NHAI Circular for Substitution of Concessionaires

1.  In view of the difficulties being faced by Concessionaires in Public-Private-Partnership (PPP Projects), Government has decided to permit the substitution of existing Concessionaires, in a harmonious manner, in accordance with provisions of Clause 40.3 of the Model Concession Agreement read with Substitution Agreement set forth in Schedule-V of the Model Concession Agreement.

2.  This decision shall be applicable to all National Highway projects under PPP mode  awarded/yet to be awarded on Build-Operate-Transfer (BOT) mode of delivery:

a.  The on-going 2-laning and 4-laning National Highway projects where financial close has been achieved by the Concessionaire but Commercial Operation Date (COD) has not yet been declared by the Authority;

b.  The 6-laning National Highway projects wherein the financial close has been achieved by the Concessionaire but the project completion certificate has not yet been issued by the Authority;

c.  Completed 2-laning, 4-laning and 6-laning National Highway projects awarded on Build-Operate-Transfer (BOT) mode of delivery under PPP mode; and

d.   All the new National Highway projects under PPP mode yet to be bid out on BOT mode of  delivery in line with (a), (b) and/or (c) above, as the case may be.

3.   Provisions pertaining to substitution of the Concessionaire by the Lenders’ Representative are contained in Clause 40.3 of the Model Concession Agreement in general, and Clause 3.1.1 of Substitution Agreement in particular. Clause 3.2 and 3.3 of the Substitution Agreement provide for substitution in the event of Financial Default and Concessionaire’s Default respectively. It is further clarified that Right of Substitution by the Lenders’ Representative can be exercised in situations other than those illustrated in Clause 3.2 and 3.3 of the Substitution Agreement. In case of harmonious substitution as envisaged in this circular, the provisions contained in Clause 3.4 of the Substitution Agreement, except those contained in para 3.4.1, shall be applicable, in addition, to the procedure laid down herein below:

i.    The Concessionaire shall make a written representation to the Lenders’ Representative with a copy to the Authority requesting the Lenders’ Representative to seek approval of the Authority for its Substitution. Upon receiving the said request, the Lenders’ Representative shall make its own assessment regarding the said request of the Concessionaire and upon being satisfied that it will be in the interest of the Project that the Concessionaire may be substituted by a Nominated Company, Lenders’ Representative in consultation with the Concessionaire would invite, negotiate and procure offers either by private negotiations or public auction or tenders, for the takeover and transfer of the Project Highway including the Concession to the Nominated Company.

ii. Selection of the Nominated Company and the valuation of the Equity of the Concessionaire would be done by mutual consent of the Concessionaire and the Lenders’ Representative.

iii. Upon receiving the proposal of the Lenders’ Representative for substitution of the Concessionaire with the Nominated Company under Clause 3.4.3, the Authority shall satisfy itself about the credentials of the Nominated Company and accord its concurrence regarding such substitution.

a.   For projects that have achieved COD, the substituting entity should have adequate experience of operating and maintaining completed road projects by itself or through its associates/subsidiaries.

b.  For projects under construction, the substituting consortium/entity should have the requisite financial and technical qualifications to bid for a project of at least the same size, or higher/better.

Thereafter, the nominated Company will form an SPV for taking over the project along with all the rights and obligations of the Concessionaire.

iv.  While concurring to the said proposal of the Lenders’ Representative, Authority’s Board may levy an appropriate penalty keeping in view the nature and extent of default as per the procedure to be prescribed for the purpose by the Authority subject to a cap of 1% (one percent) of Total Project Cost.

v.  Where the responsibility for delay in execution or completion of the project is on account of non-fulfilment of the obligations of the Authority, namely, land acquisition, environmental clearances, other statutory/regulatory approvals/clearances, no penalty would be levied on the Concessionaire for non-fulfilment of its obligations. However, the Authority would be required to remedy the defaults before the formal agreement for substitution is signed.

vi. Subsequent to such substitution, for completed projects, the lead substituting entity shall be required to maintain at least 51% holding in the project SPV, save and except the situation for dilution of equity, in accordance with the provisions of Clause 7.1(k) of the Model Concession Agreement read with the definition of “Change of Ownership” as prescribed in Article 48 of the Model Concession Agreement.

