PPPs: Extolling the virtues, examining the risks

I am usually skeptical of those who trumpet the virtues of PPPs. While they can certainly be a tonic for a cash strapped state or municipality, they can also be a toxic waste.  It takes a careful and sober analysis before rushing into one.

The following article, published on the Lexology website and elsewhere, offers a balanced perspective. I offer highlights, but you should read the whole piece.

P3S: managing risks and rewards by attorney Barbara A. Geisman of the firm Thompson Coburn LLP.   Interest in P3s is growing as governments search for ways to access expertise, deflect risk, speed up project completion, lower capital and operating costs, avoid public votes and increased taxes, and keep what might otherwise be counted against public debt limits “off the books.”

Successful P3s — Public-Private Partnerships — can be blessings for state and local governments searching for new ways to finance many types of critical “infrastructure”—roads, schools, prisons, and more—and control operating costs. Success or failure depends on how well each partner plans ahead and how realistic each partner can be.

In all P3s the government partner attempts to tap private sector expertise and financial resources while the private partner hopes to make a profit. Successful and unsuccessful partnerships of the past offer valuable lessons and can help both private and public partners considering P3s negotiate deals that make sense for both.

This tool is worth a hard look for any capital-strapped governmental entity in need of new infrastructure. But public officials must approach potential P3 arrangements with eyes wide open and a clear understanding of both prospective benefits and prospective risks.

Similarly, P3s can be a source of profit and accolades for private partners in a P3 venture. But private partners, too, must carefully evaluate potential benefits against a variety of risks: If a private entity accepts responsibility for long-term situations it cannot control or pledges too much of its capital and borrowing power to a single project, then the entity places its overall future at risk.

These arrangements must be carefully structured from both sides of the partnership to create the desired “win-win.” Without well-informed attention to detail and more than a modicum of foresight, a P3 can cause significant damage to both public and private reputations and balance sheets. Structuring a P3 is very challenging because P3s come in an almost unlimited variety of flavors, depending on the public entity’s goals.

Some types are familiar, like the federal low-income housing tax credit, or LIHTC. That program was intended in part to shift responsibility for providing affordable housing for the nation’s working class families from traditional “housing authorities” to the private sector. The LIHTC program shifts cost, operating, and financing risks to the private developer. It accomplishes its goal of providing affordable residential rental units by subsidizing annual debt service and operating costs with federal tax credits and limiting the rent the private developer can charge. Because this specific type of P3 has a sufficiently long history and is appropriately targeted to one particular purpose, most of the potential “bugs” have been worked out of the structure, and the program is generally considered a success.

At the other end of the spectrum, some P3s are essentially “one offs” — that is, there is no universally accepted and time-tested model for the contract arrangement. Those P3s present greater uncertainties and risks for public and private partners alike.

The risk that both sides may lose in a P3 deal can increase if the deal is “too good” for either side. An important key to successful P3s is responsible management of risks and benefits—that is, an allocation that is fair to both parties.

In a P3 whose structure is relatively “simple” — for example, the public sector seeks to shift only construction cost and possibly operating cost risk to the private sector — associated public sector risks can be mitigated to a significant extent by careful up front due diligence and by incorporating protections like net worth maintenance requirements or letters of credit into the construction and operating documents. Associated private sector risks can be mitigated by including clear parameters for design and construction outcomes, sharing arrangements for mitigation of unforeseen circumstances, and fair, carefully drafted cost-escalation provisions in the agreements. In long-term arrangements, both partners must recognize that the future is uncertain and that innovation or public policy changes may impact the validity of demand or cost projections.

In P3s that rely on the private sector to generate all of the income required to pay project-related debt, due diligence becomes much more complex.

Equally important, both private and governmental entities moving down the path toward a P3 partnership must have the courage to pull off the road when a collision of interests is imminent. That can be very hard when a company or a government has invested significant amounts of time and money in documenting a deal that has been essentially “promised” to shareholders or constituents. Deal momentum snowballs in the rush to schedule the groundbreaking, fill a gaping budget hole, or announce a big contract to shareholders and deal documentation can easily pick up unintentional debris in the dash to the finish line. If obstacles to a successful relationship seem insurmountable or the deal presents risks that have not or cannot be reasonably allocated or shared in a manner that adequately protects each party’s interests, it may be time to put on the brakes regardless of how near the finish line may seem.

