Dissecting (and understanding) PPP Contracts No. 1: The Step-in Rights

When a government agency and a private-sector proponent (PSP) enter into a formal, often, long-term arrangement, the ultimate aim is to provide a public service. So it would be to the best interest of everyone, parties and nonparties alike, project lenders included, if the contract will be operative up to the time the stated period expires.

However, as history will teach us, glitches, to put it mildly, occur midstream. Public-private parnertship (PPP) contracts have been terminated, guarantees called upon, traffic projections become useless, tariff adjustments not realized, and the PSP performs below par.

In the latter instance, the “step-in” rights provision may be invoked. The insertion of step-in rights provisions, or protective or intervention schemes is a security mechanism, which provides comfort to stakeholders.

(1) Who steps out? The PSP is the one who steps out. In which case, the PSP, depending on the type of nonperformance, can no longer continue being the operator, builder or service provider.

(2) Who steps in? There are two entities who have interests that the project is completed or proceeds as envisioned. The government and the lender of the PSP can step into the shoes of the PSP. Government is bound to continue with the project since it is ultimately bound to the public to deliver the service.

On the other hand, the lender must make sure that it can recover what it lent out to the PSP borrower from the revenues that will be generated from the operations of the project. The lender-bank does not actually assume the actual operations. It can engage a qualified operator or contractor to do the actual work. It can also just opt to gain control over PSP decision-making processes.

(3) Why step-out? The principal reason the PSP steps out and the government or lender steps in is the nonperformance or default of the PSP of its commitments that will have an adverse impact on the project. If the PSP abandons the project or does not meet the specified targets, the substitute or “savior” or its nominee takes the cudgels from the PSP.

(4) Who must agree to this? When the government who is party to the contract steps in, normally, no approval from any other entity is required. However, when the lender steps in and nominates a substitute, the approval of government is sought. Government must determine that the new operator is eligible, i.e., it complies with the relevant nationality requirement, has the track record, technical expertise and financial resources.

(5) For how long? Normally, the substitution of the PSP is temporary. Reversion to the original setup can happen when the PSP is able to cure the reason that led to the stepping in. Government, for instance, will be reimbursed of costs it incurred. Substitution can only be permanent. In which case, novation takes place and the substitute becomes the new PSP.

Allowing another to step-in when the original proponent fails contributes to the “future-proofing” of PPPs. While such a provision are embedded in PPP contracts, PSPs desire that they will not step out and someone else steps in.