Chapter 5
Public Private Partnerships
Summary:
Public-Private Partnerships (P3), are touted as a cutting-edge approach to construction financing, yet are actually one of the oldest methods for delivering projects for the community. The various “flavors” of P3 influence the construction financing landscape. This Chapter analyzes the nature of the private investment market as well as traditional barriers which have prevented their widespread adoption. Finally, P3 is examined with respect to recent California legislation and a step-by-step analysis on how to best take advantage of this approach in future infrastructure development.
Although there has been a recent resurgence of so-called Public-Private Partnership (P3) financing in the United States, it is hardly a novel approach. This financing practice has been used for hundreds of years in Europe, often framed as the granting of “concessions”. It has seen decades of use in developing countries where governments often do not have the creditworthiness to float government debt for major projects.
The granting of private concessions for public projects is also not new in the United States. In fact, one of the first U.S. Supreme Court cases involving public works considered a dispute between the City of Boston and two private infrastructure companies. The year of the case? 1837!
This early Supreme Court case was a battle of the early titans of P3 finance, so it was appropriately named, the Proprietors of Charles River Bridge v. The Proprietors of Warren Bridge (1837) 36 U.S. 420. The plaintiff, the original franchisee, had been granted the right to build a bridge across the Charles River by the State of Massachusetts legislature. The plaintiff’s bridge connected Charlestown to Boston and thereby eliminated the need to operate the once relied upon ferry crossing. In exchange, the plaintiff agreed to pay an annual sum to Harvard College for forty years from the collected bridge tolls for the right to build the bridge and compensate for the lost annual income of the ferry. The plaintiffs brought suit against the defendants after they built a second bridge across the Charles River, competing with the first. The plaintiff stated the City’s act of incorporating defendants’ new bridge impaired the obligation of their contract with the plaintiffs.
In deciding the case, the Court addressed whether the rights of a primary contract holder could be divested by a subsequent state law. The Supreme Court expounded on the pluck, enterprise and dramatic risk undertaken by the original bridge builders — constructing the first bridge in New England over tidal waters and so close to the sea.
The Court, nevertheless, found that a state law could be retroactive in character and not violate the United States Constitution unless the original obligation was rooted in contract. In reaching its decision, the Court found that the plaintiffs’ rights to the original bridge were derived entirely from the act of the legislature under which the plaintiffs were incorporated. As a result, the plaintiffs’ right to use the waters were not exclusive and not impeded by the defendant’s competing bridge.
Despite the fact that the Court’s holding in Proprietors of Charles River Bridge is over 170 years old, the underlying lessons of the case still apply in today’s public-private partnership sector. The moral of the story — it is important to read the fine print on government franchises to private industry. (And to attempt to secure exclusive rights.)
In its most general application, a P3 project is one where the private sector supplies infrastructure and services traditionally provided by governments. In the view of some, there must be a presence of external private financing. Others, however, view the true P3 as a design-build-finance-operate arrangement. (See: “A Primer on Public-Private Partnerships,” by Francois Michel)
In truth, the trend is truly international: a recent study of P3 projects in Europe found that between 1990 and 2005, more than a thousand partnerships had been signed in the European Union alone, representing an investment of almost 200 billion euros (Francois Michel, supra).
§ 5.1 Private Investment Market
Despite the recent U.S. economic upheavals, the private investment market dwarfs the public finance market in depth and breadth. It is more robust — as capital is attracted to high returns — and P3 projects must promise a significant return to make them attractive to private investment. The other half of the equation is that private investment and management tend to be more tightly controlled and technology driven than the public sector. As such, there appear to be specific types of projects where P3 is especially suited — those where the project would not be built without the private initiative or capital.
§ 5.2 Traditional Barriers
The principal barrier to franchises or P3 projects in California has been the competitive bidding statutes. The established public works model in California has been the design-bid-build model, in which the private contractor bids on a set of plans drawn by the agency or a third party. In the traditional model, the government sets the concept, design, financing and operational characteristics of the project and a private sector contractor with the lowest bid gets the job. Upon completion, the public agency operates the facility until it becomes obsolete and needs to be replaced by another public works project.