vii. The procedure prescribed in other clauses of the Concession Agreement and the Substitution Agreement, other than that contained in Clause 3.4.1 of the latter, shall be strictly adhered to.

viii. The Authority shall stand fully discharged of any claims whatsoever, by the exiting Concessionaire.

ix.   Such substitution may be permitted only once during construction period

4.  The above clarifications/stipulations read with the Clauses referred hereinabove are with reference to Concession Agreements based on the Model Concession Agreement dated August, 2011. However, these shall apply mutatis mutandis to the relevant provisions of other Concession Agreements signed by the Authority for BOT Projects on PPP mode of delivery from time to time.

NHAI circular on Securitization of cash flows

An NHAI Circular dated 29/05/2013 has placed a cap on securitization proceeds of BOT (Toll) projects. The contents of the circular are as follows:

“The issue regarding Securitization of future casf-flow in BOT (Toll) Projects was discussed in the 94th Board Meeting of the Authority held on 14/05/2013. With a view to ameliorate the shortage of equity and improve liquidity of the prospective bidders, Board approved the proposal for granting of permission by NHAI to the Concessionaires of BOT(Toll) projects, which have Toll revenues significantly surplus to the repayment obligations, to raise subordinate loan on the strength of future surplus cash flows of their operational BOT road projects subject to the following conditions:

a)  Raising of subordinate loan upto 30% of TPC of NHAI would be allowed only after COD of the project is achieved in case of 4-laning projects and construction is completed in case of 6-laning Projects

b)  Repayment of such loan would be the last priority under the waterfall mechanism of the Escrow Agreement. It would be allowed only after meeting all kinds of statutory levies / taxes, O&M expenses, concession fee, damages and other dues of the Authority and Debt Service along with interest due.

c)   Submission of an undertaking by the Concessionaire that it would not enhance the amount of Debt due, Termination Payment or any other liability of NHAI in any manner whatsoever.

d)   Receipt of NOC from the existing lenders of the Project

e) Receipt of such loan, giving of loan to the parent company, Servicing and repayment of loan by the parent company and servicing and repayment of the subordinate loan would be routed through Escrow account of SPV.

f)  Such loans would be used exclusively for investment as equity in road sector projects 

g)  Statutory Auditors of the SPV as well as the Group Company availing the loan from the concessionaire shall provide the details confirming the name of the project, the Authority awarding the project, TPC of the project, sources of funds and the amount of the equity invested within three months of availing such loan.

This has the approval of the Board of the Authority in its 94th Meeting held on 14/05/2013.”

Indian Yield Curve - 17/10/2013

The yield curve has held on to its spoon shape, but 10Y bond spreads over 1Y / 2Y / 5Y bonds have continued to improve, because the yields of short term notes / bonds have steadily gone down. 

Indian Yield Curve - 25/09/2013

Long-term bond yields beyond 15-yrs are still close to their highest values in the last 3-4 months (between 9 to 9.5%).

However, judging by the trend of 10Y yields over 6M, 1Y, 2Y, 5Y yields, the corrections seems to have begun. The 1Y, 2Y, 5Y yields have all fallen below the 10Y yield for the first time after 16/07/2013. The chart is below:

Eight rules for PPP policy makers

There are several papers regarding best practices in formulating PPP policies, but Public-Private Partnerships: Eight Rules for Governments (October 2008) by Aidan Vining and Anthony Boardman is probably one of the easiest to read.

This post is just a précis of the paper (do go through the original). Though it is meant for policy-makers, the paper should be read by lenders and advisors trying to get a sense of potential risks that cannot be modeled mathematically on an excel sheet. It is especially informative for managers / financiers / consultants who work with projects in multiple geographies and have to deal with different deal structures and concessions.

The rules are simple enough:

1. Establish a jurisdictional PPP constitution

As far as possible, use existing constitutional institutions and constructs to ensure transparency in the contractual structure. Ensure public availability of contracts (except for legitimate trade secrets).

