“Enhancing revenues will help us improve and solve our infrastructure problems”. — Roy Barnes
While it is unlikely that Roy Barnes had the law of infrastructure finance in mind as he uttered these words, much anguish has been recently expressed regarding the legal and regulatory framework for infrastructure. Lex Witness takes you through this voyage and unlocks the code…
Prior to the advent of economic reforms, the “infrastructure space” in India was dominated by public sector undertakings and government departments. Amongst the earliest measures taken pursuant to economic liberalisation in 1991 was simplifying the procedures for approving foreign investments. FDI proposals were approved speedily in all sectors, particularly infrastructure. The extant policy framework in infrastructure aims to move away from “direct control to indirect control”. This has to be achieved through empowered regulatory agencies which have the mandate to monitor the competition in the sectors as well as ensure that other goals of Government are implemented simultaneously. The Government is now also stepping into management and mitigation of risk in areas where there is uncertainty with respect to future revenue flows. Most importantly, the focus is on infrastructure policies with a long-term perspective in order to provide a “roadmap for investors” in structuring projects and assessing viability.
India, today, has a liberal regime for FDI as far as ‘entry norms’ are concerned. Similarly, Government’s attempts at encouraging private participation in infrastructure have also been successful. However, experience shows that there can potentially be a number of other barriers when it comes to ‘willingness’ to invest in infrastructure projects. For starters, subisdised pricing of infrastructure services, i.e., the services being priced below the cost of supply, undermines the financial viability of the project. For instance, electricity and water have long been subsidized for agriculture, a policy that has discouraged private investment in those areas. Moreover, various stakeholders with conflicting interests often influence the government policy thereby impacting private operations in the sector. For instance, consumers resent the price hike associated with privatization, while employees of public utilities are worried about the threat to their employment. Above all, governments more often than not are reluctant to give up control over key sectors, especially when foreign ownership is involved. Thus, any policy initiative which does not address these barriers to investment will achieve precious little for infrastructure development.
In the infrastructure sector, there is a division of power between the Central Government and the State Governments. While some areas are reserved exclusively for central governance, a few sectors are subject to joint governance. Since 1991, some independent regulatory agencies have been established on a sectoral basis by either the Centre or different State Governments. Notably, various Ministries under the Central Government are responsible for separate sectors that in turn work through myriad executive bodies. A Cabinet Committee on Infrastructure (CCI) was set up in July 2009 for approving, reviewing policies and monitoring implementation of projects across all infrastructure sectors. Besides, a host of regulatory authorities have been constituted which are responsible for functioning of various sectors, particularly power, telecom, ports, airports, highways. These are:
Despite infrastructure being recognized as a critical sector for economic development, its regulation is plagued by problems, simple and complex. To begin with, a “clear–cut definition” of infrastructure has not been specified by the CCI. Instead, it has compiled a list which includes various sectors within “infrastructure”. Although successive Governments have emphasized upon the development of regulatory institutions to “ensure that competition is free and fair and run professionally,” yet the Competition Commission of India became operational as recently as in the year 2009. To add to the woes, regulatory authorities like TRAI and the Government frequently disagree!
An examination of the existing laws and regulations reflect an ad- hoc approach, which is aggravated by the overlapping powers of the Central and State Governments. Although the regulatory framework in different sectors has been developed, there is lack of co-ordination between the sectors. There are instances where a set of laws and/or policy govern a particular sector without a regulatory body to oversee the operations thereof. For instance, there is no regulatory authority in the “transport sector” as a whole; the NHAI acts as the regulator as well as the operator of the national highways, and additionally several states have their own agencies which are responsible for state highways. Consequently, investors do not have recourse to any single independent regulator.
There have been calls for enactment of separate infrastructure Acts, both at the Central and state levels, so as to make the current cumbersome processes simple and transparent. In addition, these Acts would address the issues pertaining to individual infrastructure sectors. Experts have also made out a strong case for having an independent and accountable regulator. An independent regulator would help in establishing transparent systems, especially in crosssubsidy and tax matters, besides protecting the interest of consumers. Above all, the long-standing issue of ‘tariff-setting’ across various infrastructure sectors would also be settled by such a body.