§ 5.3 Statutory Authorization
The need for substantially larger investments in public projects has moved the legislature to erode the traditional design-bid-build model through the implementation of a series of statutes:
On February 20, 2009, then Governor Schwarzenegger approved Senate Bill Second Extraordinary Session 4 (SBX2 4) Chapter 2, Statutes of 2009 (Cogdill) which established the legislative authority until January 1, 2017 to allow regional transportation agencies and CalTrans to enter into an unlimited number of Public-Private Partnerships (PPP) and deleted the restrictions on the number and type of projects that may be undertaken. SBX2 4 also established legislative authority until January 1, 2014, for a design-build demonstration program for the state by allowing a total of up to 15 demonstration projects, up to five projects (local street or road, bridge, tunnel, or public transit projects) for the local transportation agencies and up to ten projects (state highway, bridge, or tunnel projects) for CalTrans.
The highlights of this bill included amendments to California Design Build statutes (Government Code §§ 14661.1 and 70391.7 (state offices, prison and court facilities), Public Contract Code § 6800 et seq. (transportation), and Public Contract Code § 20688.6 (redevelopment agencies). It also created special authorization for Public-Private Partnerships under Streets and Highways Code §143. Of special importance is the use of the California Transportation Commission (CTC) which has the power to authorize projects under these sections. There are limited numbers of these projects that an agency may proceed, including up to five projects for local transportation agencies and up to ten projects for CalTrans.
Effective January 1, 2015, Government Code § 14661.1 was repealed along with other sections of the code (2014 Cal SB 785). Health & Saf Code § 32132.5 was enacted the same day, but only applied to the building of specific facilities at a hospital in Sonoma County. Government Code § 70391.7 remains current.
There are a variety of construction industry task forces and study groups examining these new statutes. With regard to the CTC’s role, there is concern that a contractor may go through an extensive vetting process for a project, engage in time consuming and costly negotiations with an eligible agency, then find that the CTC does not approve the transaction, either out of a view of the manner that the local agency approached and managed the procurement process, the relative value of the project itself, or even the form of the final written P3 agreement. Nevertheless, these statutes represent a breakthrough in the implementation of P3 projects in California — which lags behind many other States and our northern neighbor, Canada, in seeking foreign and international investment in California Infrastructure. Several previous California statutes reflect the evolution of P3 as an important public finance option:
AB 1467, enacted by the Governor and Chaptered by the Secretary of State in May 2006, added §§ 143 and 149.7 to the California Streets and Highways Code. The bill authorizes the department and regional transportation agencies to enter into lease agreements with public and private entities. The pilot program limits the number of projects to 2 projects in northern California and 2 in southern California until January 1, 2012. This statute also authorizes high-occupancy toll lanes. Solicited and unsolicited proposals are permitted under the statute.
AB 521, enacted by the Governor and Chaptered by the Secretary of State in September 2006, amended §143 California Streets and Highways Code to limit the time and scope of the Legislature’s review of a lease agreement.
The highlights of the previous California P3 Statutes are summarized below:
1. Does the relevant law allow solicited and unsolicited proposals for P3 projects?
Yes § 143 allows the department to “solicit proposal and accept unsolicited proposals.”
2. Does the relevant law permit local/state/federal funds to be combined with private sector funds on a P3 project?
No express provision
3. Who has rate-setting authority to impose user fees and under what circumstances may they
be changed or otherwise reviewed?
By agreement. § 143(f)(2) requires the initial toll to be set by the lease agreement and all increases to
be approved by the department or regional transportation agency after a public hearing.
4. Does the relevant law permit TIFIA loans to be used on P3 projects?
No express provision.
