Public-Private Partnerships: Who Pays When the Project Fails

P3 contract structures exist on a spectrum from limited private involvement to comprehensive private responsibility, and the appropriate structure for a specific project depends on the risk profile, the government's capital availability, and the revenue potential of the underlying asset.

A design-build contract bundles design and construction under a single private contractor with a fixed price, transferring design-defect risk from the public agency but leaving financing and operations in government hands. A design-build-finance-operate-maintain contract, or DBFOM, transfers design, construction, long-term financing, operations, and maintenance to the private party for the full concession term, typically 30 to 99 years depending on the asset type. A concession agreement for an existing toll road or airport hands over operations and capital improvement obligations to the private concessionaire in exchange for an upfront concession payment, with the government retaining ownership and regulatory oversight throughout.

The DBFOM structure is the most complex because it requires the private party to raise project-level debt and equity financing, exposing lenders and investors to project revenue risk rather than the creditworthiness of the government. An attorney who handles project and infrastructure finance and P3 concession agreements can structure the contract to allocate each category of risk to the party best positioned to bear it at the lowest economic cost.

The distinction between availability payment and demand risk structures determines how a P3 project is financed, how it is valued by investors, and what the government's long-term financial exposure is regardless of how much or how little the public actually uses the asset.

An availability payment structure pays the concessionaire a fixed amount per period, subject to deductions when the asset fails to meet performance standards, regardless of how many people use the road, hospital, or water system. The payment certainty allows the concessionaire to raise lower-cost project financing because lenders are exposed to government credit risk rather than demand uncertainty. Availability payment P3s dominate social infrastructure sectors such as hospitals, schools, and courthouses where user charging is impractical.

A demand risk structure produces higher potential returns when usage exceeds projections and catastrophic losses when it falls short. The toll road concessions that went bankrupt in the 2000s following traffic projections that proved wildly optimistic illustrate the downside of demand risk transfer without adequate protection against sustained shortfalls. Many modern P3 concession agreements now include traffic revenue floors and ceilings that share the upside above a defined level with the government and protect the concessionaire from losses below a defined floor. An attorney who handles government contracts and P3 concession agreement drafting can evaluate whether the revenue risk structure as proposed produces a sustainable financial model for the concession term.

Compensation event provisions are the most heavily negotiated clauses in any P3 concession agreement because they determine which party bears the financial consequence of risks that neither party can fully control. A compensation event definition that is too narrow leaves the private sector absorbing government-caused delays and cost increases that were not priced into the bid. A definition that is too broad transfers risks back to the government that the P3 structure was specifically designed to shift to the private sector. Getting the compensation event schedule right at execution is the single most important factor in whether a P3 concession remains financially viable through its full term.

Lenders to P3 projects require specific contractual protections that are embedded in direct agreements between the lender group and the government authority, separate from the concession agreement itself, to ensure that their security interest in the project survives a concessionaire default.

Step-in rights give the lender group the right to take over the concession and cure any default by the concessionaire rather than having the government authority terminate the concession agreement and eliminate the lenders' security. The step-in right period, typically 90 to 180 days after the government authority provides notice of intended termination, gives lenders time to assess whether to cure the default, bring in a replacement operator, or negotiate an alternative resolution. Without step-in rights, a concessionaire default would immediately terminate the lenders' security, making P3 projects unbankable.

Termination compensation provisions define what the government pays if it terminates the concession agreement for the concessionaire's default, for the government's own convenience, or due to force majeure or prolonged government events. Lenders require that termination compensation in any scenario be sufficient to repay the outstanding senior debt, which means the compensation formula must be negotiated with lender requirements in mind before the financing is secured. An attorney who handles energy and infrastructure projects and P3 financing documentation can structure the direct agreement to satisfy lender requirements while preserving the government's ability to maintain project control.

State P3 enabling legislation determines which procurement authority, which risk allocation structures, and which financing mechanisms are available for a specific project in a specific state. A P3 structure that is legally available and commercially successful in Virginia may not be permitted under the enabling legislation of a neighboring state. Unsolicited proposals, which allow private parties to propose P3 projects that the government did not specifically put out for bid, are permitted in some states and prohibited in others, and the procedural requirements for processing them vary significantly even in states that permit them.

A public-private partnership is a long-term contractual arrangement in which a private entity finances, builds, operates, or maintains public infrastructure in exchange for revenue from users, government availability payments, or both, under a risk-sharing concession agreement. It differs from a conventional government contract in that the private party accepts responsibility for multiple project phases bundled together, raises its own project-level financing rather than having the government fund construction from its budget, and absorbs defined categories of project risk in exchange for long-term revenue rights. The concession agreement, not a standard construction contract, governs the relationship.

An availability payment P3 pays the private concessionaire a fixed government payment per period that does not depend on how many users the facility serves, subject to deductions when performance standards are not met. A demand risk P3 gives the concessionaire revenue that varies directly with user volume, such as toll revenue that rises and falls with traffic. Availability payment structures produce lower but more predictable returns and are common in social infrastructure. Demand risk structures produce potentially higher returns but expose the concessionaire to sustained losses when usage falls below projections.

TIFIA, the Transportation Infrastructure Finance and Innovation Act, provides direct federal loans, loan guarantees, and standby lines of credit for qualifying surface transportation P3 projects at U.S. Treasury interest rates, which are typically lower than commercially available project finance rates. TIFIA financing is subordinate to senior project debt, reducing the risk perceived by senior lenders and improving the project's overall bankability. TIFIA is available for projects with eligible costs exceeding $50 million that generate dedicated revenue streams. An attorney who handles procurement contracts and P3 financing matters can evaluate whether a specific project meets TIFIA eligibility criteria and structure the application.

Compensation events are defined circumstances for which the government accepts financial responsibility in a P3 concession agreement, entitling the concessionaire to additional compensation, time extensions, or both when they occur. Common compensation events include government-ordered scope changes, utility conflicts not disclosed in procurement documents, delayed government approvals, and changes in law that increase the concessionaire's costs. The compensation event schedule must be comprehensive and precisely defined because events that are not listed are typically absorbed by the concessionaire under the general risk allocation framework, regardless of who actually caused them.

Step-in rights give P3 project lenders the contractual right to take control of the concession and cure a concessionaire's default before the government authority terminates the concession agreement, protecting lenders' security interest in the project revenue stream. Without step-in rights, a concessionaire default would trigger concession termination and eliminate the lenders' primary security, making the project debt unfinanceable. The step-in period, typically 90 to 180 days from termination notice, gives lenders time to assess whether to cure, replace the operator, or negotiate a restructured concession. Step-in rights are formalized in a direct agreement between the lender group and the government authority, separate from the main concession agreement.

In states with enabling legislation that permits unsolicited proposals, yes. An unsolicited proposal is a P3 project concept initiated by a private party rather than in response to a government procurement. States that permit unsolicited proposals typically have defined procedures for reviewing them, protecting the proposer's proprietary information during review, and conducting competitive procurement if the government decides to proceed with the concept. States that do not permit unsolicited proposals require all P3 projects to begin with a formal government procurement. An attorney who handles government contract disputes and P3 procurement matters can evaluate whether the applicable state's enabling legislation permits unsolicited proposals and what procedural protections apply to the proposal's confidential information.