1. CASE: HIGHWAY FOUR PROJECT
Background

 The government of Finland wanted to upgrade a busy 69-kilometre section of two-lane road number four (E75) between Järvenpää (near Helsinki) and Lahti to a four-lane motorway (Highway Four). This was considered a suitable pilot case to examine the applicability of private financing to the development of infrastructure in Finland.

In the summer of 1996 the Finnish National Road Administration, on behalf of the Finnish government, arranged an international competitive bidding procedure for the construction and maintenance of Highway Four by a private company. Five consortiums submitted tenders, and in December 1996 the Road Administration decided to negotiate exclusively with a consortium that had formed a Finnish limited liability company, Tieyhtiö Nelostie Oy. The main shareholders of the company are Skanska BOT Projects AB, Skanska Oy and Hyder Investments BV. The design, build, Finance and Operate (DBFO) contract and certain other agreements, including the senior loan agreement, were signed on March 19, 1997.

The Transaction Structure

 The company was awarded a 15-year DBFO contract for the expansion and maintenance of Highway Four. The responsibility for maintaining the existing road started in May 1997 and the four-lane motorway expansion was initially scheduled for completion in two phases, the first in autumn 1999 and the second in autumn 2000. Maintenance of the new highway by the company continues until 2012. The company does not have ownership rights to Highway Four, but the Road Administration has granted it the right-of-use to all the relevant structures for the contract term. When the contract expires the company transfers all rights back to the government without any additional compensation.

Previous plans to introduce direct tolls were opposed by road users, but traffic flow should not be discouraged on Highway Four, because the essence of the DBFO contract is the shadow tolls paid to the company by the Road Administration. The shadow toll payments depend on the volume of traffic, measured at two locations on Highway Four. The payments during the 15-year contract period are estimated at approximately Fmk 1.25 billion (US$250 million).

The payments by the Road Administration have a cap but no floor. Because the company bears the risk of low shadow toll payments if the traffic flows are smaller than projected, extensive research was done on the traffic flow on Highway Four. Under certain conditions, for example if the arrangements for traffic during the construction period are unsatisfactory, the company may have to pay a fine to the Road Administration. Until the construction of the four-lane highway is completed the road Administration will only pay the company a maintenance fee. This increases or decreases according to a Finnish construction index. Certain risks, such as cost increases or decreases in shadow toll payments resulting from legislative changes remain, with certain exceptions, with the Road Administration.

Financing Highway Four

 Most of the financing was provided by Postipankki Oy (presently Leonia Bank Plc), a Finnish commercial bank, and the Nordic Investment Bank, a financing organization owned by the Nordic countries. The senior loans from these banks to the company totalled approximately USD 100 million in the form of a revolving credit facility and term loan facilities. A loan agreement containing the main features of an international project finance loan document was prepared under Finnish law. The Road Administration's shadow toll payments to the company are pledged as the principal collateral securing the repayment of the senior loans. Neither the government nor any other party has provided a guarantee to the lenders to secure the repayment of the senior loans. According to the loan agreement, senior loans must be repaid fully in 2011.

Additional financing for the construction of Highway Four has been provided in the form of junior loans and capital (equity) loans by the shareholders of the company and certain Finnish institutional investors. These loans rank below the senior loans in priority.

Tax Law Amendments

 Under existing Finnish law at the time when Highway Four was planned, there was a major problem in that the project structure had unfavourable tax consequences. Because there were no precedents for the tax treatment of the project, an advance ruling from the Central Tax Board was sought. Under the ruling, the road management service to be provided by any project company could not be treated from a tax perspective as a single service entity. It was rather to be divided into maintenance and construction services. Direct taxes and value-added tax for the construction service would be payable in the tax years the road was completed and opened to traffic as a four-lane highway, based on the value of the whole project. However, the value of the project would not be clear at the time the taxes were payable. Also, the tax burden would be substantial for 1999 and 2000. Limits on the deductibility of expenditures such as financing would impose further costs on the project company.

Because it was clear that the Highway Four project would not proceed unless these negative tax implications were eliminated, the Finnish government decided to amend the tax laws. The amendments came into force on January 1, 1997. The Act on Business Tax was amended to provide that compensation paid by the government (e.g. shadow toll payments) for all-inclusive road or railroad maintenance services provided by a private company, as defined in the Act, constitute earnings for the company in the year the maintenance service is delivered. In the Highway Four project, the yearly traffic count is the basis for formulating the extent of the delivered maintenance service.

The amended Act on Business Tax also provides that expenses incurred from the provision of the all-inclusive maintenance service and the interest expenses for the construction period incurred from the financing of the construction of the road or railroad are tax deductible in equal yearly amounts during the contract term starting from the year the road or railroad is opened to traffic. The Act on Business Tax states that the provision of the all-inclusive maintenance service will be based on an agreement having a contract term of at least 10 years.

Present situation

 The construction of Highway Four has proceeded faster than originally expected. The first part of the road which, according to the schedule, should have been ready by the fall of 1999, was opened to traffic already in the fall of 1998. However, the profitability of the project will become clear only during the upcoming years.

2. RECENT DEVELOPMENTS IN FINLAND

 In addition to Highway Four project, the transaction between the City of Karjaa and a private health care organisation Folkhälsan is, at the municipal level, a project financed by public-private-partnership model. In the transaction, the City of Karjaa has bought Meltola hospital that had not been in use, with FIM 24,000,000 and leased it further to Folkhälsan. Meltola hospital remains in the city's ownership for 20 years and Folkhälsan has been given an option to buy the hospital after this time. The City of Karjaa will purchase health care services produced by Folkhälsan.

Using private funding in Highway Four project has widely attracted public interest and thus there are plans to finance several other projects with private funds. The Ministry of Transportation and Communication has taken under consideration the initiative of using private funding next in E18 motorway construction between the cities of Porvoo and Loviisa at the southern coast of Finland.

Furthermore, it has been planned to introduce private financing to rail projects. The Ministry of Transport and Communication appointed a working group in 1997 to study the possibilities of implementing private funding principles in Helsinki-Huopalahti-Leppävaara City Railway construction project. However, it was found difficult to apply private funding in this particular project, because State Railways maintains the services in the railroad section in question. There were no separate activities that could have been allotted to private sector and that would have given sufficient revenue. The Finnish Rail Administration is working on a further study on introduction of private finance in railway projects.

In addition, many ministries and municipalities are evaluating the use of private funding in various projects. This public-private-partnership model has been considered to be applicable e.g. to conference and concert houses and the City of Espoo has already started the construction of two libraries, both by private financing method. Espoo has also made plans to build a school with private funds, so that the private sector would take care of construction and maintenance of the building and the city would lease the needed premises from the private sector.

A report on the applicability of private funding in public services made by a working group appointed by the Ministry of Trade and Industry was released in the end of 1998. The working group proposes that a separate private funding committee should be appointed. The key tasks for this committee would be to formulate the evaluation criterias for various public-private-partnership projects and to accept upcoming projects on behalf of the government. Other tasks would be to guide and help public and private sector in preparing the projects, drawing up the schedules and financial plans to meet the criteria of investors. According to the working group, the committee members would be representatives of the Ministry of Finance and various experts from private sector providing technical, financial, legal and administrative expertise.

This article contains general information on the subject matter and shall not be relied upon for a specific case. Specialist advice should be sought with respect to any specific circumstances.