Owing to significant environmental jurisprudence, there are various statutory enactments in India which call for establishment of authorities to ensure environmental safety . In the year 1978, Environmental Impact Assessment (EIA) study was commenced so as to comply with the directive of the Planning Commission for Government of India. EIA studies became mandatory in India with effect from 1994 for selected infrastructure projects. These infrastructure projects are subject to the approval of Environment Appraisal Committee (EAC), earlier conceived as National Committee on Environmental Planning and Coordination (NCEPC). The projects which require forest or wildlife clearance can be obtained only after the aforesaid approval of EAC is obtained. In 1997, the EIA regulation underwent an amendment vide which public hearing became mandatory in the interest of the citizens. This particular regulation demands another compliance i.e. to obtain a No Objection Certificate (NOC) from the respective State Pollution
Boards under the Water Act and the Air Act. Land and water approval is sought from the State Governments. The environmental clearance granted by this process has a validity of 5 years of operation with effect from the day of the grant. However, if there is any apparent change in the scope of the infrastructure project, it requires fresh assessment.
The National Environmental Appellate Authority Act 1997 constituted a statutory body called National Environmental Appellate Authority to hear appeals on environmental clearance matters granted under the Environment (Protection) Act 1986. The enactment lays down that any person aggrieved by an order constituting the grant of environmental clearance may approach the authority within thirty days from the date of such order being passed. The authority is bound to dispose of the petition within ninety days from the date of filing the appeal. The authority is guided by principles of equity and natural justice while passing the order.
Barring infrastructure projects like river valley projects or thermal power projects, there is no requirement for site assessment in the said EIA Notification. Even the Factories Act is silent when it comes to site selection. However, in 1987, the Government of India issued environmental guidelines specifically for thermal power plants which contain the following criteria of site requirements:
The sad thing about the aforesaid enlistment is that they are mere guidelines and the Government has done little to enforce it legally.
India’s coastline is extensive covering approx. 7,600 kms serviced by 13 major ports and 187 minor ports. The classification of ports into “major” and “minor” is purely for administrative purposes. While the major ports are under the control of the Ministry of Shipping (Central Government), the minor ports are controlled by the relevant ministries of the coastal State Governments. The significance of this sector is highlighted by the fact that over 90 percent of volume and 70 percent value of India’s trade is carried out through the ports. With cargo handling in the ports expected to grow at 7.6 % until 2015, the port sector is set to develop rapidly.
Continuing with the initiatives in upgrading India’s infrastructure, the Government undertook “expansion and modernization of ports” on a priority basis in its five-year plan allocations in 2007. This policy decision helped in re-defining the role of ports from simply being “trade gateways” to becoming integral parts of the global logistics chain. It is, therefore, not surprising that an investment of more than USD 9.7 billion is expected to be made by the year 2015. The Government, accordingly, formulated a comprehensive ‘National Maritime Development Policy’ laying down the vision and strategy for development of port sector till 2015. The Policy focuses on increasing the capacity of port in the next ten years; improving port connectivity with hinterlands; and enhancing the domestic share of shipping. It emphasizes on developing ports through “public-private partnerships”. Infact, all the areas of port operation have now been opened up for private sector participation. In another move aimed at facilitating private investment, improving service quality and promoting competitiveness, 100% FDI has been permitted under the Automatic Route for port development projects. Additionally, 100% income tax exemption is provided for a period of 10 years for port development projects.
In the past, the Government of India dominated the maritime activity, however, post- liberalization, India embarked on privatization of development and operation of ports. Several major ports now operate as “landlord ports”. The international port operators have been invited to submit competitive bid for terminals on revenue sharing basis and significant investment on BOT basis by foreign players has also been witnessed in the recent past. Besides, the minor ports are already being developed by domestic and international private investors. With growth in merchandise exports estimated at over 13 percent per annum, the need for large investments in port infrastructure is critical. Experts believe that there is no “buzz” in the port sector like the one seen in roads, power or telecom. One of the major problems is that the turnaround time at Indian ports is not comparable to global standards. Consequently, congestion at Indian ports is the norm! Other problem areas include poor connectivity to hinterland, lack of adequate facilities, labour disputes, even mafia problems. Since ports are critical for any country’s trade, export as well as import, these kinds of bottlenecks could derail the economic growth.
