Model Concession Agreement for Highways: An Overview

- Gajendra Haldea

The highways sector in India is witnessing significant interest from both domestic
as well as foreign investors following the policy initiatives taken by the Government
of India to promote Public Private Partnership (PPP) on Design, Build, Finance,
Operate and Transfer (DBFOT) basis. A comprehensive policy and regulatory
framework necessary for addressing the complexities of PPP, and for balancing the
interests of users and investors has been adopted in the form of a Model Concession
Agreement (MCA) and standard bidding documents.

The MCA addresses the issues which are typically important for investors as well
A comprehensive
as for limited recourse financing of highway projects, such as mitigation and framework is a
unbundling of risks; allocation of risks and rewards; symmetry of obligations between pre-requisite for
PPP
the principal parties; precision and predictability of costs and obligations; reduction
of transaction costs; force majeure; and termination. It also addresses other important
concerns such as user protection, independent monitoring, dispute resolution and
financial support from the Government.

The MCA also elaborates on the basis for commercialising highways in a planned
and phased manner through optimal utilisation of resources on the one hand and
adoption of international best practices on the other hand. The objective is to secure
value for public money and provide efficient and cost-effective services to the users.

Rationale for phased development

The four critical elements that determine the financial viability of a highway
project are traffic volumes, user fee, concession period and capital costs. As the
existing highways have dedicated traffic and the Government has prescribed the user
fee for uniform application across India, revenue streams for a Project Highway can
be assessed with a fair degree of accuracy. The concession period, on the other hand,
can be extended only marginally for improving project viability as the growth of
traffic would not permit very long concession periods. In any case, the present value
of projected revenues, after say 20 years, is comparatively low from the
Concessionaire’s perspective.

As three of the four above-stated parameters are predetermined, capital cost is the
variable that determines the financial viability of a project. Bidders would, therefore,
seek an appropriate capital grant/subsidy from the Government in order to reduce the
capital cost for arriving at an acceptable rate of return.

In the given scenario, higher the capital cost, greater would be the compulsion of
project sponsors to seek larger grants from the Government. This, in turn, would
restrict the ability of the Government to leverage a larger pool of extra-budgetary
resources, including private investment, and would hence result in a limited
programme of highway development.

In view of the foregoing, it is important to rely on cost-effective designs and to

combine them with a phased investment programme to enable a more efficient and
sustainable programme of highway development.

As a general principle, capacity augmentation of highways should be based on the Phased

standards recommended by the Indian Roads Congress for different bands of traffic development will
be affordable and
volume. The emphasis should be on phased development rather than on providing cost-effective
high cost roads for catering to the projected growth in the long term.

Where traffic intensity is comparatively low, limited widening of highways could

be undertaken with further widening planned after 7-12 years depending on projected
traffic growth. Upgradation of designs and standards, construction of bypasses in
urban and semi-urban areas and other improvements may also be planned in phases
depending on traffic intensity. These issues have been subjected to in-depth
examination and reflected in a Manual of Standards and Specifications that forms part
of the standard documents associated with the MCA.

Technical parameters

Unlike the normal practice of focussing on construction specifications, the Technical

technical parameters specified in the MCA are based mainly on output specifications, parameters
will focus on the
as these have a direct bearing on the level of service for users. Only the core level of service for
requirements of design, construction, operation and maintenance of the Project the users
Highway are to be specified, and enough room would be left for the Concessionaire
to innovate and add value.

In sum, the framework focuses on the ‘what’ rather than the ‘how’ in relation to
the delivery of services by the Concessionaire. This would provide the requisite
flexibility to the Concessionaire in evolving and adopting cost-effective designs
without compromising on the quality of service for users. Cost efficiencies would
occur because the shift to output based specifications would provide the private sector
with a greater opportunity to innovate and optimise designs in a way normally denied
to it under conventional input based procurement specifications.

Concession period

The guiding principle for determining project-specific concession period is the Concession
period to be
linked to
projected traffic
carrying capacity of the respective highway at the end of the concession period. As
such, the concession period is determined on a project-specific basis depending on the
volume of present and projected traffic. Toll paying users should not be subjected to
congested highways and the Concession should, therefore, cease when full capacity
of the road is reached, unless further augmentation is built into the MCA.
The time required for construction (about two years) has been included in the
concession period so as to incentivise early completion, implying greater toll
revenues.

