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May 19, 2015 Articles

Public-Private Partnerships

By John W. Ferrara

Public-private partnerships, referred to as P3s or PPP, originated decades ago in Europe and have existed in the United States since the 1990s. Their goal is to design, finance, build, manage, operate, and maintain assets that deliver services to the public and serve as an alternative to financing provided exclusively by the government. The belief that infrastructure could be provided at no cost to the public has long been abandoned, but this belief is often the starting point for many who are now being immersed in P3 as if it had just been invented. A P3 does not make funds suddenly appear or transfer the responsibility for payment away from our citizens. P3s will ideally enable the repair or new construction of assets and allow more consistent delivery of services, generally utilizing already existing tax revenue to pay for projects. The government in partnership with private expertise can deliver better services than the government alone. While the below discussion focuses on P3s that are created as a result of specific state legislation, there is, however, a plethora of "P3-like" work being done through nongovernmental agencies (NGOs) and without any government involvement. The various types of forms a P3 can take can get very complicated.

The requirement to stay within a budget along with many other factors impede the long-term planning that is needed for successful P3s and has resulted in many disputes about quality, timing, and economic viability. The need to build in a low-cost manner so that services can be delivered as quickly as possible is often adverse to maintaining the long-term condition of the assets. This constant tug of war often results in counsel being asked to reconcile differences that could destroy the business side of a P3. The historical expertise gained by construction and structured finance attorneys in their disputes and contract practices has placed them in positions to be critical advisors to both the governmental entities and the consortiums. Litigation- and transaction-oriented attorneys can expand their practices into the P3 space, but must stay politically attuned. Keeping up with the changing landscape of contracts is vital, just to maintain your level of incoming business. One area that is expected to see an increase in disputes is in the area of eminent domain due to the takings needed to expand public facilities. Brandon Formby, "Texas Bill Aims to Strip Toll Company of Eminent Domain Use," Dallas Morning News, Jan. 26, 2015.

Back when the U.S. economy was thriving, prior to the financial crisis and going back to the first U.S. P3s in the 1990s, governmental entities had little incentive to consider P3s as an alternative financing method. The 2008 downturn, however, reawakened discussion of P3s as a means of improving and repairing the U.S. infrastructure, and was often seen as a universal panacea. The exuberance was far ahead of a true understanding of how P3s are formed, developed, and brought into service. Unfortunately, few understood the complexity of the process and lacked a true understanding of the risks and rewards that exist within the partnership.

The goal of a P3 is to deliver better services for longer periods, while keeping the assets in good condition for the duration of the agreement and hopefully beyond. Even though a well-run, successful P3 can be an ideal alternative to traditionally run public services, the complexity of a P3 could scare those who have little time and or training on the subject. The stress of the 2008 financial crisis and the dire outlook moving forward created an urgency that was filled with the fear of the unknown. The need for a true "partnership" where the risks and rewards are fully known and apportioned to the partners that could best manage and understand them has been elusive at best. The various types of regimes used to deliver a solution can get very complicated. As a result, a handful of highly touted successes has been matched with a spattering of disputes, restructurings, and bankruptcies, which are not normally seen so early in the P3 lifecycle. If total lifecycle costs of the project are not addressed, the joint venture (JV) model, which is commonly used by P3s to complete projects, will not capture total costs, and ultimately cause the JV to fail at its very early stages. The Indiana Toll Road is a recent example. See D. Bruce Gabriel & Roderick N. Devlin, "Market Update: A Review of the US Public Private Partnership (P3) Sector in 2014," Practical L. (Jan. 7, 2015). This P3 contained a 75-year lease, which started in 2006 and declared bankruptcy in September 2014, only nine years into the lease. Tom Coyne, "Australian Company Buys Bankrupt Indiana Toll Road Vendor," Indy Star, Mar. 11, 2015. Although the recession is blamed for the failure, the motivation of drivers to avoid tolls is real, and an elusive statistic to measure. For that reason, some P3 states do not allow the use of tolls in P3s. When high-profile failures arise, even the most optimistic proponents of P3s take pause.

The European market and rest of the world had seen successful P3s created 30 years ago, and they were more easily structured because the political system and overall process were much less complicated. This issue is a critical impediment to moving any P3 forward. One of the most consistent suggestions to streamline the process is a central federal P3 office. This was suggested in the Report by Panel on Public-Private Partnerships.

The Process
As of May 2015, roughly 33 states have some form of legislation allowing P3 projects to be initiated.  "State P3 Legislation," Off. of Innovative Program Delivery, (last visited May 7, 2015). Unfortunately, the legislation is not uniform, has many restrictions, and has almost exclusively been targeted to a limited asset class consisting of transportation, water, and courthouses. Within these states, projects are considered for a P3 structure, and then potentially develop to the point where the governmental agency hires an outside team to work with the governmental team. This team will usually be composed of a financial advisor, technical advisor, and legal advisor, with one of these advisors being chosen as the lead advisor. This team will solicit consortiums, which, at a minimum, will include a funder, technical advisor, and legal advisor. Several teams are asked to bid for the project, with a "short list" of consortiums eventually decided upon—usually three to four. Each of these consortiums expends a great deal of time and money determining its best solution for a very competitive process. Bidding consortiums can expend several million dollars investigating feasibility and their best solution.

The winning consortium forms a JV or special purpose vehicle (SPV) with the governmental agency to complete the project. At this critical point, the success or failure of the P3 will be determined. A wide array of difficult questions confront the P3 at this stage: Will the JV work in partnership to uncover and make known all of the risks and appropriately share the risks? Will it maintain ownership of the assets or move some percentage into the JV? How will the value of those assets be determined for transparency purposes? If the agenda of any party to the JV is to "get the best terms for its side," the JV is doomed from the outset. The risk and rewards must be amicably apportioned so that trust and transparency are evident to all interested parties. A properly constructed P3 will find its term ending in 20 or 30 years or longer, with the asset maintained in the same usable condition as it was when the JV was started.

P3s are complex structures that are difficult to understand, have many moving parts, and require long lead times with potentially large investments of time and money. P3s are needed when, at the core of the process, there is an integral need to understand and navigate the local political terrain. P3s are not fully understood, and much education and re-education is required in order for even one P3 to proceed, let alone proliferate throughout the United States and grow into more asset classes. The need to repair our infrastructure is forcibly keeping the P3 discussion alive, but simplification of the process is the only way to enable the trust factor needed to unleash P3s' real potential.

For more information, see Am. Inst. of Architects, Public-Private Partnerships for Public Facilities: Legislative Resource Guide (2014).

Keywords: litigation, minorities, public-private partnerships, P3s, financing, public services, joint venture, special purpose vehicle

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