Amidst the ambitious economic reforms undertaken by the Government of India, a slew of initiatives have been introduced for attracting investments in the transport and road sectors. The Ministry of Road Transport and Highways' (MoRTH) capital expenditure has increased by over eight times to reach approximately Rs 2.59 trillion in 2023-24 from Rs 0.31 trillion in 2013-14. This demonstrates the Central Government's unwavering resolve to create world class roads and highways infrastructure to accelerate socio-economic development. Buoyed by MoRTH's capital commitments, the sector recorded a CAGR of 23% for the last financial year. Public-private partnership (PPP) plays a pivotal role in fostering a long and sustaining collaboration between the government and private agencies.
Amongst developing nations, PPP is identified as a tool used to reform infrastructure and subsume sector improvements. However, road projects remained riddled with non-completion and less revenue generation. The revamping of PPPs was undertaken by the introduction of Hybrid-Annuity Model (HAM). At the outset, the model was perceived as a manifestation of balanced risk-reward allocation between the public and private parties by accentuating the government's focus on promoting ease of doing business in India.
The Article aims to analyze the purported disruption in the delicate risk and reward balance that exists between the government and private sectors under HAM-based concession projects sector due to the imposition of damages during the post commissioning phase (maintenance phase) of such projects and its impact on the participation of foreign entities and investments in the road and infrastructure projects in India.
JOURNEY SO FAR: EVOLUTION OF CONCESSION AGREEMENTS
PPP projects gained significance owing to the expertise and financial capital of the private sector supplanted by the Infrastructure Project Development Find under Department of Economic Affairs. The evolution of PPPs to this end was constituted by "formalization of concessional policy frameworks, experiential basis changes in the model concession agreements, increased willingness of users to pay for higher-quality services, and the enablement of an efficient ecosystem of project stakeholders, i.e., concessionaires, lenders, implementing agencies, consultants, and asset users".
Initially, Design-Build-Operate-Transfer (DBOT) Contract was introduced wherein the project related risks was thrust upon the private sector. In addition to the design, construction, and operations and maintenance, the private contractor was required to take risks associated with revenue forecast, revenue leakage, and project financing. This led to the advent of DBOT-Toll based contract model which purported to transfer significant financial risks related to revenue forecast and collection to the private sector. Although initially well received by the private sector, many private contractors were finding it difficult to recover their investments with a reasonable rate of return. Due to the distress faced in these PPP modes, financial institutions were also wary to fund these projects.
The Indian Government to this end, and in-order to regain the private sector trust, felt necessary to introduce a more evolved approach towards risk-reward sharing. The features of the Engineering, Procurement and Construction (EPC) based contracts was combined with the long-term PPP based projects. HAM was introduced as a variation of the DBOT-Annuity model, incorporating a milestone-based payment mechanism during construction as found in EPC contracts, although this payment covers only the partial cost of construction. The structure of the HAM-based concession agreement aimed at rebalancing the financial risks between the government and the private sector.
It was observed that the HAM arrangement differs vastly from EPC and BOT model. As illustrated in the HK Toll v. NHAI, the differences arise owing to the different scope of projects, different revenue collection methodology, different risk profiles - risk participation between the developer and employer, time, and manner of transfer of ownership, manner of payment of cost, etc. Such differences not only impact financial considerations but also influence the calculation and imposition of damages, reflecting the dynamic nature of PPPs in the realm of infrastructure development. However, over the course of recent projects under the HAM-based model it has been observed that there is an imbalance of risk allocation between the government and private sector; the private sector finds itself remains placed at the unequal position and forced to assume undue risks.
LEGAL RAMIFICATIONS OF HAM-BASED DAMAGES
In cases involving alleged breach of contractual commitments relating to repair and rectification work, HAM based concession agreements generally provide for levy of damages at the higher of (a) X% of the performance security, or (b) Y% of the cost of such repair or rectification as estimated by the Independent Engineer. Unfortunately, the model HAM contract upon which most HAM concession agreements are built, does not provide a separate definition/treatment of performance security during the two distinct stages of road projects - (i) project development (ii) operations and maintenance. The performance security is pegged against the total consideration (contract value/project cost), ultimately leading to instances of NHAI claiming disproportionate amount of damages, post commissioning of projects which is in disregards to the quantum of capital allocation during the two stages. It is to be noted that any developer would have already committed its share of capital and recovery of damages would have significant impact on the returns of the investors. It is also evident that the liquidated damages formula, its components, etc. are subject to very minimal debate/revisions and are not mutually decided by the parties. This is a latent contradiction to the settled law of damages in India.
