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The Top 5 Legal Issues for Building Green in Public-Private Partnerships

The $330M Interstate 90 design, construct, and finance project is the first P3 in Ohio. In 2011, Ohio became the 30th state to authorize P3s.

The $330M Interstate 90 design, construct, and finance project in Cleveland is the first P3 in Ohio, which in 2011 became the 30th state to authorize P3 delivery.

Last September I attended and presented at the ABA Forum on the Construction Industry’s Fall Meeting in D.C. (This article has been in the works for some time and has been holding up other content here at the Journal, so thanks for bearing with me). The topic? Public-private partnerships: perhaps one of the most timely in the design and construction industries at the moment, particularly given the gridlock on Capitol Hill that seems likely to continue for the foreseeable future.

P3 project delivery has been used for decades, but it has recently come back into the spotlight thanks to shrinking budgets at the federal, state, and local levels and a boom in enabling state-level legislation: thirty-five states now have a P3 statute on the books. (For green building practitioners this should sound familiar.) In that vein, along with my co-presenter, Tracy Steedman, our talk at the Forum meeting focused on how P3 projects (and “social infrastructure” in particular, like schools and hospitals) are being increasingly delivered with green building components.

Although the following top five list was not specifically part of our presentation, I thought it would be useful to highlight these P3 legal issues from a high-level perspective, as we will likely discuss this topic in more detail in the future here at the Journal. Though written primarily from the point of view of a design firm (which typically finds itself at the bottom of the design-build and P3 contracting food chain), my hope is that design-builders, concessionaires, lenders, and legislators will also find the points raised below of some import too, regardless of whether their projects involve green building components.

1. Vocabulary

While P3 delivery is pervasive abroad, it has been slow to take root here in the U.S. So P3 vocabulary is an important threshold matter. What is a P3? The National Association of Public Private Partnerships defines it as “a contractual agreement between a public agency (federal, state, or local) and a private sector entity. Through this agreement, the skills and assets of each sector (public and private) are shared in delivering a service or facility for the use of the general public. In addition to the sharing of resources, each party shares in the risks and rewards potential in the delivery of the service and/or facility.”

Yet “public-private partnership” is not a well-understood term, which has implications across the board, from governments enacting enabling legislation down through project team consortiums evaluating a particular pursuit. Legislators may balk at the possibility of capital or social infrastructure projects having a private funding component. And project teams may not fully understand the implications of P3 funding mechanisms on their contract documents and financial risk profiles. “One party’s BOO (build/own/operate) is another’s DBFOM (design/build/finance/operate/maintain)” was a common talking point at the Forum. So becoming familiar with the terms used in P3 settings is critical to assessing risk, negotiating terms, and succeeding in this new paradigm.

2. Legislative and Regulatory Structures

While at least 35 states now have P3-enabling legislation, the statutes vary widely in their breadth and applicability. In many states public contracting requirements still apply even though private funds will be used to build the project. So the first step in any P3 paradigm is to review the applicable statutory scheme. This is particularly important in the green building context. First, sometimes it is not clear if public requirements apply to a P3 project. So determining what public sector LEED or green building-related requirements may even apply is an important threshold question. If so, how will these obligations translate into the contract documents? We will discuss this issue further below.

It was particularly interesting that one Forum plenary laid out the key elements of what makes a good P3 enabling statute:

(1) Claims: the statute should allow the design-build team to have a pass-through right to make claims in the concessionaire’s name against the public entity (though this may not be permitted under state law).

(2) Design Review: the public entity’s ability to review the project’s design should be limited to whether the requirements of its agreement with the concessionaire were met, with a reasonable time allowed for that review and a limited ability for it to request resubmissions and/or reject design submittals.

(3) Disputes: because of the likelihood of significant liquidated damages in the event of project delays, expedited procedures for disputes over the design should exist (coupled with the appointment of a technical expert for those purposes).

(4) Utilities: agreements with local utility companies are often key to a successful P3 project as utilities often need to be relocated and the companies themselves are slow to act. So the public entity should remain responsible for this risk by statute.

(5) Rights of way: in the same vein, acquisition of any necessary public rights of way for the project should remain the public entity’s responsibility.

(6) Definitions: appropriately defining substantial completion and final acceptance is critical because standard definitions may not translate well for large horizontal P3 projects. Again, with the potential for significant liquidated damages to accrue if the concessionaire and its design-build team miss those milestones, proper definitions for these milestone dates and the obligations they will trigger is therefore crucial.

(7) Public bidding requirements: is the project exempt from the jurisdiction’s public contracting requirements, like prevailing wage laws and other statutory requirements, including green building requirements? Because of the hybrid nature of P3s making this determination may not always be cut-and-dry.

(8) Unsolicited proposals: some states, like Florida and Virginia, allow private parties to propose their own P3 projects to government agencies. Understanding the bidding and procurement mechanisms behind these schemes is therefore important.