Government officials and private decision-makers must carefully consider the long-term public policy implications of the deal under consideration. Will it unacceptably limit the government’s ability to monitor and refine long-term strategies to address changing needs? If an agreement prohibits the development of new roads in an area served by a P3 toll road, citizens may be forced to endure unacceptable traffic congestion for the term of an agreement which may last many decades. If an agreement prohibits expansion of a region’s mass transit system to preserve demand for a toll road, that region’s sustainability efforts may be intolerably hampered—and the only remedy may be for the public sector to “buy back” the project at significant cost and re-assume the operating and maintenance burden when the public sector’s primary interest in the agreement in the first place was to shed that burden. If an agreement requires a private company to operate and pay for operating a facility when that private entity cannot control the market for the facility’s “outputs,” the company’s assets can be decimated even to the point of bankruptcy.

The operating pro forma must make sense for each party and the P3 agreement must allow for changes in that pro forma as new situations develop. New technologies are coming on the market every day and public polices change over time. Such issues can be addressed by reasonable partners: for example, instead of inking a 75-year “all or nothing” term, the partners can agree to 5-year or 10-year agreement increments where each partner may decline to renew the agreement at the end of the incremental term but once the agreement is renewed neither can terminate during the renewal period. That arrangement strikes a balance between predictability and inability to foresee what tomorrow will bring: either party can completely bow out when the agreement comes up for renewal but, if the working relationship has been a good one, it is more likely that each party will view the renewal as an opportunity to tweak the agreement and work out bugs.

Each partner must understand, empathize with, and fairly respond to the legitimate concerns of its counterpart. Risk allocation imbalance is dangerous for both sides. If the government unreasonably over-allocates risk to the private sector partner, either no one will respond to the request for proposals or those who do respond will be more likely to fail because they have little experience in evaluating and quantifying P3 types of risks. If the private partner loads too much risk on the public partner, the government will be criticized by its constituents. Appropriately balanced risk is the hallmark of a win-win deal.

A corollary here is that the private sector partner must always remember that all of the terms of a P3 deal are [-- or should be, see here and here --] public. Virtually all governments are subject to some type of “Sunshine law” that enables reporters and others to access virtually all of the final documents involved in any deal. Each P3 deal must withstand public scrutiny — if a big or even medium-sized deal cannot pass a “smell test,” it is likely that some reporter will discover the deal’s flaws by poring through the public record.

Each party should think hard before it agrees to overt or “disguised” non-compete provisions. For example, a trash-to-energy arrangement may require the public sector to deliver a minimum volume of trash each month to a privately owned incinerator at a set price for a multi-decade term. Prospectively, that may look like a reasonable private sector “ask” but, in hindsight, such a provision could prevent the government from competing with the private incinerator by diverting part of its waste stream to a recycling facility.

Both parties must choose their partners carefully. A government with an unstable political climate will be a bad partner for an established private company because political battles can lead to capricious reconsideration of decisions and generate bad publicity for the company as political opponents seek to discredit each other. A government with an unfriendly business climate may, wittingly or unwittingly, hamper the project’s success. Careful due diligence on both sides of the partnership is essential for P3 success: mistakes are inevitable and each partner must be able to responsibly and successfully shoulder its negotiated share of responsibility for those mistakes.

Both parties must also look carefully at the quality of the public sector “assets” upon which the deal is predicated. Is there a market for the asset or service? Is that market likely to grow or decline? Will the government partner support or thwart private efforts to sustain and grow the market? Can and will the private partner invest sufficiently in the asset to fulfill the government partner’s goals? What happens if the market assessment was “off”?

Each party should approach untested technologies with a large grain of salt. P3s should not be viewed by either party as opportunities to experiment: risks associated with experiments are difficult if not impossible to allocate and a failed experiment will inevitably generate bad press.

Beware of projects that attempt to address too many goals by placing unrealistic burdens on the private partner. If a project is overburdened with requirements that do not relate directly to the core purpose of the project—e.g., excessive minority participation, local training, and workforce requirements—the cost of the project will escalate.

While local government charters and other organizational documents are often flexible as to the types of contracts permitted, a local P3 will almost certainly require passage of a specific law that authorizes the particular P3 agreement. On the federal and state levels, special legislation empowering agencies to enter into P3 types of arrangements is almost always required, although many states and the federal government have recently enacted legislation authorizing some types of P3s.

Each party must be willing to invest in good professional help in structuring the P3 agreement—and must be willing to pay for that help, even if it ultimately decides to crater the prospective deal. Private parties unused to dealing with prevailing wage, public bidding, and local benefit concerns may find themselves saddled with unanticipated costs and negative media coverage. Public parties unused to negotiating with sophisticated businesspeople may lose on key points if they cannot benefit from equally sophisticated help.

