Ted Gibbs of The Walsh Group, Ltd. co-authored this article.
The primary vehicle for allocating design and construction risk in a public private partnership (P3) using the design-build-finance-operate (DBFOM) P3 model is the Relief or Supervening Event regime in the public private agreement.1 A Supervening Event entitles the private partner to some financial or schedule relief from the public authority under the public private agreement (PPA).
The PPA will be consummated in a competitive request for proposal process including input from the public partner, private partner, and impacted participants including developers/equity providers, lenders, design-builders, and operation and maintenance service providers. This article focuses on the Supervening Events that can have an impact on these participants during the construction phase of the PPA. The Supervening Event issues addressed in this article include
- Voluntary changes or breaches by the public sector
- Right of way/land access
- Permits, environmental conditions, endangered species, archeological conditions and hazardous materials
- Changes in law
- Labor shortages or strikes
- Other force majeure events
- Differing site conditions
- Utility delays
Before we get into the case law and sample contract terms for these issues, it is worth pausing to reflect on how the financial markets view these risks in terms of rating the financial risks associated with a P3 transaction. Moody’s has published a wide variety of risk and rating data based on P3 transactions and financing risks. Here is Moody’s risk factor summary from a P3 rating article published in 2016:
|Factor 1 – Construction risk allocation between the public and private sector|
|Factor 2 – Construction complexity|
|Structure complexity and construction technique risk|
|Construction constraints risk|
|Factor 3 – Constructor/Consortium experience and project readiness|
|Factor 4 – Resilience of constructor to cost overruns|
|Profit margin and contingency/robustness of budget build-up|
|Strength of the constructor and relative size of the project|
|Factor 5 – Resilience of project to construction schedule overruns|
|Construction schedule room|
|Liquidity to withstand a schedule overrun|
|Ease of replacing constructor|
|Amount and quality of security available to replace constructor or mitigate losses2|
Supervening Events are largely meant to deal with Factors 1 and 2. The other factors are dealt with in the procurement and security package terms.
As it relates to Supervening Event risks, here is a modified version of Moody’s analogous risk allocation table:
|Typical Construction Risk Allocation in a PFI/PPP/P3 Project|
Understanding these, and other, rating methodologies is critical to implement an effective P3 procurement and contract negotiation. It is therefore critical to engage an experienced team of financial, legal, and technical advisors to establish and structure the P3 procurement. With this background, we turn to the legal and contractual issues implicated in a U.S. P3 DBFOM model for dealing with the primary Supervening Event risks.
Basic contract sample language defining the sub-categories of Supervening Events is offered effectively by the Federal Highway Administration’s contracting guides. Here is FHWA’s sample term dealing with Compensation Events:
|Compensation Event means the occurrence of any one or more of the following events or conditions:|
|a||Any breach of this [Concession Agreement] by the [Department];|
|b||Any violation of [Applicable Law] by the [Department];|
|c||A [Department Change] (other than a [Non-Discriminatory O&M Change]), a [Discriminatory O&M Change] or the issuance of any [Directive Letter];|
|d||The issuance by the [Department] of any [Safety Compliance Orders];|
|e||Any [Qualifying Change in Law];|
|f||Any damage, interruption or interference to the [Construction Work] caused by a capital works project (other than the [Project]) by the [Department] or another [Governmental Entity] (or any contractor on behalf of the [Department] or another [Governmental Entity]) in the vicinity of the [Project Right of Way], excluding any [Utility Relocation Work] or work performed by a third party that is the subject of a [Third Party Agreement];|
|g||The granting of access to the [Project Right of Way] that is subject to restrictions of use and/or right of entry permits in either case not specified in the [Concession Agreement];|
|h||Any suspension of the [Construction Work] has occurred and is considered a [Compensation Event] pursuant to the [Concession Agreement];|
|i||The execution by the [Department] of any [Third-Party Agreement] after the [Setting Date] on terms materially inconsistent with the versions referred to in the [Technical Requirements];|
|j||Any breach of a [Third Party Agreement] by a third party, as applicable;|
|k||Any amendment or variation to the terms and conditions of any [Third Party Agreement] or [Department-Provided Approval] after the [Setting Date] (including any variation to the terms and conditions of any final [Department Provided Approval] (or the terms and conditions of any extension or renewal thereof) as compared to the draft thereof provided to the [Developer] prior to the [Setting Date], except to the extent that such variation is the result of a difference between the [Reference Design] and the [Developer’s] [Final Design]);|