Electricity appears in the Concurrent List of the Indian Constitution and administration or legislation of the same is the lookout of the Government of India as well as the States. Critically speaking, this area has not been an investor-friendly sector and is filled by adverse risk profiles that make the availability of project finance difficult to come by. However, recent trend suggests that there is a huge room for private sector participation, particularly from foreign investors. The total electricity generation capacity in India is 101500 MW; 72000 MW out of which is thermal, 24500 MW is hydel and 2800 MW is nuclear, while the rest are renewables.
In 1991, a new power policy was introduced as part of an overall reform programme so as to give a boost to foreign investment in the sector. Various legislative and fiscal reforms were introduced, but foreign investors remained nervous about obtaining the license or concession procedures. Particularly, the credit worthiness of the State Electricity Boards was considered doubtful, as a result of which the structuring and negotiation of suitable payment, and security mechanisms under the power purchase agreements were considered to be hazardous. Apart from the Electricity Act, other legislations which impact this sector are Water Act 1974, Air Act 1981, Forest (Conservation) Act 1980, Wildlife Act 1972, Environment (Protection) Act 1986, Factories Act 1988, Town and Country Planning Act 1952. Any power project involves a number of statutory clearances which need to be obtained from various clearing authorities e.g. for pollution control clearance (water and air), the State Pollution Control Board is to be approached. Forest clearance is generally obtained from the State Government and the same applies for the allotment of a project. In case any sort of clearance from the Municipality or a Panchayat is required, the local body is the clearing authority. A notable point is that, in case the project comes within 25 kilometres from reserve forest area or within 50 kilometres from inter-state boundary, the approval has to be obtained from the Central Government. Arguably, one of the most relevant reforms was the introduction of the Electricity Act 2003 that transformed the entire legal framework governing the electricity sector and has been designed to remedy many of the problems bothering India’s power sector as well as to attract capital to large-scale power projects. The legislative intent seems to be to give the private sector access to the State Electricity Board transmission grids, allowing private power producers to sell directly to large industrial consumers.
Not surprisingly, India boasts of having the third largest road network in the world and spreads over a length of 3 million kilometers. The national highways are governed by National Highway Act 1956, which underwent an amendment in 1995 to bring private participation into its ambit. To encourage private developer participation, the government strengthened the land acquisition provisions. To give it a further boost, the government also facilitates relocation of utility services, cutting of trees, resettlement and rehabilitation of the affected population. Apart from this policy, even the property rights on the highway land stretch are granted to private investors. The National Highways Authority of India (NHAI) came into being with the National Highways Authority of India Act, 1988.
This statutory body is responsible for the development, maintenance and management of national highways entrusted to it. Drafting Concession Agreements meticulously is a challenge and it has to be done keeping in mind, both the parties, i.e. Concessionaire and the Concessioning Authority, e.g. Government of India. Build Operate Transfer (BOT) concession contracts with an estimated value of USD 9.2 billion have been awarded under various packages and these are expected to be operational by 2015. For all practical purposes, the projects executed by NHAI and expressways, are subjected to EIA provided the cost incurred for the same exceeds Rupees 50 crores or in case they cross through reserve forests.
Public participation in development decision-making process ensures transparency as well as quality of decision. Although some legislations contain provisions for public participation, but owing to fear of delays and confrontation, they are rarely utilized. Public participation can be achieved at two stages. Firstly, at the time of enactment, there can be an extensive public consultation on any legislation, policy or scheme which deals with public interest issues, especially infrastructure development. Secondly, once the law is being enforced or the scheme is being implemented, it can provide ample opportunity for public participation.
The first serious attempt was made in the year 1997 with an amendment to EIA Notification 1994 introducing “public hearing” as a part of assessment procedure for ensuring participation of locals and stakeholders in various development activities. Public hearings are especially critical in projects involving large displacement of residents or major environmental impacts. Recent amendments in public hearing notifications have made hearings mandatory for all projects to which the EIA Notification applies. In support of this new requirement, the process includes provisions for public access to information. Having said that, it cannot be denied that there are some lacunas! For instance, for development of roads, ports etc., unless the concerned projects come under the purview of the EIA Notification, public participation is limited to the process of land acquisition only. The argument that openness be encouraged in considering all possible options for development has its challenges, given the logistics and time factor. Nevertheless, experience shows that it is time this mechanism is utilized effectively for the benefit of all.