If such constitutional means are not already available, the legal & constitutional framework should be put in place before the PPP process gets underway. An well-structure framework also discourages parties from following 'win first, renegotiate later' policies.

2. Separate the analysis, evaluation, contracting / administration, and oversight agencies

Separate the agencies that (a) analyzes projects feasibility, including social cost-benefit analysis; (b) decides which of the alternative provisioning modes to employ (government production, contracting or P3); (c) organizes the tendering of bids, selects the partners, makes the final decision whether to proceed with a P3 (or not) and monitors the implementation of the contract; and (d) evaluates the overall success of projects.

Though this step introduces several layers of bureaucracy, it ensures the avoidance of the conflicts of interest which would exist if all these functions came under the same body. Discrete, independent bodies also reduce the chances of a project being undertaken due to political or external pressures, rather than the primary motive: highest social benefit with lowest possible social cost.

3. Ensure that the bidding process is reasonably competitive

The policy should be to ensure that a sufficient number of serious bidders are competing with the project. Public sector companies should also be encouraged to participate in bidding.

This ensures that the competitors put up their most cost-efficient bids, and makes it difficult for bidders to raise costs through collusion and cartelization. A sufficient number of bidders also reduces the risk of the process being rigged or influenced, and thereby being at the risk of legal action or review at a later point of time.

4. Be wary of projects that exhibit high complexity and uncertainty

Any infrastructure project involves some form of complexity or uncertainty. Change in costs, changes in design or scope over the construction period should be expected and accounted for in the contractual framework. However, political changes, unexpected events, changes in law during the project lifetime cannot be anticipated in advance.

Therefore, the framework must include a provision for a simplified, low-cost process for renegotiation when the changes are not under control of the public or private parties involved in the project.

Additionally, it is wise for both parties to ensure that any unnecessary complications (unproven technology, unrealistic milestones, etc) are not introduced by the counter-party in the pre-construction phase.

Projects that can be broken into discrete packages, should be broken down and tendered separately.

5. Include standardized, fast, low-cost dispute resolution / arbitration procedures

Disputes take a lot of time to reach a resolution or a conclusion. They are extremely expensive and increase transaction costs due to legal fees, capitalized interest expenses, insurance expenses, project management costs, etc. 

The bigger issue is that the longer an infrastructure project takes to complete, the more its viability comes under question by investors, lenders and suppliers. If the project loses the support of investors and lenders, it can be quite difficult to restart and conclude the project.

Stakeholders in such long-term projects occasionally find themselves in situations where they do not necessarily agree with each other, and a solid dispute resolution process goes a long way towards attracting potential investors.

6. Avoid standalone deals with Private Sector shells bringing limited equity

PPP projects are often undertaken by private parties through project-specific SPVs. This allows them to finance these projects off-balance sheet, at a higher leverage than would have been possible if the project were financed on the parent company's balance sheet. The SPV structure simplifies tax assessments, transfer of project assets at project closure, etc. and therefore is a widely accepted structure.

However, it is important for lenders and policymakers to ensure that leverage does not reduce the equity requirement to a level where the promoter is incentivised to abandon a project rather than work towards a solution, in case that the project does not perform as per expectations.

7. Prevent the Private party from exiting the contract / project too early

The riskiest phase in the tenure of the concession is the construction phase. Therefore, the valuation of a project jumps as soon as the project is operational. This means that a developer has the incentive to sell the project and recover the invested capital as soon as the construction period is past. If this is allowed the developer may just complete a project, book their profits and leave without any further liability.

Therefore it is important to ensure that developers are present during the post-completion liability period, thereby forcing them to maintain construction standards and avoid under-investment during the construction phase.

8. Have a direct conduit to lenders / debt holders

Most PPP projects are too large to be secured with collateral. Since project assets are to be transferred to the government at the end of the concession period, the contract usually does not allow for a way to recover the outstanding debt by liquidating the project assets. Thus, projects debt is mostly unsecured in nature.

Therefore, financing a project is going to be difficult if lenders do not have some sort of recourse to the authority which awarded the contract. In the event of a default due to the concessionaire / developer, there must be a mechanism for lenders to approach the authority for redressal.