|l||Any physical damage to the [Project] directly caused by a capital works project (other than the [Project]) carried out during the [Operating Period] by a [Utility Owner] or any other [Person] acting under a permit issued by the [Department] in the vicinity of the [Project Right of Way];|
|m||Issuance of a temporary restraining order, preliminary or permanent injunction or other form of interlocutory relief by a [Governmental Entity] or court of competent jurisdiction under [Applicable Law] that materially and adversely affects the [Department’s] or the [Developer’s] performance under the [Agreement], except to the extent resulting from the negligence, willful misconduct, recklessness, breach of contract or [Applicable Law], or violation of a [Governmental Approval], by any [Developer-Related Entity];|
|n||Issuance of a rule, order or directive from U.S. Department of Homeland Security or comparable [State] agency regarding specific security threats to the [Project] or the region in which the [Project] is located or which the [Project] serves, to the extent such rule, order or directive requires specific changes in [Developer’s] normal design, construction, operation or maintenance procedures in order to comply;|
|o||discovery of archeological, paleontological or cultural resources on the [Project Right of Way], excluding any such resources known to the [Developer] on the [Setting Date]];|
|p||any release of [Hazardous Substances] into the [Project Right of Way] by the [Department] or any [Department Related Party];|
|provided, however, that each of the above events does not arise by reason of:
And here is FHWA’s sample contract provision dealing with Delay Events:
|Delay Event means the occurrence of any one or more of the following events or conditions:|
|a||[Force Majeure Event];|
|b||*[the discovery of an [Undisclosed Geological Condition] during the carrying out of the [Construction Work]];|
|c||*[the discovery of any [Undisclosed Endangered Species] during the carrying out of the [Construction Work]];|
|d||*[the discovery of any [Undisclosed Hazardous Environmental Condition] during the carrying out of the [Construction Work]];|
|e||*[the discovery of any [Unforeseen Utility] during the carrying out of the [Construction Work]];|
|f||*a failure to obtain, or an unreasonable and unjustifiable delay in obtaining, a [Governmental Approval] by the deadlines specified in the [Concession Agreement];|
|g||any [Change in Law] that is not a [Qualifying Change in Law];|
|h||any [Non-Discriminatory O&M Change];|
|i||any release of [Hazardous Substances] into the [Project Right of Way] after the [Setting Date] other than by the [Developer] or its [Subcontractors];|
|except, in each case, to the extent attributable to any breach of this [Concession Agreement] by, or any negligent act, or negligent omission of, the [Developer] or any of its [Subcontractors].|
|* [internal citations omitted; see FWHA guide for specific terms.|
Right of Way/Land Access
As noted in applicable construction law reference documents, "where plans, specifications and conditions of contract do not otherwise provide, there is an implied covenant that the owner of the project is required to furnish whatever easements, permits or other documentation are reasonably required for the construction to proceed in an orderly manner."4 An owner interested in changing this “implied covenant” and shifting access risk to a private partner would: a) need to include language in the contract specifying the transfer; and b) understand that the risk profile would be much higher. Indeed, Moody’s advises that “[t]he most supportive risk allocations from a credit point of view are those where . . . the sponsoring government keeps the risks that cannot be easily controlled/priced by the private sector (such as land acquisition) and provides both for schedule relief and timely compensation for those risks.”5
Permitting and Environmental Risks
The Moody’s matrix notes that some permitting is best handled by the government (long lead time permits) and some by the private partner (construction permits). Leading construction lawyer Patrick O’Connor identifies the following environmental risks: asbestos, underground storage tanks, lead paint, contaminated soils, wetlands, coastal zone areas, brownfields, endangered species, storm water runoff, construction waste, PCBs, other hazardous materials, and indoor pollution.6
The critical point for Supervening Event management is that applicable permits and environmental regulations or conditions must be identified as early as possible and allocated to the party best positioned to manage the process of securing them. The tool for allocating responsibility between the public and private partners is typically the Supervening Event clause and related permit exhibits. And in simple terms, if the government fails to obtain permits on its list, then the private partner would be entitled to relief.
