Grand Fao Port Project: Procurement vs Public-Private ...2. Under the PPP Model, the project company that “owns” the port will benefit from its success (or suffer from its failure),

Pillsbury Winthrop Shaw Pittman LLP

OECD - 7th Meeting of the Working Group on Infrastructure Finance in Iraq

Grand Fao Port Project: Procurement vs Public-Private Partnership (PPP)

Pillsbury Winthrop Shaw Pittman LLP – Abu Dhabi OfficeChristopher D. Gunson, Esq.

El-Erian & Associates LLCMostafa A. El-Erian, Esq.

Tuesday 13 November 2012

In this presentation, we will build the Grant Fao Port – two ways:

• First, by way of a traditional public procurement, where the Government enters into a construction contract with a contractor.

• Second, by way of a public-private partnership (PPP)through a project company with a sponsor.

Today’s goal: evaluate the differences.

Overview

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• In either model, the “RFP” is critical to getting the best deal.

• The Government must set certain criteria (i.e., expertise, experience, reputation, financial resources, etc.), create the model, and then distribute the RFP to qualified participants.

• The RFP should state exactly what must be built, the project deadlines, special factors, and model contracts.

• Qualified participants will review the RFP, and then submit bids to the Government.

• The Government then reviews all bids and selects the strongest participant (looking at technical, legal and financial terms).

• In the PPP Model, the Government should also consider the participant’s relationship with the contractor, sub-contractors, managers and lenders.

Role of “Request for Proposals” (RFP)

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Procurement Model:Construction Contract with a Contractor

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Procurement Model:Basic Structure

Government of Iraq

Contractor

SubcontractorSubcontractor

Supplier

Construction Contract

Grand Fao Port

Ownership

Ministry of Transportation

5 |

Procurement Model: Timeline and Milestone Payments

2013 2014 2015 2016 2017

Contract Awarded (by RFP)

Pays 10%(US$800m)

Pays 20%(US$1.6b)

Pays 20%(US$1.6b)

Pays 20%(US$1.6b)

Pays 30%(US$2.4b)

Appoints subcontractors and breaks ground

Excavates and builds foundation

Constructs docks, port infrastructure and buildings

Completes most structures and core infrastructure

Finishes project and Government takes completed port

Government (self-funded)

Contractor

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• High upfront costs for the Government – project must be paid for during construction, and must be fully paid for before it can be used. (Government can pay for the project out of current funds or by issuing bonds).

• Post-completion management and quality control.

• Traditional contracting procedures and simpler RFP process.

• Government has direct control over the contractor and oversees its performance on a regular basis.

Procurement Model:Characteristics

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• Types of Risk for the Government:

• Force Majeure (events outside the control of the contractor or the Government): What if bad weather, power failures, labor strikes, etc., causes the contractor to fail to perform?

• Sub-contractor or Supplier Failure: What if a sub-contractor or a supplier fails to perform?

• Change Orders: What if there is a change order? How are the scope of work, the schedule, and the price affected?

• Failure to perform by the contractor: What if the contractor fails to perform (or only partially performs)?

Procurement Model: Managing Risk

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Procurement Model: Simulation of Risk Events in Timeline

2013 2014 2015 2016 2017

Contract Awarded

Pays 10%(US$800m)

Pays 20%(US$1.6b)

Pays 20%(US$1.6b)

Pays 20%(US$1.6b)

Pays 30%(US$2.4b)

Government (self-funded)

Contractor

• Bad weather causes 12 month delay.• Will the Government agree to pay 12 months later?

Contractor may question if funds will be available.

• Change Order to scope of the project.

• Will the contractor attempt to increase the cost?

• Sub-contractor mistake results in construction defect.

• Will the Government decide to withhold payment to the contractor and will the contractor threaten to stop work?

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Procurement Model:One possible scenario…

Government of Iraq

Construction Contract

Grand Fao Port

Ownership

Ministry of Transportation

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SubcontractorSubcontractor

Supplier

RFP

Contractor

• Options for the Government:

• Withhold or delay payments.

• Termination - remove contractor or sub-contractor.

• Accept increase in cost, delay in schedule or poorer quality.

• Devote more people and resources to oversight of the project.

• Points of Caution for the Government:

• Contractor is in a short-term relationship that finishes at completion, and is principally interested in its fees being paid, and its fees being paid on time.