Virginia's road project got PPP'd on

How Virginia paid more than $250 million for a road that never got built

The problems help explain why top officials in Gov. Terry McAuliffe’s administration have recently increased scrutiny of public-private partnership deals, a sharp shift in tone in a state that has for 20 years been a national leader in pushing such projects. Transportation Secretary Aubrey Layne said this month that the I-66 project should not be ceded to private investors for “ideological” reasons, as might have happened in the past. Keeping the construction of toll and carpool lanes under state control could generate hundreds of millions of dollars for additional transportation projects, he said, and avoid a repeat of cases in which the state was left “holding the bag.”

Virginia officials are trying to get back tens of millions of dollars from a private company that was supposed to build a 55-mile toll road in southeastern Virginia. State officials had been sending the company multimillion-dollar installments each month to build the road. But the state lacked federal construction permits, so the road wasn’t built. And now the commonwealth is out about $256 million.

Virginia officials governed the project using the state’s Public-Private Transportation Act, which went into effect 20 years ago and gave officials extraordinary flexibility in pairing public projects with private firms. The idea was to try to tap the construction expertise, business acumen and cost-consciousness of private companies, with the benefits flowing to shareholders and state taxpayers. If Virginia officials didn’t have the stomach to set aside large sums to add long stretches of highway, they could lure private investors to put up much of the money. Companies would cover project costs and company profits with the decades of toll revenues they collected.

Among the critical problems, Layne said, was a sort of automatic payment plan, which sent millions to the firm monthly starting in early 2013. Those routine payments were in addition to funds sent to cover specific work that was completed. "Payments continued to go to the contractor for things they knew couldn’t possibly be accomplished, because they didn’t even have a permit,” Layne said. Del. S. Chris Jones (R-Suffolk), chairman of the House Appropriations Committee, said, “I can’t think of a worse contract that I have seen in my years of public service.” Jones said that the deal was rushed to avoid political scrutiny.

Layne said he was not seeking to disparage state representatives, but noted that they emerged from a more “process oriented” background within state agencies and lacked the entrepreneurial and negotiating experience and resources of private firms. Private negotiators had often been doing a much better job than their well-meaning state counterparts. “These guys are buying the best attorneys in the world.”

Layne said the company negotiated in good faith. It is the commonwealth’s responsibility to protect its interests, he argued. “I don’t think they’ve done anything that wasn’t allowed in the contract,” Layne said. But, “I’m not saying it was a good contract.” “I don’t blame them for taking the money. It was a negotiated payment schedule,” Layne said. “They didn’t ask to stop getting payments. . . . If I were them, I wouldn’t either.”

The initial concept was that a private firm would pay to build the toll road and control it for decades, a major undertaking with significant risk. The Public-Private Transportation Act allowed many of the state’s basic procurement rules to be bypassed, Layne said, a feature intended to give the state flexibility to find the best deal.

But private firms balked at taking long-term control of the road because traffic tallies and resulting toll revenues were projected to be too low. So state officials changed course. They decided they wanted to hire a company whose primary responsibilities would be to design and build the road. But in a quirk of the transportation act, the state’s basic procurement rules — which limit certain types of financing arrangements and require more rigorous oversight — did not kick back in, even after the nature of the project shifted radically.

State officials then failed to invite a wider group of firms to vie for the business. That left just the three groups that had been competing for the original public-private partnership, Layne said.

Officials “continued to negotiate with a group that was really set up to do something else,” Layne said, noting that only a few large firms had the needed financial heft and inclination to finance, design, build and operate the project as it was initially envisioned. “Had they opened it up, they would have had many more firms willing to bid on this particular project,” Layne said. “It was basically, ‘Build the road and turn it over.’ ”

And more competition could have brought a better deal, he argued.

Project executives with the two firms that make up 460 Mobility – Ferrovial Agroman, a major multinational construction and engineering concern with roots in Spain, and a Pennsylvania-based building firm now known as Allan Myers – declined to comment. “Our employees and contractors have been professional and accommodating throughout the commonwealth’s reconsideration of this project,” said Shannon Moody, 460 Mobility’s public relations manager.

Transparency is collateral damage when major work is contracted out

I have previously mentioned the debated issue whether procurement transparency laws follow on to the contracts let for government work. See Will FOIA be foiled by outsourced subcontracting? 

The article cited below (click link)arises in Minnesota where its Supreme Court ruled, in the factual context of that case, that private contractors are immune from the State's equivalent FOIA law by a contract clause excluding them from the coverage of the law.

Minnesota high court: Business not subject to open-records laws

The Minnesota Supreme Court ruled Wednesday that a private business that contracted with a northern school district to renovate buildings isn’t subject to state open-records laws. The high court reversed the Appeals Court’s October ruling, which had been viewed as a victory for public access to government contracts.

