How do Concessions work?

Nigeria is suddenly experiencing a flurry of activity concerning concession programs – from the Port Concessions, to airports, and now road concessions and bridges.

It is a new day in Nigeria’s jurisprudence and new ideas are flying about the place. This article (and the subsequent weeks) seeks to put some of these ideas in perspective as further talking points for all and sundry – the learned and “unlearned” alike. This week shall deal with basic concepts, next article shall deal with the Legislative framework for Concession in Nigeria (or the dearth of it) and the last article shall unveil the major clauses in negotiating concession agreements.

What is a Concession?

This is a variant of a Public Private Partnership (PPP) whereby an Asset owned by a Government (or built for the Government) is operated and maintained by a private investor for a set duration on terms contained in a Concession Agreement. The idea is for the private investor to manage the asset and achieve 3 goals:

(i)     Provide a public service in an efficient reasonably priced manner;

(ii)   Make a Return on Investment in the course of the business;

(iii)  Keep the asset maintained and eventually return it to Government at the expiry of the concession period.

What are the key issues that typically arise in concession jurisprudence?

1.      The Public Service Obligation (PSO) argument

Many believe that the Government has an obligation to provide certain public services and that responsibility should not be abdicated. They posit further that putting public services in the hands of private profiteers is inimical to the existing social contract that exists (or should exist) between Government and its citizens – we pay our taxes and you provide certain amenities.

Civil Rights activists in several countries have on these grounds for example succeeded in inserting into their respective Road Concession laws an obligation on the part of Government to provide an alternative route - that for every road that imposes a Toll Government should provide a parallel road (option) that has no Toll.

By way of commentary, I have heard people quote this obligation within the Nigerian context but I daresay that this onerous obligation is not contained anywhere under Nigerian law. Lets be honest, this is just as well because we are still struggling with providing one passable route in many instances, talk less of an alternative. Also from a commercial viewpoint does an alternative route not dilute the investment of a Concessionaire?

What Government can do (and has done in Nigeria) is to set up a mechanism to ensure that the Charges on Concession assets are reasonable. The Utilities charges commission Act 1992 therefore seeks to regulate the charges on certain Utilities. 

2.      Risk allocation

The risk involved in any Concession can be broken down widely into: Political risks; Commercial risks and Operational risk.

Political risks deal with for example the possibility of government expropriation and nationalization during the life of the Concession. Commercial risk deals with monetary issues like whether traffic level at a particular airport or seaport may decrease over time for whatever reason. Operational risks arise from an operator's technical inability to fulfil its obligations, the failure of equipment to meet specifications during commissioning, or a host of other factors.

Negotiations always dwell on how these risks will be allocated. There are either shared or borne solely by one party. The risks are dealt with by a combination of approaches with no hard and fast rule:

Insurance policies – a party takes out Insurance to cover the risk. 

Government guarantees – the government gives a cash-backed Guarantee that it will fulfill its obligations.

Escrow Accounts – a party actually puts money aside with an instruction to the bank to pay a named party in event of default.

No fault principle – each party bears its own risk. For example: where it is an Act of God or event outside control of either party.

3.     Bankability of the Transaction

A major plank of every Concession Agreement is that it must be bankable – that a Lender should ordinarily find it attractive. A concession agreement must offer protection to private investors and Lenders - protection from possibility of a Government default on its contractual obligations and ensuring that project cash-flows are not disrupted. Only projects with such features can attract finance from bank syndicates or investors through the capital markets.

4.    Legal & Regulatory Framework

The Legal and Regulatory framework consists mainly of a Concession Law and the Concession Contract. Many countries would have a Concession Law in place that governs the A-Z of Concessions. Nigeria has a similar (but not so similar) law called the Infrastructure Concession Regulatory Commission Act 2005. The entire regulatory framework will be dealt with in greater detail next week.

5.   Financial Structure 

The financial structure is the heartbeat of any deal. The typical advisory structure is to have a Financial Adviser lead the advisory team because everything revolves around the money: How much? Where is it coming from and where is it going to?

Options for financial structures are endless. The key is that they should be creative enough to protect the 4 major interests in any Concession: The Public; The Government; The Concessionaire; and the Lender.

Financial structuring involves options on almost everything: Some examples are a decision as to whether to use Shadow toll or real Toll. With shadow tolls the public pays no Tolls, the Government pays periodically a fixed sum per head based on the number of people who used the train, airport or road in a given period. Would it be Annuity based or Pay as you go? Annuity based sets a price to be paid to the Concessionaire by the collecting agency annually based on the financial projections. How much should the entry fee be? It is typical for Concession Agreements to Pricing Mechanisms and adjustment provisions. We can go on and on!

6. Procurement Process

This process usually tells the whole world whether the Government is one to be reckoned with or not. The efficiency and transparency of this process sets the mood for the quality of bidders that the Government will attract. There are International best practices in this regard and it is typically a broad 2 step process: First a pre-qualification exercise that determines those that would be entitled to bid; then the bidding stage that covers the Technical and Commercial proposals

7.         The Concession Agreement

A draft of the Concession Agreement is usually attached to the Request for Proposals (RFP). Why? It is necessary for Investors and Lenders to know upfront the basic terms and structure which helps them take informed decisions in packaging their proposals – particularly the commercial proposals. The complexion and outlook of the draft concession agreement is one of the key determinants to qualitative bidding. The Schedules attached to the Concession Agreement have to be carefully selected to represent both the Engineering and Financial aspects of the deal and that is a key role of the lawyer.

Conclusion:

In the next few years we would have great opportunities to shape the landscape and start the journey of ensuring that our Nigerian Concession Law and Practice begins to evolve.

Ayuli Jemide, is the Lead Partner of DETAIL – a firm of Commercial Solicitors.