5. Is the number of P3 projects limited to only a few “pilot” or “demonstration” projects?
Not anymore. The 2009 amendment removed the requirement that number of projects be only 4. However, §143(t) prohibits lease agreements after January 1, 2017.
6. Are there restrictions concerning the particular mode of transportation eligible to be developed as a P3 project (e.g., truck, passenger auto, freight rail, passenger rail)?
Yes. §143(a)(6) requires the P3 to be for the “Transportation project” to mean one or more of the following: planning, design, development, finance, construction, reconstruction, rehabilitation, improvement, acquisition, lease operation, or maintenance of highway, public street, rail, or related facilitiees supplemental to existing facilities currently owned and operated by the department or reegional transportation agencies…
7. Is there a legal requirement to remove tolls after the repayment of project debt?
No. The tolls may be continued after the lease expires, but they must be used to benefit the same facility.
8. Is there a restriction that prevents the revenues from P3 projects from being diverted to the state’s general fund or for other unrelated uses?
Yes. §143(j)(1) requires toll revenues to go to the facility, debt, or the State Highway Account.
9. Is prior legislative approval required when an individual P3 proposal is required?
Yes, §143(c)(5) requires negotiated lease agreements to be submitted to the State Legislature. The Legislature has 60 days from the day of submission to reject a lease agreement, otherwise it is deemed approved. The Legislature is prohibited from amending a lease agreement.
10. Are there any similar requirements that subject the P3 proposal or negotiated P3 agreement to a local veto?
No. §143(c)(5) only requires a public hearing at or near the proposed facility’s location, but only the legislature has veto power.
11. Does the relevant law permit all kinds of procurement for P3 project delivery? These might include: calls for projects; competitive RFQ and RFPs; qualifications review followed by an evaluation of proposer concepts, use of design build, procurements based on financial terms such as return on equity rather than price; long-term asset leases for some period of up to 60 years or longer from the time operations commence?
Yes. §143(f)(2) allow the transportation agency to utilize a variety of procurement approaches.
12. Does the public sector have the authority to form nonprofits and let them issue debt on behalf of a public agency?
No express provision.
13. Does the relevant public agency have the authority to hire its own technical and legal consultants?
Yes. See §143(f)(1)(B).
14. Does the relevant law permit the public sector to make payments to unsuccessful bidders for work product contained in their proposals?
No express provision.
15. Can the agency charge application fees to offset its proposal review costs?
No express provision.
16. Does the relevant law allow adequate time for the preparation, submission and evaluation of competitive proposals? Note that the agency should have the authority to establish these deadlines on a case-by-case basis depending on the complexity and scope of the initial proposal or other factors that might promote competition (e.g., more review time during holidays).
Yes. §143(b) does not include any time restrictions.
17. Is the public sector required to maintain comparable nontoll routes when it establishes new toll roads?
No.
18. Are there any non-compete clause prohibitions?
Yes. § 143(i) prohibits an agreement from infringing on the authority of the department or regional transportation authority. This section would allow reasonable compensation to a leaseholder for adverse impacts under certain circumstances.
19. Is the authority to enter into P3s restricted to the state DOT or state turnpike authority or may regional or local entities also do so?
Restricted. § 143(c)(1) allows only the department, in cooperation with regional transportation agencies, to solicit P3 proposals. However Government Code § 5956 gives local governments the authority to pursue P3s.
20. Does the relevant law specify evaluation criteria for P3 proposals received under a given procurement approach?
No.
21. Does the relevant law specify the structure and participants for the review process involving P3 proposals?
Yes. §143(c)(1)-(5) require the CA Transportation Commission, legislature, regional transportation agency, and public to be involved.
22. Does the relevant law protect the confidentiality of P3 proposals and any related negotiations in the period prior to execution of the P3 agreement?
No.
23. Does the relevant law provide for the ability of the public sector to outsource long-term operations and maintenance and other asset management duties to the private sector?
No express provision.