Adverse weather conditions are one of the most common causes of construction delays and disputes. Weather conditions, while incapable of being predicted with absolute certainty, are predictable to a degree. Therefore, as a general rule, the risk of weather delays lies on the private sector partner. “In the words of one court: ‘[i]t is well-established … that supervening circumstances making the performance of a promise more difficult and expensive than originally anticipated is not enough to excuse the promisor.’”7
Changes in Law
Statutory or regulatory changes are another key concern for implementing long term P3’s and similar deals. Here is an instructive Illinois case law example:
In Robbins Resource Recovery Partners, L.P. v. Edgar, Foster Wheeler developed and operated a municipal recycling-and-solid waste-to-energy facility. The economic justification for the project was grounded in an Illinois law that required utility companies to enter into 20-year contracts to purchase electricity from qualified solid-waste-to-energy facilities at retail rates instead of at a federally set regulatory rate. As Foster Wheeler's project was nearing completion, the Illinois legislature amended its retail rate statute to cover only facilities that convert methane gas into electricity. While Foster Wheeler's facility met the requirements of the original law, the facility did not qualify for preferential rate treatment under the revised law. As a consequence, the economics of the facility were turned upside down and, eventually, Foster Wheeler abandoned the project after losing substantial sums of money.8
Labor Shortages or Strikes
It goes without saying that the private sector partner/developers will be responsible for providing the work and labor necessary to complete the construction improvements required in the public private agreement. Moody’s suggests that industry-wide labor strikes should give rise to relief event9; however, a general labor shortage is not generally considered basis for relief in favor of the private sector.10 Case law dealing with specific labor unrest on a project itself offers a number of lessons:
[a]s a general rule, delays and extra expense caused by strikes or labor unrest, including refusal of workers to cross picket lines, are excusable but not compensable. In other words, the contractor is able to avoid paying the owner for its delay damages but is not entitled to recover its own costs associated with the delay. This also holds true for extra costs incurred by the contractor to work around or through a strike. If labor unrest or a strike is reasonably foreseeable such that the contractor should have taken it into account when preparing its bid and entering into the contract, the delays associated with the labor problems may become the contractor's responsibility. Similarly, if the strike is caused by the contractor engaging in an unfair labor practice, the delay associated with the strike will not be excusable. Unfair labor practices committed by subcontractors may, however, be beyond the control of the general contractor and, therefore, may be excusable. The occurrence of a labor strike, even if unforeseen, will not give rise to a right of recovery under the government's differing site conditions clause. A long line of precedent has imposed a temporal limitation on the applicability of the Differing Site Conditions clause and the Changed Conditions clause.11
Other Force Majeure Events
Force majeure is a French doctrine that is embodied in American case law in the equitable defense of impossibility. The concept is that courts will excuse performance if an unforeseen condition, outside the control of the parties, renders performance impossible. As a general rule, the doctrine will not apply where the parties allocate risks in the written contract.12 Therefore, it is recommended the contract contain a robust force majeure clause to deal with as many contingencies as possible. Legal advisors to the developer should strongly consider circumstances that will give rise to right to terminate the public private agreement.
Here is the sample force majeure clause offered by FHWA:
|Force Majeure Event means the occurrence after the date of this [Concession Agreement] of:|
|a||war, civil war, invasion, violent act of foreign enemy or armed conflict;|
|b||nuclear, chemical or biological contamination unless the source or cause of the contamination is brought to or near the Site by [Developer] or its [Key Contractors] or is as a result of any breach by [Developer] of the terms of this [Concession Agreement]; or|
|c||ionizing radiation unless the source or cause of the ionizing radiation is brought to or near the Site by [Developer] or its [Key Contractors] or is as a result of any breach by [Developer] of the terms of this [Concession Agreement]; or|
|d||any blockade or embargo;|
|f||any act of [Terrorism],
In each case which directly causes either [Party] (the Affected Party) to be unable to comply with all or a material part of its obligations under this Agreement.