Under the law, private residents or businesses contracting with the government must comply with the state’s Data Practices Act “as if it were a government entity.” A notice of the requirement must be included in the contract. In this case, the notice was excluded. Without it, the Supreme Court concluded there wasn’t a provision in the Data Practices Act that made the contract between Johnson Controls and the architectural firm public.

In 2011, the state Department of Administration sided with Helmberger, but an administrative law judge threw out the request because the subcontract “did not involve the performance of a government function.” The Appeals Court disagreed, arguing that the planning of five public schools falls under state laws that mandate the duty of a school district to “furnish school facilities” to children, including constructing and renovating buildings.

The state Supreme Court’s ruling didn’t address the question of whether Johnson was performing a government function. In a concurring opinion, Justice Alan Page wrote that he didn’t agree with the court’s “blanket conclusion” that data held by an individual, corporation or association performing a government function are nonpublic. It should depend on whether the contract calls for the contractor to perform a government function.

“If the court had ruled on the question of government function, it may have gotten into Alice-in-Wonderland complexities that would have been extremely difficult to resolve from case to case,” said Anfinson.

Todd Wind, who represented Johnson, said the Supreme Court struck the right balance for the business community and citizens of Minnesota. The ruling recognizes the Data Practices Act doesn’t make all information public just because somebody does business with a government entity, he said. “The ruling makes the requirement of the notice abundantly clear,” he said. “But we believed Johnson wasn’t performing a government function anyway.”

It seems fairly well settled, on Guam, that a procurement contract executed with the government of Guam is a public record that must be disclosed to the extent it is not protected by provisions regarding proprietary information or trade secrets.

But notice that this case did not involve a question of a government contract, rather, a subcontract between the government contractor and a subcontractor. That becomes a more iffy question, but would probably be covered by a governmental function rule -- if there is a governmental function criteria applied to FOIA coverage.

Since government is now engaging in larger and more complex acquisitions than in times past, times need to keep up and legislate to include -- or exclude if that is the preferred policy -- subcontracts of government contracts within the scope of public record transparency requirements, subject, of course, to matters determined by the government to be proprietary information or trade secrets. Issues like the contract definitions and descriptions of the scope of work, as appeared to be at issue in this case, would hardly ever be considered proprietary information or trade secrets.

Will FOIA be foiled by outsourced subcontracting?

I have previously reported how a couple of states have responded to claims that contractors are immune from making disclosures under Freedom of Information Act requests, using that phrase loosely since rights to government data are not uniform, either in substance or practice.

In Reveal the truth or face the consequences, I discussed a New Mexico state decision that followed Florida law to the effect that contractors who perform state functions by acting on behalf of a government entity must disclose disclosable information under the relevant local FOIA law. The test applied there was essentially based on an agency analysis under the totality of the circumstances.

The issue is being raised elsewhere, as revealed in the following two articles.

Transparency Outsourced as U.S. Hires Vendors for Disclosure Aid

At least 25 federal agencies are outsourcing parts of the FOIA process. The contractors, sometimes using workers with security clearances, are building FOIA software, corresponding with requesters, redacting documents and recommending what information should be withheld.

With contractors involved, the process becomes more complicated because the companies employing the FOIA workers aren’t directly subject to FOIA laws, said John Wonderlich, policy director at the Sunlight Foundation, a Washington-based group that pushes to open government records.

“If I was in charge of an agency and wanted to create an unaccountable FOIA process, the first thing I would do is put an outside contractor in charge of it because fewer of our accountability laws apply to them,” Wonderlich said in an interview. “It would just be another layer between me and the public.”

Using contractors to answer FOIA requests falls into a murky area of law, said Scott Amey, general counsel at the Washington-based Project on Government Oversight.

The vendors aren’t allowed to approve agency responses to FOIA requests because the work is considered “inherently governmental,” according to federal acquisition rules. On the other hand, they are permitted to “support” the preparation of responses.

While contractors may suggest what information will be released, redacted or denied, the agency must make the final decision, Amey said.

“They are walking right up to the line,” he said. “It still makes you question the integrity of the system if contractors play such a vital role and merely have their guidance approved.”

Some open-records advocates say hiring contractors to speed up the FOIA process may help federal agencies as they wrestle with budget cuts and a growing backlog of requests. FOIA contractors know employees aren’t allowed to make decisions for the government and would never cross that line, said Randolph Wagner, chief financial officer for Wagner Resources Inc., another Gaithersburg-based company.

“It’s more like a cliff,” said Wagner, whose company derives about 50 to 60 percent of its revenue from FOIA-related tasks. “We don’t want to make the decision on behalf of the government.”