Selection of Concessionaire

Selection of the Concessionaire is based on open competitive bidding. All project Competitive
parameters such as the concession period, toll rates, price indexation and technical bidding on single
parameter will be
parameters are to be clearly stated upfront, and short-listed bidders will be required to the norm
specify only the amount of grant sought by them. The bidder who seeks the lowest
grant should win the contract. In exceptional cases, instead of seeking a grant, a
bidder may offer to share the project revenues with the Government.

Grant

Based on competitive bidding, the Government may provide a capital grant of up Grants to bridge
to a maximum of 20 per cent of the project cost. This would help in bridging the viability gap
viability gap of the PPP projects. Where such assistance is inadequate for making a
project commercially viable, an additional grant not exceeding 20 per cent of the
project costs may be provided for O&M support during the period following the
commissioning of the Project Highway.

Concession fee

Concession fee is a fixed sum of Re. 1 per annum for the concession period. Concession fee
Where bidders do not seek any grant and are instead willing to make a financial offer should be levied
only if revenue
to the Government, they will be free to quote a premium on concession fee in the streams can
form of a share in revenues from user fee. In addition, the revenue share quoted for sustain it
the initial year could be increased for each subsequent year by an additional 1 per
cent. The rationale for the above fee structure is that in the initial years, debt service
obligations would entail substantial outflows. Over the years, however, the
Concessionaire will have an increasing surplus in its hands on account of the
declining debt service on the one hand and rising revenues on the other. Recognising
this cash flow pattern, the concession fee to be paid by the Concessionaire will be on
an ascending revenue share.
 Risk allocation

As an underlying principle, risks have been allocated to the parties that are best Risk allocation
and mitigation is
suited to manage them. Project risks have, therefore, been assigned to the private
critical to private
sector to the extent it is capable of managing them. The transfer of such risks and investment
responsibilities to the private sector would increase the scope of innovation leading to
efficiencies in costs and services.

The commercial and technical risks relating to construction, operation and

maintenance are being allocated to the Concessionaire, as it is best suited to manage
them. Other commercial risks, such as the rate of growth of traffic, are also being
allocated to the Concessionaire. The traffic risk, however, is significantly mitigated as
the Project Highway is a natural monopoly where existing traffic volumes can be
measured with reasonable accuracy. On the other hand, all direct and indirect political
risks are being assigned to the Authority.

It is generally recognised that economic growth will have a direct influence on the
growth of traffic and that the Concessionaire cannot in any manner manage or control
this element. By way of risk mitigation, the MCA provides for extension of the
concession period in the event of a lower than expected growth in traffic. Conversely,
the concession period shall be reduced if the traffic growth exceeds the expected
level.
The MCA provides for a target tariff growth and stipulates an increase of upto 20
per cent in the concession period if the growth rate is lower than projected. For
example, a shortfall of 5 per cent in the target traffic after 10 years would lead to
extension of the concession period by 7.5 per cent thereof. On the other hand, an
increase of 5 per cent in the target traffic would reduce the concession period by 3.75
per cent thereof.

Financial close

The MCA stipulates a time limit of 180 days (extendable up to another 120 days Project
on payment of a penalty) for achieving financial close, failing which the bid security implementation
must commence
shall be forfeited. By prevalent standards, this is a tight schedule, which is achievable as per agreed
only if all the parameters are well defined and the requisite preparatory work has been timeframe
undertaken.

The MCA represents a comprehensive framework necessary for enabling financial

close within the stipulated period. Adherence to such time schedules will usher in a
significant reduction in costs besides ensuring timely provision of the much needed
infrastructure. This approach would also address the typical problem of infrastructure
projects not achieving financial close for long periods.
 User fee

A balanced and precise mechanism for determination of user fee has been
specified for the entire concession period since this would be of fundamental
importance in estimating the revenue streams of the project and, therefore, its
viability. The user fee shall be based on the rates to be notified by the Government.

The MCA also provides for indexation of the user fee to the extent of 40 per cent
thereof linked to WPI. Since repayment of debt would be virtually neutral to inflation,
the said indexation of 40 per cent is considered adequate. A higher level of indexation
is not favoured, as that would require the users to pay more for a declining (more
congested) level of service when they should be receiving the benefit of a depreciated
fee. A higher indexation would also add to uncertainties in the financial projections of
the project.

Local traffic

Owing to the absence of an alternative road, highways should be open to use by

local residents without any payment of tolls until free service lanes are provided. This
would ensure local support for the project and avoid legal challenges or local
opposition arising out of easement rights.

Frequent users should be entitled to discounted rates, in accordance with the

tolling policy.

