As we end the first quarter of 2023, it’s safe to say no one could have anticipated the myriad of challenges that now face public-private partnership (“P3”) deals. Inflation continues unabated, while interest rates continue to rise. Supply chains are complicated and tangled, and the high-profile closure of Silicon Valley Bank and the two-stage rescue of First Republic Bank has rattled regulated and unregulated lenders creating a very cautious lending environment.
That being said…it’s not all bad news. Beneficiaries of the Infrastructure Investment and Jobs Act (“IIJA”) remain poised for new deals. Projects are moving forward, but deal structures and risk allocation among participants must change to address current economic and market challenges.
Adaptation may be the word of the day when it comes to complicated P3 projects as evidenced by a movement toward partnering approaches where fixed-price deals are no longer an option. Parties are using predevelopment agreements (“PDAs”) as part of progressive P3 structures. Progressive P3 structures have been made necessary because of inflation, credit scarcity and contractors’ refusal to work on a fixed price basis. Lenders and equity sponsors are reluctant to take on long term revenue and operating cost risk. Owners are impacted by lower projections, loss of liquidity and the passage of time. Volatility and uncertainty have dramatically changed the risk allocation landscape forcing parties to address risk during the predevelopment agreement stage.
In this blog we look at how negotiations are changing and how parties are adapting to a rebalancing of risk between the private and public parties in the face of increasing risk that accompanies the increasing uncertainty. It’s a daunting process for both the public and private sectors when the average project often exceeds 30 years.
Predevelopment Agreements and Progressive P3 Approaches
In response to pricing uncertainty and volatility, PDA’s are becoming a part of the procurement process. Negotiating a PDA forces parties to focus on partnership behavior at the inception of the process. Under this process, project awards are made on a range of criteria instead of being limited to committed pricing. This approach allows the parties to adapt to persistent construction cost inflation and allows negotiation of inflation risk-sharing protection measures through bidding and delivery.
The progressive P3 approach provides the opportunity for the parties to work as partners together to define the project requirements, design, pricing and risk through a development phase that begins with the selection of a partner, often through a competitive procurement process. The development phase must rely on transparency and good faith negotiations based on the parties’ experience and expertise. As projects are increasingly complex, the quality of the discussion during the development phase is a “make or break” factor for the project. There is an underlying assumption the parties participating in the development phase are better suited to apportion risk and the public and private sectors are motivated to share risk in a way that makes sense over the life of the project.
Parties are quickly learning to negotiate project governance during the development phase because risk allocation is dependent on execution. Where risks are to be shared, no party should accept governance that does not provide for timely communication and disclosure. Parties should also insist on the ability to object before any decision is implemented and on user-friendly dispute resolution procedures for when objection is not enough.
Necessity is going to force parties to change their behavior if projects are to proceed. Participants will need to recognize that risks will be unique for each project, and traditional risk allocation may need to adapt to both the current and anticipated environment. For example, economic and financial uncertainty requires owners to think carefully about project scope, risk allocation, cost and time to completion. This can be addressed through phasing and adopting different approaches to reach risk sharing acceptable to private and public project participants.
Parties long used to fixed-price contracts and traditional contract enforcement will need to consider that progressive P3’s require active ownership and engagement. Stated another way, progressive contracts are a different kind of transaction that require ongoing participation, negotiation and implementation of agreements regarding new phases. It is no longer a “one and done” contract. It is an active process that requires a higher level of collaboration, engagement, and an active effort to preserve relationships. Progressive P3’s will break down if aggressive approaches are taken placing project completion at risk.
For behavior to change, all parties need to be vested in successful project completion and need to find an allocation of risks and rewards that is sufficient to keep everyone at the table and corroborating. To be sure the progressive P3 is as complicated as the project being undertaken is complex. For this reason, all of the parties participating need to carefully consider their respective risk/reward proposition and care should be taken by all parties to ensure a level negotiation platform. Taking unfair advantage of a party creates an illusory short-term win that almost guarantees a long-term adversarial relationship that puts the project at risk. Creating a successful P3 project is, in this respect, like creating a nation. In the words of Benjamin Franklin, we must all hang together, or, most assuredly, we shall all hang separately.
Progressive P3’s and Dispute Resolution
The very structure of a progressive P3 creates a need for careful project governance and specialized dispute resolution procedures designed to prevent and mitigate disputes. Dispute resolution provisions need to be carefully drafted to reflect the needs of the parties and the project. Escalation provisions and the ability for the parties to negotiate the type of dispute resolution required when a dispute arises can be efficient and reduce cost. Rapid, efficient resolution of disputes during the course of the project will always be better for the project, and the parties, than the nuclear options of termination, arbitration, and litigation.
Marc Benioff has said “You must always be able to predict what’s next and then have the flexibility to evolve”. P3 project parties have the opportunity to adopt partnership behaviors that will provide the flexibility to successfully access IIJA and other funds to complete infrastructure projects this country desperately needs. There is no need for P3 projects to languish because fixed-price contracts are no longer an option.
In our future blogs we will be looking at specific corporate governance and dispute resolution issues for progressive P3’s. We will consider the parties’ and the project’s unique needs and how best to prevent and mitigate disputes. We will address options for dispute resolution and provide tips on drafting corporate governance and dispute prevention and resolution contract provisions that are designed to help implement a user-friendly, cost effective, and efficient partnership between the parties.