It would be fair to say that a right balance has to be struck between economic development and environmental management while carrying out any infrastructure project. All infrastructure projects should compulsorily have a certain level of environmental and social assessment. Since the current policies aim at plundering the natural resources, by improving the efficiency of the existing plants’ productivity and undertaking proper environmental assessment, this issue can be tackled. Infrastructure forms the axis around which the globe of economic success revolves. Through consistent focus on infrastructure growth, India can embark on a journey of revolutionary growth. The “conglomerate” of statutes involved in infrastructure financing demands lawyers who can draft agreements of international standards keeping in mind the enforceability of the clauses. Be it an infrastructure project of Build Own and Operate (BOO), Build Operate and Transfer (BOT) or Build Lease and Transfer (BLT) type, the Government and the regulatory authorities have to be on “high alert” to welcome foreign investors’ and private participation.
Dr Umakanth Varottil Assistant Professor, Faculty of Law, National University of Singapore
Essentially a lot of infrastructure finances are oriented towards bank financing. One must consider broad based debt financing through bonds or collateralized instruments. While there does exist fairly elaborate success for bond market, there seems to be a lack of attraction in that market. To that extent, I think, more often, infrastructure financing is confined to bank financing rather than security-oriented structure where security is issued to the public at large.
SEBI has considered this issue and has come out with a separate set of guidelines for bond markets. There seems to be some reason as to why the infrastructure market in India has not been that attractive to investors. It is not that a legal regime does not exist, but there are many other commercial considerations and the lack of liquidity for a bond market in India. I think, in terms of infrastructure financing, there is a lot that can be done. One source of financing could be the external commercial borrowing route. As far as infrastructure is concerned, the Reserve Bank of India has been quite liberal in opening up the policies and making the entry requirements quite attractive. A lot more can be done by raising debt finance from the public market and this is one area which can be addressed.
Santosh B. Parab Senior Director-Legal, IDFC Limited (Mumbai)
Concession Agreement is the heart of infrastructure projects undertaken on PPP basis. It lays down the rights and obligations of each party (Concessioning Authority, i.e, usually the Government or Government Authority; and Concessionaire, i.e, the SPV which has been awarded the project after the bidding process) and hence is a very important document. Through the Concession Agreement, the Concessioning Authority transfers the construction risk and financing risk of the infrastructure project being developed to the Concessionaire. In consideration of the same, the Concessionaire gets rights to collect and retain the cash flows generated from such infrastructure projects. For example, in the road projects, the Concessionaire is obligated to build (i.e construct), finance, operate and maintain the road and simultaneously gets the right to collect the toll throughout the Concession Period. The Concession Period being the period for which the Concession Agreement will be valid and binding.
The Concession Agreement should be drafted taking into consideration the interest of all the parties involved, firstly, the Concessioning Authority and secondly, the Concessionaire. The Concession Agreement should also be bankable document, i.e., it should give enough comfort to the lending banks and financial institutions which funds the infrastructure projects. Since there is no tangible security which can be offered by the Concessionaire to the lenders, the lenders rely on the Concession Agreement (especially the assignment of Concessionaires rights under the Concession Agreement, the substitution right and right to receive the termination payment on termination of the Concession Agreement). Therefore, special care needs to be taken while drafting the Concession Agreement to make it a bankable document.
The lawyers play a crucial role in negotiation of any agreement. However, before negotiating the project tendering agreement, lawyers should first understand different aspects of the project in detail, like the type of project, the need for the project, risks involved, other legal issues if any pertaining to land acquisition, environment, etc,.
Based on the above, a project tendering agreement should be negotiated so that the risk allocation is properly done and the risk is transferred to the party best capable of taking that risk. A practical view should be taken in some of the issues without comprising the interest of the parties.
Amit Aggarwal Partner, S.N. Gupta & Co. (New Delhi)
Project Bonds are long term bonds issued in relation to a specific project with an intention to finance the long terms financial needs of project sponsors. These bonds help the sponsors to arrange the financial requirements for the project when banks and financial institutions are not able to support the long term financial requirements. A subscriber to bonds gets repaid from the revenues generated from the project and hence, runs the risk along with the sponsors and other project participants, as the repayment usually happens once either when the project is completed or has crossed the desire milestone. Therefore, the project bond subscriber is usually a large financial institution having technical expertise and knowledge relating to the similar projects and risks of investments associated with it.
