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Private cash for public projects

Industry Spotlight
|Written By Janet Guttsman
Private cash for public projects

As Canadian governments build hospitals, schools, and transportation in an era of budget constraint and slowing growth, they are turning to the private sector to construct, manage, maintain, and even operate a range of vastly different infrastructure projects.

Initial building costs are possibly higher, given that the private sector typically pays more to borrow than governments do. But measured over a 20-, 30-, or even 40-year life span, the major players agree the model of a public-private partnership, an alternative method of building and financing known by its P3 initials, is here to stay. They tout fewer cost overruns, faster construction times, and a transparent long-term management plan.

“Government needs infrastructure, but may not have the capital resources at any given time to fund what’s required,” says Brian Swartz, executive vice president and chief legal officer for Toronto-based construction company Aecon Group Inc. “By using the private sector to borrow the money over time . . . it allows governments to finance other things and other priorities and at the same time build their infrastructure. It has worked in Canada and it has worked around the world.”

Swartz says the P3 model has fuelled Aecon’s growth in recent years. But he insists it’s been successful for governments too. He and others active in the P3 space, say the model is only going to grow.

And grow, even despite a scathing report issued in December by Ontario auditor general Bonnie Lysyk which said Infrastructure Ontario’s use of private-public partnerships has cost $8 billion more than traditional public financing.

Infrastructure Ontario responded quickly, saying the $8 billion number doesn’t tell the whole story.

“AFP [alternative financing and procurement] works, and there is a benefit to risk transfers. It is misleading to talk about the cost of private finance without also considering the value of risk transfer,” says Marni Dicker executive vice president, general counsel, and corporate secretary at Infrastructure Ontario, the Crown corporation that helps Ontario modernize its infrastructure and real estate.

Canada is already one of the biggest global markets for public-private partnerships, where a consortium of private firms get together to bid for a government project. And unlike traditional infrastructure development, where the builder hands over the keys and walks away when construction ends, the consortium may commit to maintain or operate the finished facility over a period that could last 40 years.

Ottawa now requires buyers to review every project valued at more than $100 million to see if it’s suitable for a P3 before it chips in with any federal funding. But the P3 model is supported across political lines.

“It’s a way of depoliticizing the planning and procurement process,” says Dana Porter, a partner in Stikeman Elliott LLP’s commercial real estate practice and co-head of the firm’s public-private partnership/infrastructure group. “Once you’ve signed the project agreement . . . it’s very difficult for a government sponsor to get out of it without a huge expenditure. It reduces the risk that you are going to have a 180 degree about face by some politician about to score points.”

Of course a long-term P3 project imposes very different risks and challenges than does a conventional construction plan, and complex contract details bear those risks and what happens if things go wrong.

Technology will obviously change over the lifetime of a project, as can political priorities, and different participants are involved at different times of the build/operate/maintain cycle. Third-party lenders keep a close eye on things, which adds a level of discipline that may be lacking in other circumstances.

“Most risks can be categorized,” says Ilan Dunsky, a Montreal-based partner at Dentons Canada LLP, who focuses on infrastructure, P3s, and energy. “At a 10,000-foot level you can categorize a risk — default by private partner, default by authority, risk of a problem that is nobody’s fault.”

P3 contracts are now relatively standardized within Canadian jurisdictions, and knowing what’s going to be in a document reduces the legal costs.

“Our project agreements are very comprehensive,” says Dicker. “They are heavily templated in the sense that the market knows our contract, they know the deal, they know how we transfer risk. Every one is unique and may have its own nuances, but it’s not a white paper every time we do another P3. There are no surprises. It’s relatively easy for bidders to understand what they should price.”

Dicker recently surveyed the most senior lawyers in Canada’s P3 space about possible changes to Ontario’s P3 contracts after a decade of operations in the field. The final question was a catch-all: “What should Ontario look at now?”

The results were gratifying, she says.

“They have provided a really good amount of input into our documents, but surprisingly it seems that we’ve got it right. There were no outliers who were saying ‘The contract is wrong,’ or ‘Your section on something is incomplete.’” The overall message, she says: “You’ve really got it right. Think about these few tweaks, but you are there.”

Dicker moved to Infrastructure Ontario in 2013 after 14 years at SNC-Lavalin Group Inc. She says it’s been something of an eye-opener.

“Coming from private sector you looked at how you can mitigate the risks that are being transferred and whether they are risks that you are willing to absorb,” she says, admitting she always had the feeling that government was trying to offload all risks to the bidder. “You always want to win a project, but it’s better to lose a project if you are going to lose money. Wearing that hat was one of my main functions in the private sector. Knowing when to say no, or knowing when to say yikes.”

“Now that I am in government . . . I see that my prior thoughts were wrong.

Government tries to determine who is best suited to absorb risk. Government worries about the cost of risk transfer. It is sometimes better to keep the risk and not have private sector price it.”

That concept will be important as governments shift other areas of infrastructure construction, maintenance, and renewal toward P3, including potential projects in transportation, waste disposal, or water purification. Digging road or subway tunnels, for example, adds a new level of risk in that builders must relocate underground utilities, and they may not know precisely where those utilities lie when they submit their bid.

“Under a conventional model the government co-ordinates with the utility to move all that, but under the P3 model the government asks the private sector to take the risk,” says Swartz from Aecon. “Many contractors have been burned around the world where they had inordinate costs in utility relocation that were not properly budgeted, and the risk was not properly shared with the state.”

Porter says Ontario’s auditor general’s report is correct that the government can borrow money at lower rates than the private sector, but that isn’t the whole story. In the right circumstances, the P3 model can provide savings and non-financial benefits that will offset the higher finance costs, such as risk transfer, deferral of cost over the life of the asset, and providing a mechanism to ensure that operation and maintenance of the asset is properly budgeted for to preserve the value of the asset over its life.

 “The suggestion that the province should bring large project expertise in-house and use traditional procurement methods across the board seems a bit misguided. It ignores the fact that the province already has a great pool of procurement expertise in Infrastructure Ontario, and it assumes that a one-size-fits-all procurement approach will work for all projects, which isn’t correct,” he says.

Dunsky allows that P3s are not necessarily cheaper than conventional projects — in fact, they can be more expensive given the contractual requirement on the private partner to operate and maintain the infrastructure for 30 years or so — a significant expense not always included in  budgets for conventional, government-led projects.

That said, the biggest advantage to governments of a P3 are the risks (cost overruns, time delays, poor maintenance) shifted to the private operator. “I don’t know of many conventional projects that are completed on-time and on-budget,” he says, noting that often they cost substantially more than budgeted, and in a conventional project that extra cost is generally picked up by the taxpayer.

“In a P3, absent a change in the project specifications or an excusing event such as a force majeure, it is the private operator who bears the loss. In its conclusions, particularly that Ontario spent $8 billion more on its P3 infrastructure projects than necessary, the report appears to be based on a comparison of the actual cost of PPPs to the budgeted cost of similar conventional projects. Perhaps that was necessary, since a project developed as a P3 cannot, by definition, have an actual cost as a conventional project. But to my mind that vitiates the validity of the conclusion, because it seems to fail to take into account the cost overruns and delays incurred by many conventional projects which add significantly to their cost,” says Dunsky.

A project size between $50 million and $100 million, is generally viewed as the smallest viable for a P3 model, while the ceiling depends on how much the private sector can finance.

“For a real P3 with all the bells and whistles, $100 million is probably a fair threshold, but I’ve worked on projects that are much smaller,” says Dunsky. “In terms of too big, the upper limit is the amount of financing available for any particular project. If you went to the market with a $10-billion project there might not be enough money for one single project.”