His employees, who work on-site at agencies, may be involved in the process from “beginning to end,” he said.

They receive requests, communicate with information seekers and contact agency officials to retrieve the records, Wagner said. When they receive the records, his employees provide recommendations about how much information can be released. A higher authority in the agency makes the final decision, Wagner said.

The FOIA offices aren’t manned to handle all of the work, Wagner said. “In most cases, we outnumber the people we work with, three to one. They’re the decision-makers and we’re the workers.” The work isn’t glamorous and there isn’t much opportunity for federal employees in FOIA offices to get promoted, Wagner said. “If you want open transparency, you’ve got to have somebody work on it,” he said.

Government contracts called public data

In a sweeping ruling Tuesday, the Minnesota Court of Appeals said government contractors are subject to state open records laws.

The ruling means that Milwaukee-based Johnson Controls must reveal to Timberjay Newspapers of Tower, Minn., details of its subcontract with a Minnesota architectural firm to build schools in St. Louis County.

Helmberger was concerned about flaws he noticed in an $80 million project involving construction and renovation of several St. Louis County schools, whose district contracted with Johnson Controls for the project. In 2010 he requested a copy of Johnson's subcontract with Duluth-based Architectural Resources Inc. under the state's Data Practices Act. Johnson refused Helmberger's request, maintaining that the contract contained proprietary secrets and was not subject to open records laws.

Under the law, private residents or businesses contracting with the government must comply with the Data Practices Act "as if it were a government entity."

In March 2011, the Minnesota Department of Administration sided with Helmberger, but an administrative law judge threw out the request because the subcontract "did not involve the performance of a governmental function."

The Appeals Court disagreed, arguing that the planning, design and construction of five public schools falls under state laws that mandate the duty of a school district to "furnish school facilities" to children -- including constructing and renovating buildings.

Attorneys for the contractors have not yet decided whether to petition the state Supreme Court to hear the case.

Procurement reform -- India

A procurement policy to curb corruption soon The government is working on a new central public procurement policy to bring transparency, curb irregularities and corruption.

The policy aims to plug the inconsistencies in the government purchases as there is no uniformity in guidelines.

he procurement of services will also be part of the new policy for engaging experts on contracts instead of permanent employment involving salary, service benefits and pension to avoid a big drag on the government's economy.

The services are sought to be procured in the PPP (Public, private partnership) mode. So far there are absolutely no rules for hiring experts and others for providing services.

He points out that many countries have such a policy in practice for many years while it is for the first time when India is drafting a foolproof policy.

Raman gives credit for the whole idea to Central Vigilance Commissioner Pratyush Sinha who wrote to the Cabinet Secretary in February, stressing need to put in place a comprehensive public procurement standards in India with a single authority to handle the task.

There will be, however, no centralised procurement, clarified M Raman, who has prepared a concept paper on the draft public procurement policy before laying down the office as the Director General of Supplies and Disposal (DGS&D) last month-end.

Officers who held a round of meetings on Sinha's suggestion, however, disagreed on the controls going into the hands of a single agency.

Raman's draft paper suggests a Central Public Procurement Law to cover purchases by all government departments and organisations and lay down rules for different type of procurements.

He has recommended two laws: A substantive law enacted by Parliament to lay down rights and obligations of the public procurement entities and a procedural law that may be laid down by the government, without going to Parliament, to specify the sector-specific rules and procedures for procurement.

The ministries can tweak the second but it should be "in complete concordance with the public procurement law, both substantive and procedural."

Slovakia's procurement "reform"?

It is hard to understand how anything that would reduce means to accountability can be considered "reform". Hopefully there's a better explanation than this article reports.

Sme reports that Slovakia’s Act on Public Procurement is amended

Slovakia’s ruling coalition, led by Prime Minister Robert Fico’s Směr party, recently passed an amendment to the Act on Public Procurement that abolished the right of the country’s Public Procurement Authority (ÚVO) to file a lawsuit in the event that the procurement law is violated, the Sme daily wrote on its website on April 19.

Sme wrote that if state ministries violate the public procurement law and sign a contract damaging the state, no public body will be able to question the contract involved and that from now on only competitors or tender participants will be able to file such a motion – but only if they cover a court fee amounting to €100,000. The fee will be returned only in case of victory in the trial, according to Sme.

Sme wrote that the only court in Slovakia where such a suit can be filed is in Malacky.

According to Transport Minister Ľubomír Vážny the amendment was proposed by Smer under pressure from private businesses. Sme reported that the minister told public-service Slovak Radio that “bank consortiums” claimed to the state that they would loan funds for planned PPP highway projects only “if this chance for the ÚVO to attack a contract will cease to exist”.