NSW Government's "Working With Government: Risk Allocation and Commercial Principles"

By John Shirbin.

Key Points:
The recently released NSW Government's "Working With Government: Risk Allocation and Commercial Principles" provide an essential outline to the private sector as to the risk allocation and commercial terms which the Government will look for in privately financed social infrastructure projects.

The NSW Commercial Principles are substantially similar to their Victorian equivalent. There are, however, some differences to note between the NSW and Victorian regimes in relation to applying the Relief Event, Force Majeure Event, and Compensation Event terms.

NSW Risk Allocation and Commercial Principles: Purpose and philosophy

In May 2007, the NSW Government released its "Working with Government: Risk Allocation and Commercial Principles" ("NSW Commercial Principles"). The final form did not contain any material variations from the draft version issued in December 2006.

The NSW Commercial Principles set out the NSW Government’s preferred risk allocation for privately financed infrastructure projects. The document focuses on social infrastructure projects such as schools, hospitals and prisons, rather than economic infrastructure projects such as toll roads. The key hallmark of a social infrastructure project is that the private party’s revenues are service charges paid by the Government for developing the facility, making it available and providing support services such as facilities maintenance, cleaning and security.

The risk allocation outlined by the NSW Commercial Principles exhibits a high degree of commonality with its Victorian counterpart.[1]

This article will examine three aspects of the risk allocation under the NSW Commercial Principles - the "Relief Event"; "Force Majeure Event"; and "Compensation Event" regimes - and outline some of the differences between the regimes of the two States.

The "Relief Event" regime in NSW: An introduction

"Relief Events" are a class of events for which the Government bears the performance risk by relieving the private sector of its obligations to undertake those services, or perform those obligations, when it is prevented from doing so as a result of that event. The private sector bears the financial risk in the form of decreased revenues and increased costs, as no compensation is paid if delays occur as a result of the occurrence of such events.

The rationale is that the private sector is in a better position than the Government to manage the risk, for example, via insurance or insurance in combination with risk management and proper planning.

In NSW, what constitutes a Relief Event is to be decided on a project-by-project basis. The NSW Commercial Principles provide a number of examples of what will generally constitute a Relief Event, including:

• a failure by an authority (including utility provider) to carry out works or provide services which it is obliged to carry out or provide
• fire or other damage
• any blockade or an embargo
• industrial action affecting the construction or facilities management sectors or a significant segment of it.

In each case, an event will not constitute a Relief Event if it was caused by the action or inaction of the private party.[2]

In Victoria, the corresponding concepts are Extension (of time) Events and Intervening Events.[3]

Relief Event: Differences between the Victorian and NSW regimes

There are some differences between Victoria and NSW on exactly what events could constitute a Relief Event. For example:

A statutory authority not acting pursuant to its power

In Victoria, a Relief Event/Intervening Event occurs where a statutory authority fails to carry out works or provide services, unless the statutory authority, in failing to do so, is acting in accordance with or pursuant to its statutory powers and discretions or obligations.

This exception has not been adopted in the NSW Commercial Principles.

In NSW, an event will not be a Relief Event if it is caused by the action or inaction of the private party. This excludes circumstances where the works or services are withheld because of a failure by the private party to comply with the requirements of the relevant statutory authority, and accordingly, it is not seen as necessary to include the additional caveat present in the Victorian regime.

Site-specific blockades or embargos

In Victoria, site-specific blockades or embargos which affect specialised project equipment (to be determined on a project-by-project basis) will be an Intervening Event.

In NSW, a Relief Event will not be limited to blockades or embargos affecting specialised project equipment. So long as the blockade or embargo is not caused by the act or omission of the private sector, then the Government will grant performance relief.

Even though the private sector is granted relief from its obligations and extensions of time, the term of the agreement is never extended, so that the private sector bears full decreased revenue/increased cost risk. In the Government’s view, this provides strong incentive to the private sector to mitigate and manage this event as quickly and efficiently as possible.

Industrial action

In Victoria, industrial action is a Relief Event/Intervening Event, but only to the extent that it directly affects the project and project-related industries and the private party can demonstrate that it results directly from an act or omission of the contracting Government party or any of its employees at the facility/site.

In NSW, relief is generally granted where industrial action affects the facilities management or the construction industry or a significant sector of it. Other than showing that the industrial action was not caused by the act or omission of the private party, it is not necessary to prove that the industrial action arose from an act or omission of the contracting Government party or its employees before being granted relief.

To what extent can deductions from the service fee be applied when failure to provide services is due to a Relief Event?

In social infrastructure projects, the private sector is paid a regular service fee upon completion of construction and commencement of services. The service fee (over the length of the term) pays for the capital cost of construction, equity and debt financing costs and the costs of providing the services. The service fee is subject to abatement where the private sector fails to satisfy key performance indicators.

In NSW, because the private sector takes financial risk of Relief Events (even though the private sector is given relief from the performance of obligations), abatements still continue if the failure to perform results from a Relief Event.

While the Victorian Commercial Principles are not entirely clear, it appears that Victoria will also continue abatement, but will cap the abatements at an amount which guarantees the payment of the debt financing cost component of the service fee.