Differing Site Conditions
Underground soil conditions are a major risk factor on any project requiring substantial earthwork or deep foundations. Techniques available for evaluating soil conditions have improved drastically in the last fifty to seventy-five years, and the public authority should be able to identify underground soil conditions. A conceptual challenge can arise in a P3 setting where the government wishes to transfer all or most risk but does not or cannot allow for the time, money, and expertise necessary to conduct a meaningful site investigation before awarding the contract. This is reflected in the Moody’s matrix, which places geotechnical conditions with the private sector, utilities with both parties, and archeological conditions with the public sector. As a practical matter in a vacuum, the site due diligence and investigation is better suited for the government to handle as a preliminary matter before even undertaking any procurement, whether P3 or otherwise. The data and baseline geotechnical reports can then be given to the prospective private partners during the procurement to enable the most effective pricing competition and risk.13
Utilities are one type of underground condition that warrants special attention. There are a number of starting assumptions or issues. First, the government should possess or have access to information about existing utilities within the project site, raising the question whether the government will make that information available in the procurement and in such a way so as to allow reliance on the information by the private sector partners. Second, many states regulate or create special remedies against contractors that damage preexisting utilities. Both issues should be examined and dealt with in the Supervening Event clause.14
- P3 Contracting and Risk: An Introduction to Public-Private Partnerships for U.S. Transaction, PLI Building Better Construction Contracts, 2017, p. 4
- Construction Risk in Privately-Financed Public Infrastructure (PFI/PPP/P3) Projects, Moody’s Investor Services, 2016, p. 5
- Id., p. 9.
- Bruner & O’Connor on Construction Law, Sec. 7.65, citing COAC, Inc. v. Kennedy Engineers, 67 Cal. App. 3d 916, 920, 136 Cal. Rptr. 890 (1st Dist. 1977), quoting Visintine & Co. v. New York, C. & St. L. R. Co., 169 Ohio St. 505, 9 Ohio Op. 2d 4, 160 N.E.2d 311 (1959). See also Lapp-Gifford Co. v. Muscoy Water Co., 166 Cal. 25, 134 P. 989 (1913) (owner could not seek delay damages from contractor as it had obligation to secure right-of-way from railroad); Nat Harrison Associates, Inc. v. Gulf States Utilities Co., 491 F.2d 578 (5th Cir. 1974) (owner liable to contractor for delay in securing right-of-way for transmission line project); Appeal of Perini, Horn, Morrison-Knudsen, E.N.G.B.C.A. No. 4821, 87-1 B.C.A. (CCH) ¶ 19545, 1987 WL 40950 (Corps Eng'rs B.C.A. 1987) (owner responsible for delays where it represented work could proceed during certain times but this was not possible due to actions of third party railroad).
- Moody’s at 8.
- O’Connor, 7:92.
- O’Connor at 7:230, citing Barnard-Curtiss Co. v. U. S., 157 Ct. Cl. 103, 301 F.2d 909, 912 (1962). See also S.J. Lemoine, Inc. v. St. Landry Parish School Bd., 527 So. 2d 1150, 47 Ed. Law Rep. 1248 (La. Ct. App. 3d Cir. 1988) (rain and cold were not unforeseeable adverse weather conditions entitling contractor to relief from delays to the work).
- O’Connor, 7:234
- See Moody’s risk allocation table, endnote iii above.
- O’Connor, 7:82.
- O’Connor, 7:81-83
- O’Connor, 7:229
- For a discussion of engineering standards and case law dealing with differing site condition claims on construction projects, see O’Connor, 14:17 – 21.
- For case law dealing with utility disputes on construction projects, see O’Connor, Section 7:68.