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The Viewpoint – Change Force Majeure and Renegotiation Infrastructure Projects

The Viewpoint – Change Force Majeure and Renegotiation Infrastructure Projects

Bar & Bench

By Amit Kapur & Vishnu Sudarsan

Inherently, renegotiation of a concluded contract is counter-intuitive to the principle of sanctity of contract (pacta sunt servanda) which is one of the guiding principles of commerce in common law countries.  In context of infrastructure services (highways, water supply, etc) renegotiation in privately owned/ managed facilities is viewed with suspicion for various reasons which have been debated much in recent days in the public domain. It is bound to alter some basics like levels of investment, nature of concessions, duration of concession, rate/tariff charged for the facility, standards of performance or specifications. The original basis on which the concession was competitively bid out may be altered affecting the competitive fairness of the award.

Yet often governments and public authorities are in situations where they have to face up to renegotiation of existing contracts /policies at the risk of litigation and questions about probity of process. The question is what could be the legitimate reasons for a government to even consider renegotiation?

It helps to remember that infrastructure services are inherently public goods /essential services and necessities. Public private partnerships and private investment are an outcome of limitations of public finance and management, predicated upon a value for money proposition. The investments are in essential facilities which involve 70% to 75% is public money through debt financing by banks and financial institutions. Also these facilities and services are in short supply and hence even in private hands these facilities retain a strong public service character and invariably the tariff, quality if supply and commercial aspect are tempered by regulation driven to secure welfare. Should the private operator collapse the state cannot look away from a failed utility and has to step forward to restore the facility (water, electricity, sewerage, roads et al).

In this context, any renegotiation must be focussed on salvaging the intrinsic public asset/interest. It can be a positive instrument to resurrect a vital asset when it addresses an unforeseen development that renders the facility unviable or commercially impracticable. Of course, while securing the underlying public interest and welfare objectives it is critical that the same be based on a robust assessment to avoid abuse by any investor.  Properly used, renegotiation can enhance welfare. There are a number of instances where renegotiation / allowances have been done in infrastructure concessions when the original contract and financial impact of a concession contract is significantly altered and such changes were not the result of contingencies spelled out in the contract. Another fact of life is an acknowledged fact that infrastructure contracts cannot fully contemplate all possibilities and contingencies that may arise in the 25 to 50 year lifecycle of the concession/asset. While change-in-law and force majeure clauses are useful in this regard, they are not a panacea or a magic wand.

International experience shows that renegotiations are not an unknown phenomenon with public private partnerships in the infrastructure sectors. A study has shown that of nearly a thousand Latin American concession contracts awarded between the mid 1980s and 2000, 30% were renegotiated (54.4% in the transportation sector, i.e., roads, ports, tunnels and airports) with such renegotiations favouring the concessionaire – in 62% of the cases they led to tariff increases, in 38% to extensions of the concession term and in 62% to reductions in investment obligations.

India has also seen instances where concessions have been renegotiated or allowances have been permitted, both in sectors with regulators and in concessions where the primary means of regulation is through contract.

In the telecommunications and FM-radio broadcasting sectors, licenses used to be awarded on a fixed-fee basis – licenses were competitively bid out based on the highest bids received vis-à-vis the license fee payable to the Government of India. In times of poor market response – well below the underlying assumptions, licences were unable to meet the fee requirements and faced hardship. On grounds of this economic hardship and financial nonviability, the system of a charging a fixed fee was changed to one of a revenue share whereby both the upside and the downside of the economic activity were shared by the Government.

The cases of the Delhi and Mumbai International Airports are also noteworthy. In these cases, the private operators were permitted initially by the Ministry of Civil Aviation and now by the Airport Economic Regulatory Authority of India to levy an airport development fee on all passengers to facilitate the bridging of gaps in capex finances as well as to ensure continued and sustained financial viability. The result is a world class facility as also probing questions by airlines and passengers.

In another instance, the Tariff Authority for Major Ports allowed royalty/revenue share as pass through for tariff fixation specifically for Chennai Container Terminal Pvt. Ltd. (CCTPL) to mitigate financial losses. This direction was issued so as to avoid likely loss to CCTPL on account of the revenue share not being taken into account for tariff fixation. The tariff revision was to neutralise the current financial deficit in running the terminal. A mitigation measure to neutralize the perverse incentives was put in place such that the pass through in tariff was for the 2nd highest bidder’s royalty bid while award was to the highest bidder. The revision was to make the terminal operation viable.

In the recent case of Konark Power Projects Ltd. v Bangalore Electric Supply Company Ltd. decided on 10.02. 2012, the Appellate Tribunal for Electricity (APTEL) held that the tariff in a subsisting PPA can be modified by a state electricity regulatory commission for reasons such as promoting renewable energy or reviving a closed generating station, if situation so warrants in larger consumer interest. The State Commission has to maintain a balance of interests amongst consumers getting the fair price for electricity and the generators not suffering unnecessarily. It would not be desirable to keep any generating unit out of service for want of ‘just’ tariff.

In another case, APTEL recently observed that negotiations may be permitted even after competitive bidding in the interests of the consumer. APTEL went on to recognize that consumer interests have to be balanced against the interests of generators. Consumer interest is best served by vibrant a power sector that can viably supply cheap and affordable power.

From the instances cited above, evidently regulators and authorities have displayed sensitivity towards the commercial and financial realities and needs of viable investments.

Keeping this in mind, it is important that a framework for regulating such renegotiations be prepared so as to prevent abuse or misuse, and to secure the underlying public interest from being sacrificed in the reset. Such framework should prevent opportunistic renegotiation – renegotiations must be resorted to only where absolutely necessary in view of the changed circumstances.  It must also be ensured that pre-existing contractual remedies are exhausted before renegotiations are commenced. While retaining the checks and balances, any such framework should not be impracticable.

In this regard it is notable that Public Private Partnership (Preparation, Procurement and Management) Rules 2011 published by the Department of Economic Affairs, have a provision for variations in concession agreements whereby justification for such variation as well as necessary authoritative approval are mandated.

The ever increasing investment required to sustain infrastructure for a booming Indian economy has resulted in a greater role for private investment in the infrastructure sector. However, the private investor banks lend on the promise of a return on such investment. Thus, infrastructure concessions need to provide adequate security to the private investor. In this regard, a fair and equitable stance on renegotiation of concessions in the event of circumstances that render such concession financially unviable is absolutely necessary.

Amit Kapur (pictured right) & Vishnu Sudarsan (pictured left) are Partners with JSA. Views of the authors are personal.