by Melanie Grimmitt
One of the most interesting aspects of working in different jurisdictions is seeing how different regions approach the same issues in different ways – both legally and commercially. An example of this in the context of PPP transactions, is the differing approach taken in the UK and the Middle East in respect the inclusion of delay liquidated damages regimes in Project Agreements.
Liquidated Damages in UK PPP transactions
In the UK, the general presumption is that a Project Company will not be liable for delay liquidated damages in the event that the service availability date (or “commercial operation date”) is not achieved by the relevant target service availability date (or “scheduled commercial operation date”). Indeed, English guidance suggests that delay liquidated damages should only be included in exceptional circumstances.
The main reasons for this are three fold:
First, English law prohibits the levying of penalties and liquidated damages must be a genuine pre-estimate of loss. In the majority of PPP projects it is difficult to envisage how a procuring authority will suffer any loss and, accordingly, how liquidated damages will be held to be anything other than a penalty. This is because the procuring authority is unlikely to have made any capital contribution or other payment during the construction phase and the fact that it will not be obliged to pay the service charge until the service availability date is actually achieved. Therefore it is unlikely that the loss that the procuring authority suffers as a result of any delay to commencement of the service will be greater than the service charge it will no longer be obliged to pay in respect of such delay.
Secondly, the way in which PPP projects are structured means that there is already a large incentive on the Project Company (and the Construction Sub-Contractor) to achieve the service availability date on or before the target service availability date. As mentioned above, the procuring authority will not start paying the service charge until the service availability date is achieved. However, the payment profile of senior debt (principal and interest) is likely to require repayment to start on, or soon after, the target service availability date. Where, as a result of delay, the service charge is not being paid to the Project Company on the date that it has to start making debt repayments then the Project Company has a funding gap. This funding gap is filled by the Project Company levying delay liquidated damages on the Construction Sub-Contractor under the Construction Sub-Contract. Accordingly, the Construction Sub-Contractor is incentivised to minimise delay through the operation of a delay liquidated damages mechanism even where no such mechanism exists in the Project Agreement.
Thirdly, best value for money is not likely to be achieved by including a delay liquidated damages mechanism in a Project Agreement. As we have already seen, a PPP Construction Sub-Contract is likely to include a delay liquidated damages mechanism even if the Project Agreement does not. The Construction Contractor will mitigate its exposure to such delay liquidated damages by both including a financial contingency in its price and a time contingency in its construction programme. Both such contingencies will be included in the Project Company’s service charge and construction programme. Should the procuring authority include a delay liquidated damages mechanism in the Project Agreement, then the Project Company will simply pass down in full such mechanism to the Construction Sub-Contractor in addition to the “debt service” liquidated damages that would have be included in any event. Obviously the effect of this is that the financial and time contingencies in the project would be significantly increased and this is unlikely to provide best value for money.
The common position in the Middle East
General market practice in the Middle East is almost entirely the opposite. The inclusion of substantial delay liquidated damages in PPP/BOT Project Agreements is common. Of course, this means that a full pass down of risk from the Project Company will require the Construction Sub-Contractor to assume both the Project Agreement delay liquidated damages and well as the “debt service” delay liquidated damages (referred to above). This is likely to create a significant daily liability for the Construction Sub-Contractor.
The reasons for such a differing approach could be down to the combination of a number of factors:
The law of most Middle Eastern countries does not prohibit penalties in the same way that English law does. Accordingly, there is less of an emphasis on whether the Project Agreement delay liquidated damages are a genuine pre-estimate of loss. However, note that under the Civil Code of many countries in the region, where the amount of compensation payable in respect of a breach has been fixed in advance by the contract (eg. delay liquidated damages) a party may apply to the court and request that such compensation be adjusted to reflect the actual loss suffered by the relevant party. In some jurisdictions that adjustment may be downwards only, in others it may be upwards or downwards. Whether the courts actually exercises that discretion in practice is a different matter and difficult to predict.
The majority of PPP / BOT projects tendered to date in the region are for process plants and not accommodation based projects. It may be that the price that the procuring authority would pay for the relevant off-take (eg. power or water) under the relevant purchase agreement is significantly less than the price that it is paying, or costs that it is incurring, for its current supply. In such circumstances it is possible to envisage that any delay in achieving the commercial operation date could cause the procuring authority to suffer a loss.
The procuring authorities in the region are not subject to the same obligations to achieve “best value” as their counterparts in the UK. Often, as is typical in the region, the emphasis is more on the speed of delivering the relevant asset than on achieving the absolute best value solution. To an extent, and certainly from a presentational perspective, it is possible to understand why this could lead to including delay liquidated damages in the Project Agreements.
Finally, there other cultural, commercial and structural factors. For example, whilst there have been a number of PPP / BOT projects in the region, some on a staggering scale, the market is still in its relative infancy and is a melting pot of different international contractors and advisors, each with a different idea of the “correct” way of doing things and all with a desire to do business in the region. Arguably, this leads both to the seeking of commercial positions that would not, necessarily, be sustainable in other markets as well as the willingness to accept commercial positions that may be severely resisted in the relevant home market. It remains to be seen whether an economic upturn might lead to a hardening of position on this and other points by the private sector.
Co-authored by Rob Graham, an associate in Pinsent Masons’ Dubai office