• Contractor may decide to stop work and walk away if not paid, if partially paid, or if paid late.

• The contractor has not invested its own money and has no responsibility for long-term success.

Procurement Model: Resolving Risk

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• In our experience, traditional procurement comes with a real risk of non-completion because of a lack of incentives for the contractor.

• Easy for the Government or the contractor to terminate the short-term relationship when problems arise.

• The parties do not have aligned interests and they do not share risk.

• In reality, the Government will have multiple contractors with components that impact each other, and accordingly, the risk of non-completion is multiplied.

Procurement Model: Risk of Non-Completion

Traditional procurement may leave you with a partially built,

but unusable project…

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PPP Model:Partnership with a Sponsor through a Project Company

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PPP Model: Basic Structure

Government of Iraq

Partnership

Agreement

Construction Contract

SponsorMinistry of Transportation

“Ownership”Project Company Grand

Fao Port(Lease or Concession)

Lender

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SubcontractorSubcontractor Supplier

Contractor(often, a Sponsor affiliate)

PPP Model: Timeline and Milestone Payments

2013 2014 2015 2016 2017

Partnership created (by RFP)

Pays 10%(US$800m)

Pays 20%(US$1.6b)

Pays 20%(US$1.6b)

Pays 20%(US$1.6b)

Pays 30%(US$2.4b)

Appoints subcontractors and breaks ground

Excavates and builds foundation

Constructs docks, port infrastructure and buildings

Completes most structures and core infrastructure

Completes Port and Project Company commences management

Contractor

Project Company(funded by Lender)

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• Very low upfront costs for the Government, which only: (1) grants land to the project company, (2) contributes limited funds, and (3) provides guarantees to lenders.

• The project company controls the project and manages the contractor, and the Government retains rights of consent through the partnership agreement.

• Sponsor and the Government have aligned interests and share risk as partners in the same project company.

• Project company (and its sponsor) will arrange construction financing from a lender.

• However, a PPP involves more complex contracting procedures and a more complex RFP.

PPP Model: Characteristics

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• Types of risk for the project company are the same as for the Government in a traditional procurement:

• Force Majeure.

• Sub-Contractor or Supplier Failure.

• Change Orders.

• Failure to perform.

• However, these risks are managed differently...

• The project company (and its sponsor) has more experience and better relationships and it takes the lead (with the lender) on a daily basis

• The government still controls major decisions

• Most importantly, the contractor is more motivated to find a mutually acceptable solution.

PPP Model: Managing Risk

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PPP Model: Simulation of Risk Events in Timeline

2013 2014 2015 2016 2017

Contract Awarded

Pays 10%(US$800m)

Pays 20%(US$1.6b)

Pays 20%(US$1.6b)

Pays 20%(US$1.6b)

Pays 30%(US$2.4b)

Project Company(funded by Lender)

Contractor

• Bad weather causes 12 month delay.• As the contractor will be confident that the lender

has dedicated funds, it may be more agreeable to 12 month late payment.

• Change Order to scope of project.

• A contractor affiliated with the project company will be less likely to unfairly increase costs or delay completion.

• Sub-contractor mistake results in construction defect.

• A contractor with other business relationships with the project company, sponsor and lender will be more motivated to keep working.

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PPP Model: One possible scenario…

Government of Iraq

Partnership

Agreement

Construction Contract

SponsorMinistry of Transportation

“Ownership”Project Company Grand

Fao Port(Lease or Concession)

Lender

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Contractor(often, Sponsor affiliate)

SubcontractorSubcontractor Supplier

RFP

PPP Model: Resolving Risk• The options for the project company are the same but risks are handled more

smoothly because of the aligned interests of an experienced project company and a more motivated contractor:

• The sponsor should have the experience working with the contractor.

• The contractor will have been brought to the project by the sponsor - the two may be affiliates, and in any event they will have global relationships.

• The lender, also brought to the project by the sponsor, will provide dedicated funds for payment of the contractor and further assurances to the contractor.

• The lender may also have global relationships with the contractor and the sponsor.

• In our experience, these relationships make the PPP Model much more likely to result in the project being successfully built – notwithstanding bad weather, sub-contractor problems, etc. – and also being successfully managed…

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Once the Grand Fao Port is built, it must be managed and maintained.

1. The procurement model leads to a management contract by which the Government, as the owner of the port, contracts with a manager.