One final aside here: at the Forum meeting, an underlying theme was that there is a real opportunity for attorneys to participate in the P3 legislative process, as many P3 schemes are still emerging at all levels of state and local government. (This in some ways mimics the emerging green building legal space in the late 2000s.) So it’s an exciting time for attorneys, in particular, who can help legislators in crafting legislation that could build next-generation civil and social infrastructure projects that are sorely needed across the country.

3. Scope Creep

Like any green building project (or any construction project for that matter) delineation of scopes of work between the design-builder and its designers is paramount on a P3 project whether it includes a green building component or not. But scope creep may occur where blurred design and construction responsibilities exist between the builder and the designer. Under those circumstances, construction-related responsibilities may flow to the designer, improperly shifting additional and inappropriate risks.

On the other hand, the builder or even the concessionaire may assume project responsibilities that are professional in nature. In addition, for P3 projects involving an operation and maintenance phase, a clear delineation between that phase and the construction phase is also important, particularly for purposes of payment. Like any design-build scenario, many of these types of risks exist in the P3 setting because of the inherent nature of alternative project delivery mechanisms. Focusing on scope and how it may affect each party’s risk profile is therefore critical to a successful design-build or P3 delivery.

4. Financial Risks

Much P3 design work is performed on the front end for little fee, so there are significant financial considerations for design firms considering a P3 pursuit. Complicating matters is that many contractor-led design-build consortiums will not share any participation stipend or success fee from the concessionaire for winning with the design firm. So fair compensation for design firms (at least according to many panelists who spoke at the Forum last fall) is to break even regardless of the outcome. Then, if it is a win, to be profitable and earn full fees on the balance of the project.

Many P3 contracts will also contain penalties or indemnity obligations if design failures lead to the consortium team losing the project to competing bidders. Understanding, assessing, and attempting to negotiate those financial risks is therefore critical if a design firm chooses to participate in a P3 procurement.

It is also worth noting here that, once the design reaches a certain level of completion, bridging design-build agreements have the potential to mitigate against some the financial risks posed by P3 contracting for designers. While certainly its own topic, bridging essentially contemplates the owner directly hiring a designer to prepare the design to a certain percentage of completion (usually 30 to 50 percent) before the design-builder assumes responsibility for preparing the final design and construction documents. This allows the designer to earn its fee rather than spending its own money to advance the design during the SOQ process before the design-build team has even won the project. From the owner’s perspective, it provides more control over the development of the design than in a typical design-build where the contractor controls the designer and the design program.

5. Contract Terms

Contract risks are acute not only because of the typical P3 lending structure: the concessionaire is usually set up as a special purpose entity with no assets. So its funding is off-balance sheet – meaning it holds no liabilities or assets other than the contracts. This requires it to flow all risks downstream. Financial, schedule, and operational risks will therefore shift completely from the public entity, through the concessionaire, and down to the design-build project team. Conceptually this is a different risk shifting construction paradigm. Risk is not shared by the party most able to bear it but rather the party least able to resist it, which in the P3 context is typically the designer sitting at the bottom of the contracting food chain. So negotiating acceptable terms from such an unenviable position can be a major challenge for designers and their counsel.

Generally P3 procurement is in two phases. Because of this, some public entities have reported having problems finding bidders on account of the high costs of participating in the proposal process. Here’s how it typically works. Participation in a P3 project team is generally locked in at the statement of qualifications (SOQ) phase before the public entity and the concessionaire have finalized the concession agreement or even the RFP terms that will flow down to the design-build team. So the team may not know what terms it will need to comply with until its participation is already locked in at the SOQ phase. This impacts each consortium team member’s ability to assess risk (regardless of whether the pursuit includes a green building component). For the designer, this makes choosing the right design-build partners so important on a P3 (or any design-build project, for that matter).

More specific P3-related risks also implicate many of the green building legal issues that you are by now no doubt familiar with. For example, heightened standards of care, driven by lender requirements and some of the scope creep issues that we discussed above, or liquidated damages (driven by the debt service that the lending partners will be paying through the availability payments or revenue from the project upon completion) or consequential damages exposure. The latter may exist in particular on a green building P3 project where the end user has an internal mandate to occupy a building certified at a certain level of third-party certification.

Other contracting issues to consider include construction warranty-related language that similarly may flow down to the designer and open-ended liability exposure created through lenders asking for blanket reliance on design documents. Those documents may also need to be shared freely between consortium team members beginning at the SOQ and RFP phases. Because of the long-term nature of P3s, longer tail exposure during the operations and maintenance phases of the project may exist for the entire design-build team. Finally, by participating in the consortium of firms that will contract with the concessionaire’s special purpose entity, expanded third-party liability may exist to the other participants in the design-build team.

Conclusion

The promise of public-private partnerships increasingly delivering new infrastructure projects across North America is exciting, and also portends an increase in green building projects that are also delivered by P3. Understanding and analyzing these top 5 legal issues when considering a P3 or design-build project with green building components will hopefully assist in fully assessing and understanding risks on these types of projects.

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