In India, beyond a period of 5-7 years, it becomes difficult for banks and financial institutions to render project finance facilities. Usually, the construction risks are borne by the banks as the bond investors may not be willing to take the construction risk. This inability of the bond investors to take up construction risk has created a large vacuum in the infrastructure financing. Hence, there is immense opportunity for the ‘serious bond investors’ to invest in viable projects.
Usually the lenders prefer to have floating rate of interest as it helps them to earn the return and secure their positions due to fluctuation and changes in the interest rates. However, wherever its possible sponsors and borrower opt for fixed rate of interest in order to determine and crystallise their payment obligations. In case of floating rate of interest, borrower and sponsors should try to negotiate on the margins in the event the base rate tends to fluctuate beyond a defined percentage. This could help to keep the overall cost of borrowings within a targeted range.
There is no standard list of the requirements, however, ‘bankability’ requires:
It is usually seen that the acquisition of immovable property and allocation of land with clear and marketable title is a big challenge. The financial worthiness of the sponsors also plays a pivotal role in determining the bankability and viability of the project.
Andrea S. Kramer Partner, McDermott Will & Emery LLP (Chicago)
When an international oil company negotiates a concession or license agreement with the “host government”), several special clauses should be negotiated, such as force majeure, dispute resolution, and allocation of liability between the parties for gross negligence, wilful misconduct, and indirect or consequential damages. But let us focus on two special clauses: waivers of sovereign immunity and economic stabilization provisions.
Turning first to sovereign immunity waivers, a company should seek such a waiver from the host government that the company is entering into the agreement with. A sovereign immunity waiver clause is often added to a concession or license agreement so that the host government (for itself and its agencies, instrumentalities, properties, or assets) irrevocably waives any rights it might otherwise have to claim immunity from legal actions brought against it. The waiver language typically provides that transactions covered by the agreement are “commercial activities,” “not of a governmental nature.” This is because a host government cannot usually waive immunity for its governmental activities. Another key provision often found in a concession or license agreement stabilizes key financial terms. A stabilization clause keeps a transaction’s economics in place, even if the host government’s laws change over time. Traditional stabilization clauses freeze the laws to remain the same as they were at the time the contract was signed by the parties. Modern stabilization clauses, on the other hand, often include mechanisms to allow the host government to change laws as long as it agrees to compensate the company for any economic disadvantages if the subsequent legislation were to increases the company’s ultimate financial burden.
Lawyers with experience in negotiating international construction contracts often play a critical role in negotiating these contracts to best fit their clients’ needs. Experienced lawyers are called upon to negotiate construction projects that often involve multiple agreements, parties from different countries and different legal systems (civil, common, religious law, or combination systems). These lawyers understand the interplay between governing law, choice of law, and dispute resolution provisions. They often negotiate, for example, times for completion of work, notification requirements and periods for defects andindemnity provisions. They also work with local lawyers to ensure that collateral and security agreements are enforceable under appropriate local laws. And, they can assure their clients that all of the individual agreements that make up the complete set of project documents — as a whole — fit together correctly.
Lawyers with experience in negotiating international construction contracts often play a critical role in negotiating these contracts to best fit their clients’ needs. Experienced lawyers are called upon to negotiate construction projects that often involve multiple agreements, parties from different countries and different legal systems (civil, common, religious law, or combination systems). These lawyers understand the interplay between governing law, choice of law, and dispute resolution provisions. They often negotiate, for example, times for completion of work, notification requirements and periods for defects andindemnity provisions. They also work with local lawyers to ensure that collateral and security agreements are enforceable under appropriate local laws. And, they can assure their clients that all of the individual agreements that make up the complete set of project documents — as a whole — fit together correctly.
KK Sastry General Manager- Legal & Contracts, Maytas Infra Limited (Hyderabad)
It is necessary to specifically get the schedule for the works incidental thereto or necessary performance of any or all obligations of the agreement. Mostly the contracts are on DBFOT basis, i.e. design, build, finance, operate, transfer. It is necessary to have clear understanding and also to ascertain the project commencement date and to record the financial calculations for the entire project till the end of the transfer. Otherwise, the internal rate will differ. We should have clear vision of the grant of concession. Generally, in a DBFOT contract, the contract is inclusive of the exclusive rights of license authorities during the subsistence of the agreement to construct, operate and maintain the project. The following clauses are generally included in a Concession Agreement:
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