Source: U.S. Department of Transportation (DOT)
§ 5.4 P3 Case Studies
The following are a few significant projects that give the breadth and scope of P3 activity:
Project: City of Burlingame Wastewater Treatment Facility
Website: https://www.burlingame.org/departments/sustainability/wastewater_treatment.php
Location: Burlingame, CA
Summary: In 1972, Burlingame, located just outside San Francisco, contracted with Veolia to provide full operations services for its 5.5 MGD (million gallon per day) wastewater treatment facility. First U.S. Public-Private Partnership in that management of a municipally-owed wastewater facility was ever transferred to a nonpublic entity. The contract has been continually renewed over past three decades making it the longest running municipal wastewater P3 in the U.S. and received 1999 Winner of National Council for Public- Private Partnerships Award.
Type of Project: O & M
Total Amount: Unknown
Private Sponsor: Veolia Water North America
Government Entity: City of Burlingame
Project: SR 91 Express Lanes
Location: Orange County, CA
Summary: Four-lane toll facility in the median on a 16km section of the 91 Riverside Freeway one of the most heavily congested highways in the U.S. The privately-owned and operated project sought to relieve congestion by adding express lanes in center of existing highway and through use of variably toll-way (as of July 2019, tolls varied between $1.70 and $8.95 reflecting level of congestion delay avoided in the adjacent nontolled freeway lanes). SR 91 one of projects originally authorized under Assembly Bill 680 in 1988 (SR 125 below also included). Express lanes opened in December 27, 1995 and were subsequently purchased from CPTC by OCTA in January 2003 for $207M after a vote in April 2002. The purchase (and operation by a public agency) was the result over a hotly contested non-compete clause in the original agreement which ultimately postponed other surrounding projects and, in public opinion, created additional congestion and safety risks.
Type of Project: Build Operate Transfer. 35-year franchise agreement between California Private Transportation Company and the State of California. At the end of 35-year franchise agreement, Public Sponsor regains control of the facility.
Total Amount: $130 Million
Private Sponsor: California Private Transportation Company (CPTC), Level 3 Communications, Cofiroute Corp, Granite Construction.
Government Entity: $7 million loan from Orange County Transportation Agency
Lender: $65 million in 14 year variable rate bank loans, Banque Nationale de Paris, Deutsche Bank, Societe Generale, Citibank, $35 million in longer term loans (24 years)
CIGNA Other Participants: $20 million private equity, $9 million subordinated debt to OCTA to purchase previously completed engineering and environmental work.
Project: South Bay Expressway (SR125)
Website: https://www.fhwa.dot.gov/ipd/project_profiles/ca_southbay.aspx
Location: San Diego County, CA
Summary: New 12.5-mile highway alignment from SR 905 (near border) to SR 54 connecting the only commercial port of San Diego to the regional freeway network. The southern 9.5 mile section of South Bay Expressway constructed as a privately financed and operated toll road using FasTrak, an electronic toll collection system. A limited partnership, San Diego Expressway, holds a franchise with the State of California under which it finances and builds the highway, then transfers the ownership to the State. The LP then leases back, operates, and maintains the facility for 35 years, at which, control goes back to the State at no cost. Both the private and publicly funded portions will be built by the same contractor under two design-build contracts. California Transportation Ventures, Inc. (CTV), the general partner, manages the project and will administer the contracts. Washington Group International is the contractor with a joint venture of Parsons Brinckerhoff Quade and Douglas, Inc and J. Muller International as the design subcontractor. Construction began September 2003 and the project opened November 2007.
Innovations: $140 Million TIFIA loan is the first-ever provided to a private toll road development. The 38 year loan has a fixed rate borrowing cost equal to 30-year treasuries. Competitive (best value) bid, design-build procurement process was followed in which the same designer, design subcontract, and design price were mandated to each proposer. The designer was a joint venture composed of subsidiaries of the project sponsors.