Then there is the question of the genuineness of the losses suffered. The Supreme Court in Kailash Nath v. Delhi Development Authority held that the compensation stipulated in the contract should be fixed on the principles of mitigation and causation under Section 73 of the Indian Contracts Act, 1872; and that the cost must be a "genuine pre-estimate" of the loss. The amount mutually decided and stipulated in the contract acts as a mere upper limit to the amount that may be awarded as the compensation. The Court strengthened this justifiable approach in M/s Construction and Design v. DDA whilst holding that the liquidated damages due to employer "must be reduced to half in guise of reasonable compensation".
The intervention by the Court usually comes at the instance of unequal bargaining power between the Parties. For instance, the Supreme Court had previously in ONGC v. Saw Pipes observed that while parties remain the best judge of what constitutes as the "appropriate consequence" of breach for them, Court will remain cynical if the negotiation is premised on unequal footing of the parties.
In the present context, it is evident that the parties to the contract - private sector does not enjoy an equal bargaining power to the government authority. It is also observed that the liquidated damages are to be awarded upon breach of the contractual obligations by either party. The completion of construction of the respective project shall remain determinative of this "breach". Arguably, the private contractor cannot become liable to pay inconsiderably high damages after the project has been commissioned and primary responsibilities of the contractor have been fulfilled i.e., the construction of the project has been completed. The claim amount sought by the government authority in this sense, does not augur well with the principles of "reasonable compensation" as prescribed under Section 73 of the Indian Contracts Act, 1872.
ANALYZING THE COMMERCIAL ASPECT
The Asian Development Bank while highlighting the differences between HAM based projects and internationally accepted FIDIC form of contracts, recently remarked that while such differences are well-received by the private sector, there is a lack of global confidence towards investment in the Indian infrastructure sector. In commercial terms, it is to be understood that under the guise of this newly 'balanced risk-allocation', the private contractor or developer receives miniscule amount of monies as compared to the cost incurred by the developer during the construction phase. To put things in perspective against a project cost of about Rs. 1000 crores the private contractor only receives approximately Rs. 3 crores every year towards maintenance charges. This is further supplanted by high damages during the post commission phase, borne by the private sector which evidently remains opposed to the balanced risk-reward allocation.
It is also argued that there is an inadvertent link forged between the performance security and the alleged breach during the post commission phase against the private contractor or developer. For instance, under the FIDIC form of contract (for instance the Yellow and Red Book), the performance security is deemed valid and enforceable till the issuance of certificate of project completion or the performance certificate. The significance of performance security in the post commission phase thus remains unsettling in the contours of liquidated damages. Moreover, FIDIC form of contracts contemplate the fundamental role played by the engineer to determine the claims – including liquidated damages without requiring employer's approval. Under the HAM-based PPP and in practice, it remains a common act of the government authority to seek higher compensation claim without drawing inferences from the engineer's report. Arguably, the calculation of liquidated damages after the completion of project, firstly, contradicts the settled position of law on damages in India and secondly, results in commercial complications that does not warrant a balanced risk-reward ratio between the parties.
THE ROAD AHEAD
The balance of risk-reward allocation for increased likelihood of successful project outputs, is one of the defining features of any infrastructure project. However, the present form of HAM based annuity model that provides for recovery of damages after the commissioning of the project against performance security pegged against project cost strikes at the very heart of the risk-reward principles. It is worth considering if such provision will help shape, and rather uplift the global confidence in the Indian infrastructure sector. The continuance of such a provision may have a cascading effect on all interests of stakeholders including investors, lenders and the public at large. We hope that NHAI scrutinizes the trend of recovery of such damages in the context of the current government's push towards the creation of a developed InvIT market attracting capital from general public in HAM based road projects.
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