worse than expected in the Original Base Case and arguably there may be a stronger incentive on the Private Partner to ensure the PPP Project is terminated. Conversely, if the Private Partner has been performing better than expected it will be undercompensated and arguably may be concerned that this might incentivise, or result in political pressure on, the Contracting Authority to terminate the PPP Contract early. See Section 4.7, Sample Drafting 4, Schedule, Clause (1)(d), Option 1(a).
(b) Market Value Approach (Option 1(b)): in this approach, the amount payable is determined by assessing the price which third party investors would be willing to pay for (i) the shares in the Private Partner and (ii) the receivables arising under subordinated debt, subject to certain assumptions (including that the event giving rise to the early termination had not occurred).
Compared to the Original Base Case Approach (Option 1(a)), this option takes full account of the actual performance of the Private Partner under the PPP Contract so is fairer on that front.
However, this method is complex to implement in practice and the result could be undesirable on both sides - the Contracting Authority could pay more than expected under the Original Base Case and the Private Partner's Equity Investors may feel their interests are not sufficiently protected in circumstances that are largely beyond their control. It may be difficult to establish a market value (particularly if no market exists) and this could lead to disputes. See Section 4.7, Sample Drafting 4, Schedule, Clause (1)(d), Option 1(b).
(c) Adjusted Base Case Approach (Option 1(c)): under this approach, the amount payable is determined by reference to the distributions which Equity Investors would have expected to receive under the Original Base Case, but only from the termination date. The amount payable will be the aggregate amount of distributions forecast in the Original Base Case to be made after the termination date, discounted using the Base Case Equity IRR.
This approach takes into account the performance of the Private Partner under the PPP Contract up to the termination date. It also provides greater certainty as it does not require a market valuation mechanism and is easier to implement.
However, it does not take into account likely actual performance in respect of the period after the termination date, so (as highlighted under the Original Base Case Approach (Option 1(a)) the Contracting Authority may be over or under-compensating the Private Partner for that period. This will have a greater impact the earlier termination occurs. See Section 4.7, Sample Drafting 4, Schedule, Clause (1)(d), Option 1(c).