The management contract with manager brings the same issues with the traditional procurement model – the manager is a mere contractor and its interests are not aligned with the Government, only on having its fees paid.

Additionally, there is the challenge of transition.

2. Under the PPP Model, the project company that “owns” the port will benefit from its success (or suffer from its failure), so it will be motivated for successful port operation.

The transition challenge is minimized, particularly if the manager is an affiliate

Port Management

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Timeline Comparison

2013 2018 2028 2038

Procurement Model

PPP Model

Project Company (PPP)

Construction Company Manager

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• For the manager, it (1) was not responsible for the construction, and (2) has no investment in the port. The manager is not motivated to solve problems.

• For the project company, it (1) was responsible for construction, and (2) “owns” the port and has invested into it. The project company (backed by the sponsor) shares risk and is motivated to solve problems.

MAJOR CONSTRUCTION DEFECT DISCOVERED

• Both traditional procurement and the PPP model are realistic options to use for the construction (and management) of the Grand Fao Port.

• Procurement Model:

• Government must fund the entire construction upfront.

• The Government has more direct control, but faces higher completion risk.

• Simpler contracting and RFP process.

• PPP Model:

• Government has low upfront costs due to lender funding.

• Experience and technical expertise of the project company increases the likelihood of completion, and multiple relationships with contractor lead to better outcomes.

• Government retains indirect control through its partnership with the sponsor.

• More complex contracting and complex RFP process.

Closing Observations

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Traditional Procurement – Government Cash Flow(Best Case Scenario)

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2013 2018 2028 2038

• The port is completed, operations commence, and government begins to gain revenue from the port operations.

-$2b

-$4b

-$6b

-$8b

-$10b

• After four years, revenues increase substantially as the port reaches greater capacity.

• By 2033, the Government has made back its money. The port generates profit for the Government.

• Government pays contractor over “milestones.”

Traditional Procurement – PPP Model(Best Case Scenario)

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2013 2018 2028 2038

• Government also provides guarantees to Lender for project company loans.

-$2b

-$4b

-$6b

-$8b

-$10b • Government provides land and capital to the project company.

• By 2029, the loan is repaid, the guarantees extinguish, and the project company distributes dividends to partners.

• The port is completed, operations commence, and the project company begins to gain revenue from the port operations.

• As revenues increase, lender loan to the project company is repaid, and Government guarantee withers.

• By 2036, the project generates profit for the partners.

Iraqi Legal Considerations

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• Law No. 21 of 1997 (as amended) – The Companies Law

• Project company can be Iraqi LLC (limited liability company) or JSC (joint stock company)

• Project company could be partially listed on the Baghdad Stock Exchange

• Law No. 22 of 1997 – State Companies Law

• Law No. 13 of 2006 (as amended) – National Investment Law

• Project company could benefit from the significant incentives, protections and guarantees afforded under the Investment Law

Iraqi Legal Considerations: Project Company

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• Ownership of land by non-Iraqi nationals prohibited by Iraqi law – can a project company with a foreign sponsor “own” the port?

• “Ownership” options: Law No. 22 of 1986 – Leasing State Real Estate

Law No. 40 of 1951 – Civil Code

Law No. 30 of 1984 – Commercial Code

CPA Order No. 40 of 2004 – Banking Law

• Hold by way of a lease or usufruct

• Grant Musataha rights to develop land

• Grant of a concession

Iraqi Legal Considerations: Land “Ownership”

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• “Transfer” options:

• Expiration of term of lease / Musataha / concession

• Key issue: can lease / Musataha / concession be registered with the land registration authorities?

• Iraqi basic enabling legislation:

• Public law contracts (Civil Code and Commercial Code)

• Law No. 21 of 1995 – Law on Ports (State Ports Authority / General Company for Iraqi Ports)

• Law No. 56 of 1985 – Maritime Agency Law (State Company for Maritime Transport)

• Law No. 80 of 1983 – Transportation Law

Iraqi Legal Considerations: Enabling Legislation

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Q&A

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Christopher Gunson Pillsbury Winthrop Shaw Pittman LLPAl Sila Tower, 21st floorP.O. Box 39740Sowwah Square, Sowwah IslandAbu Dhabi, UAETel: +971.50.554.6205christopher.gunson@pillsburylaw.comwww.pillsburylaw.com

Mostafa El-ErianEl-Erian & Associates LLCTel: +1 (202) [email protected]