Type of Project: Design Build Finance Operate (DBFO)
Total Amount: $635 Million ($138 million for connector and interchange)
Private Sponsor: California Transportation Ventures, Inc. (a wholly owned subsidiary of Macquire Infrastructure Group), Washington Group (design-builder)
Government Entity/Sponsor: CalTrans
Lenders: TIFIA program, bond holders
Finance: $140 million TIFIA loan, $160 equity from Macquarie Infrastructure Group
Revenue Sources: Toll revenues
Other Participants: $48 million in right-of-way grants from local developers, Commercial Debt (connector route: $132 million federal and local funding)
Project: San Joaquin Hills Transportation Corridor Agency (SR 73)
Location: Orange County, CA
Summary: First new public toll facility developed by TCA. 15-mile, six-lane, limited access highway with 108 total lane miles. Designed to relieve congestion on I-405, I-5, Pacific Coast Highway, and other major arterials in Orange County. Initial design includes six travel lanes. Median reserved for future proposed exclusive high occupancy vehicle (HOV) lanes and possible transit options. Toll operations & marketing concessioned to private firm.
Type of Project: Design Build Contract w/ guaranteed maximum price and completion date.
Total Amount: $1.4 Billion ($790 million in design/construction)
Lenders: Tax Exempt Bond Funds
Government Entity: San Joaquin Hills Transportation Corridor Agencies (SJHTCA) — formed in 1986 to plan, finance, construct and operate Orange County’s 15-mile public toll road system. Public Resources Advisory Group (Lead Underwriters) First Boston (Initial Issuance 1993) Smith Barney (Refunding 1997)
Status: Opened to commercial traffic in November 1996.
Project: Alameda Corridor Rail (Freight)
Location: Los Angeles County, CA
Summary: 20 mile rail cargo route connecting Ports of Los Angeles and Long Beach and rail yards near downtown L.A. Eliminates 200 surface street railroad crossings. Smooths cargo flow to and from ports and eases congestion. One of the largest design-build projects in the United States. Project involves:
North-end: grade separations and bridge replacements
Mid-corridor: 10-mile trench, 50 ft. wide, 33 ft. deep accommodating grade separated rail line ($712 million)
South end: grade separations and bridge replacements
Type of Project: Design-Build for mid-corridor, Design-Bid-Build for north and south
ends
Total Amount: $2.5 billion
Private Sponsor: Port of Los Angeles & Port of Long Beach
Government Entity: Alameda Corridor Transportation Authority - a joint powers agency of the Cities and Ports of Los Angeles and Long Beach
Type of Finance: $1.2 billion in revenue backed bonds; $400 million USDOT loan; $394 million in grants from Ports of Long Beach and Los Angeles; $347 million from Los Angeles County MTA; $160 million in interest / other resources
Lenders: USDOT & Bondholders
Status: Project opened April 15, 2002
A website describing private toll roads authorized under AB bill 680 which authorizes the state to enter into agreements with private companies to build and run expressways without any state funds. SR125 (above) was originally authorized under this bill, however, it is distinguished as a Design Build Finance Operate P3. It is arguable that the other routes do not meet the true description of P3 under the DBOT, design build, long term lease, or lease develop operate type of P3 agreements outlined on the DOT website. Project Finance case studies can be found at the U.S. Department of Transportation websites, barchanfoundation.com, and numerous other public finance websites and publications.
§ 5.5 Cutting Edge Issues
As stated in the excellent Francois Micheal Article, above, many other questions regarding the future of P3s are being raised by the investment community. These are just a few of the questions that should be answered as this area rapidly evolves:
• What are the best accounting methods for P3s to improve government’s governance mechanisms (and incentives)?
• How should risks arising from P3s be examined, integrated in the budgetary framework, and aggregated at the ministry/government level (in a multi-year framework featuring contingency reserves)?
• Under which safeguards should P3s be allowed for local governments? What capacity within governments needs to be developed to assess risks?
• How do tax regimes affect the choice between P3s and traditional procurement schemes?
• What is the optimal role of internal and external controls in a P3 program?
• To what extent can transparency substitute for procedural controls?