Construction

Handing over possession of at least 80 per cent of the required land and obtaining Safety and
of environmental clearances are among the conditions precedent to be satisfied by the quality of service
must be ensured
Government before financial close.

The MCA defines the scope of the project with precision and predictability in
order to enable the Concessionaire to determine its costs and obligations. Additional
works may be undertaken within a specified limit, only if the entire cost thereof is
borne by the Government.

Before commencing the collection of user fee, the Concessionaire will be required
to subject the Project Highway to specified tests for ensuring compliance with the
specifications relating to safety and quality of service for the users.

Operation and maintenance

Operation and maintenance of the Project Highway is to be governed by strict Maintenance

standards
will be enforced
strictly
standards with a view to ensuring a high level of service for the users, and any
violations thereof would attract stiff penalties. In sum, operational performance would
be the most important test of service delivery.

The MCA provides for an elaborate and dynamic mechanism to evaluate and
upgrade safety requirements on a continuing basis. The MCA also provides for traffic
regulation, police assistance, emergency medical services and rescue operations.

Right of substitution

In the highways sector, project assets may not constitute adequate security for Lenders will have
lenders. It is project revenue streams that constitute the mainstay of their security. the right of
substitution
Lenders would, therefore, require assignment and substitution rights so that the
concession can be transferred to another company in the event of failure of the
Concessionaire to operate the project successfully. The MCA accordingly provides
for such substitution rights.

Force majeure

The MCA contains the requisite provisions for dealing with force majeure events. Concessionaire
will be protected
In particular, it affords protection to the Concessionaire against political actions that against political
may have a material adverse effect on the project. actions

Termination

In the event of termination, the MCA provides for a compulsory buy-out by the
Government, as neither the Concessionaire nor the lenders can use the highway in any
other manner for recovering their investments.

Termination payments have been quantified precisely. Political force majeure and Pre-determined
defaults by the Government shall qualify for adequate compensatory payments to the termination
Concessionaire and thus guard against any discriminatory or arbitrary action by the payments should
provide
Government. Further, the project debt would be fully protected by the Government in predictability
the event of termination, except for two situations, namely, (a) when termination
occurs as a result of default by the Concessionaire, 90 per cent of the debt will be
protected, and (b) in the event of non-political force majeure such as Act of God
(normally covered by insurance), 90 per cent of the debt not covered by insurance
will be protected. However, if the Concessionaire fails to commission the project
owing to its own default, no termination payment would be due.
 Monitoring and supervision

Day-to-day interaction between the Government and the Concessionaire has been Independent
kept to the bare minimum by following a ‘hands-off’ approach, and the Government supervision is
shall be entitled to intervene only in the event of a material default. Checks and essential

balances have, however, been provided for ensuring full accountability of the
Concessionaire.

Monitoring and supervision of construction, operation and maintenance is to be

undertaken through an Independent Engineer (a qualified firm) that will be selected
by the Government through a transparent process. Its independence would provide
added comfort to all stakeholders, besides improving the efficiency of project
operations.

The MCA provides for a transparent procedure to ensure selection of well-reputed

statutory auditors, as they would play a critical role in ensuring financial discipline.
As a safeguard, the MCA also provides for appointment of additional or concurrent
auditors.

To provide enhanced security to the lenders and greater stability to the project
operations, all financial inflows and outflows of the project are to be routed through
an escrow account.

Support and guarantees by the Government

By way of comfort to the lenders, loan assistance from the Government has been Support and
stipulated for supporting debt service obligations in the event of a revenue shortfall guarantees by the
resulting from political force majeure or default by the Government. Authority are
essential
Guarantees have also been provided to protect the Concessionaire from
construction of competing roads, which can upset the revenue streams of the project.
Additional tollways would be allowed, but only after a specified period and upon
compensation to the Concessionaire by way of an extended concession period.

Miscellaneous

A regular traffic census and annual survey has been stipulated for keeping track of An effective
traffic growth. Sample checks by the Authority have also been provided for. As a dispute resolution
mechanism is
safeguard against siphoning of revenue share by the Concessionaire, a floor level of critical
present and projected traffic has also been stipulated.

The MCA also addresses issues relating to dispute resolution, suspension of

rights, change in law, insurance, defects liability, indemnity, redressal of public
grievances and disclosure of project documents.

Conclusion

The aforesaid contractual framework addresses the issues that are likely to arise in Private
financing of highway projects on DBFOT basis. The regulatory and policy framework participation
should improve
contained in the MCA is a pre-requisite for attracting private investment with efficiencies and
improved efficiencies and reduced costs, necessary for accelerating growth. reduce costs