Force Majeure Events

• Traditionally, force majeure events are catastrophic events outside the control of either the Government or the private sector, which prevent a party from performing all or a material part of its obligations under the project agreement.[4] Under the NSW Commercial Principles, the occurrence of a "Force Majeure Event" will result in the private sector being granted relief from the performance of obligations affected by the Force Majeure Event. During the period of force majeure, the Government will only be liable to pay the private sector for services actually received.
• If after its occurrence the Force Majeure Event continues for a specified period (usually six to 12 months) and the parties cannot agree on the best way to continue the project, either party can terminate the project. The Government, however, will have the right to continue the project, despite the private sector electing to terminate, by paying the full service fee less costs not incurred.

At a conceptual level, the mechanisms for the treatment of Force Majeure Events are similar in both Victoria and NSW, although there are some material differences to note.

Force Majeure Events as an extension of the Relief Event regime

In NSW, the Force Majeure Event regime operates as an extension of the Relief Event regime. A Force Majeure Event is defined as a Relief Event which exists or is likely to exist for more than six months.

In contrast, Victoria has a separate and distinct Force Majeure Event regimes, they being "events of exceptional severity" (for example, lightning, cyclones, earthquakes etc.).

Servicing debt obligations during the occurrence of a Force Majeure Event

In Victoria, where a period of suspension arises as a result of a Force Majeure Event, for which insurance is not available, the Government will service senior debt commitments forecast in the base case financial model as being due and payable during the period of suspension.

The NSW Commercial Principles do not provide for the automatic servicing of senior debt obligations during a force majeure event. The rationale behind this is that:

• The Government should not automatically be obliged to pay the private sector any amount simply to service the private sector’s debt obligations.
• If termination occurs, the Government will, in any event, compensate the private sector for outstanding senior debt.
• If termination does not occur, then the parties will be discussing continuation of the project against a back drop of such a compensation payment.

In NSW, a right to terminate following a Force Majeure Event will only arise after the parties have used reasonable endeavors to attempt to find a way to continue the project. Accordingly it is assumed that any solution could well involve agreement by the Government to cover senior debt obligations; otherwise, if the private party is unhappy with the position, it will elect to terminate.

Compensation Event Regime and the calculation of compensation

Compensation Events are events for which the Government takes both performance risk and increased cost/decreased revenue risk, by providing the private sector with both relief from the performance of obligations affected by the Compensation Event, and compensation for increased costs or decreased revenue.

The Compensation Event regimes in the NSW and Victorian Commercial Principles are largely similar. There are however slight differences. For example:

• Unlike Victoria, NSW will provide compensation where it exercises its step-in rights and such exercise is unrelated to any breach by the private party.
• The NSW Commercial Principles provide for when certain emergencies, unrelated to the conduct of the private party, may warrant the Government stepping in and providing the services itself for a short period of time. In such cases, the private party will be compensated for the effects of such step-in, including any damage caused by the Government in stepping in. This compensation will go beyond the Victorian approach of simply the paying the service fee less costs not incurred.
• In NSW, to the extent that the Government engages a third party (other than the private party) to undertake additional capital works on the site, then it will compensate the private party for any disruption this may cause.
• Generally, project agreements in NSW contain an undertaking by the private party to comply with all Environmental Notices served by a statutory authority. The Government will compensate the private party in these circumstances except to the extent that the Environmental Notice relates to an area for which the private party is taking the contamination risk or the private party is in breach of the project agreement.

Calculation of compensation

The NSW and Victorian Commercial Principles also differ in the method for calculating compensation payable as a result of a Compensation Event.

The Victorian Principles calculate compensation on the basis of the reasonable additional costs incurred by the private party as a direct result of the Compensation Event less insurance proceeds. The NSW Commercial Principles go into considerably more detail, specifying compensation as the lower of the sum of the following costs which would be incurred by the private party, or which would have been incurred by an efficient and competent provider of services:

• incremental design and construction costs (including incremental preliminaries)
• incremental costs to deliver the services (including incremental lifecycle costs)
• reasonable external third party advisory costs
• debt financing costs
• lost service fee or lost commercial opportunities (limited to the revenue projected in the base case financial model)
• changes in the cost of insurances

less

• insurance proceeds or damages or other compensation or amounts (other than those received under the project agreement) received by the private party as a direct result of the Compensation Event
• any costs avoided (including tax, financing and/or other benefits associated with deferred expenditure) accruing to the private party as a direct result of the Compensation Event
• any other amounts received or receivable by the private party as a direct result of the occurrence of events which gave rise to or constituted the Compensation Event.

The next issue of Project Insights will feature Part 2: The termination regime under the NSW Commercial Principles.

Thanks to Julian Gratiaen for his help in writing this article.

 

[1] Partnerships Victoria: Standard Commercial Principles, Department of Treasury and Finance, Victoria (2005).

 

[2] Section 12.1(b), Working with Government: Risk Allocation and Commercial Principles, New South Wales Treasury (2007).

 

[3] Sections 12.2 and 17.1, Partnerships Victoria: Standard Commercial, Department of Treasury and Finance, Victoria (2005).

 

[4] Section 13.1, Working with Government: Risk Allocation and Commercial Principles, New South Wales Treasury (2007).

For further information, please contact John Shirbin.