Moneycontrol
Apr 14, 2013 07:49 PM IST | Source: CNBC-TV18

Unravelling truth behind renegotiation of contracts

In a recent time, there has been many examples of private companies in infrastructure sector wanting to renegotiate their contracts with public bodies on the ground that projects are becoming unviable due to unforeseen developments.


In a recent time, there has been many examples of private companies in infrastructure sector wanting to renegotiate their contracts with public bodies on the ground that projects are becoming unviable due to unforeseen developments.


However, it remains to be seen whether such demand for renegotiations of contracts arise from genuine unanticipated developments or because the bidder bids predatory prices to edge out competition.


This phenomenon was seen in two recent cases.


Adani Power agreed to supply power to the Gujarat electricity company Gujarat Urja Vikas Nigam Limited (GUVNL) for 25 years at a levelised tariff of Rs 2.34 per kilowatt-hour (kWh) and to Haryana electricity companies at Rs 2.94 per kWh. The company did not opt for any escalability clause while bidding.


Three years after winning the contract the company entered into long-term coal purchase agreements in Indonesia with its own group company at USD 36 per tonne, much lower than prevailing prices. However, Indonesia changed rules last year asking companies to change long-term contracts to prevailing market prices. This resulted in coal prices doubling for Adani.


The company has therefore asked the electricity regulator to allow a price escalation.  The Central Electricity Regulatory Commission (CERC) in its recent order asked the two electricity companies and Adani to arrive at a way to compensate the company for a limited period till the higher prices last.


In another instance, GMR Infrastructure walked away from a road widening project awarded by the National Highways Authority of India (NHAI) on grounds of delayed clearances by various government bodies. The NHAI has now asked GMR to return to the project by offering some sweeteners. It has allowed GMR to backload the payments it has to make to NHAI to a date after the toll collections start. In exchange the company will be charged 10 percent cost of capital. So GMR instead of paying Rs 320 billion to NHAI will pay Rs 590 billion. In the meanwhile NHAI will provide a guarantee to lenders upto 90 percent of the project cost in case GMR defaults. The restructured contract is yet to get cabinet approval.


Such demand for renegotiations of contracts raises some fundamental questions


1. Bidders who are edged out could take the government bodies to court saying the incentives were not extended to them and they were unfairly edged out.
2. The sanctity of the contract is violated and many more project developers can demand similar renegotiations.
3. There is a moral hazard in that private bidders know their losses will be wiped out by subsequent government larges while their profits don't have to be shared.
4. How does one distinguish between projects that are unviable because of a genuine unforeseen development and projects that are unviable because the bidders bid at predatory prices merely to edge out competition.


CNBC-TV18 spoke with three eminent personalities who have in-depth knowledge of such contracts namely Amit Kapur, Senior Advocate Jyoti Sagar Associates, SL Rao India’s first CERC Chairman and KK Mohanty, CEO, Gammon Infra.


Below is the verbatim transcript of the discussion.


Q: What is the more common problem, projects becoming unviable because prices have gone out of whack suddenly, or because companies purposely quote lower, confident that having won, they can either suck out their equity or just walk away.


Rao: It's a mix of all this. Let’s start at the beginning. In any kind of infrastructure contract, particularly in the case of power, you are trying for what is called a levelised tariff, you're trying to get a single tariff over a period of 30 years. Now within that you are allowing certain kinds of escalations on account of foreign exchange evaluations or whatever else. However, we have to remember that 30 years is a very long period in a complex world and in that complex world in those 30 years so many things can change particularly when you are talking about a Rs 20,000 crore rupee project, building 4000 megawatts of a power plant or building 100 kilometers of road going to all kinds of forest lands and so on.


I am not going onto all the other issues- land clearance being delayed, environment clearance being delayed all the other things that are causing big delays in infrastructure but I am talking about your requirement of a single tariff. Now within that you make assumptions and those assumptions are extremely difficult. Even the best economist in the world will not be able to tell you what things are going to be like in the next 30 years particularly in specific items like this. So, I think that is where it starts. Second, you also have as you said quite rightly very aggressive bidding. We have seen this particularly in the case of road projects, power projects also particularly in some Ultra Mega Power Projects (UMPP) projects.


Thirdly, whoever is looking at the bids has no concept of a floor price, saying below that price the project is unviable. The best example of this is the Secunderabad Metro where Maytas had quoted a price where they did not want viability gap funding. They  in fact willing to pay, but what happened at the end? The project just collapsed. Now Larsen and toubro (L&T) are doing it and they are also having problems because of forecasts. These are the 3 things that I wanted to point out.


Q: You have looked at the entire variety. Just at the outset, is it always possible to distinguish against wilful default or wilful predatory pricing and cases where things have been in a sense genuinely miscalculated?


Kapur: I would concur with Rao for the reason that the most predictable reality of infrastructure projects is that in a 30 year cycle, unpredictable happen.


So unless your contract structure provide to deal with handling unpredictable situations which are not controllable, for which no one can be blamed; you have already started with an incomplete contract. Now that's where the problem begins. Second aspect just to add to what he said was also the structure of the concessions. Largely when the government started with the idea of getting investments post 91, they were very risk averse. And the approach was to try and pass on as much as away from the government.


So from a public-private partnership (PPP), which was a concept, the idea was that the public will be the good, but private will be the person who takes the entire risk of the operations, so that was one problem. So we have contracts and concession arrangements and legal frameworks that do not address the uncertain realities which are not blameworthy on any party, that's one issue.


Second issue is that people were excited with the prospects of bidding and they made assumption which were not actually robust and that happens all the time, you look at the national telecom policy 94, in 99 the telecom policy was rewritten from highest royalty you went to revenue share. But what was the outcome? The outcome was that teledensity went up tremendously from Rs 32 a minute, you came down few paisa.


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Today, you have more mobile connections than you have landlines. So, it is the approach of dealing with the unforeseen and the ability to deal with them which defines the course of what emerges in future. If somebody is at fault for underbidding you have to see it in context of the date of the bid. Ten years down the line the ground may have changed entirely. Those are two facets I wanted to add to what Rao said.


Q: Why do these cases come up? In your judgement is it because there are a lot of imponderables and Indian infrastructure sector being probably young and feeling its way, is making mistakes in terms of assumptions or is it because in a larger number of cases the bidding is wantonly predatory, wantonly intended to just get the contract and then work your way thereafter?


Mohanty: I will not try to judge someone on what context they have bidded, but one suggestion I can offer is that when you are renegotiating such projects, whoever you are protecting the private sector or public sector should be allowed to present fresh bid.


Q:  But, we have to first apportion blame at least to some extent, would you agree that at least in 50-40-60 percent of the cases, the bidder, in your experience, has been wantonly predatory?


Mohanty: I would not like to judge other bidders but we believe that the projects which we did not get, were the project we found it unviable beyond our quoted price. So, in our judgement, the biddings were not at that range, and not sensible for us. But, others may have a different context, different competitive advantage, different reason, purpose and strategic reason to take it. So it is difficult to comment on that.


Q: Let us accept that it is in the public interest first to save these infrastructure projects since they are important for the country. A lot of bank money is stuck and it is possible that project developers are genuinely caught by unforeseen circumstances. Yet, changes in contracts will be challenged by competitors who lost the contract and also possibly by government bodies like distribution companies (DISCOMs) who now have to pay more. If we change contracts, how can we make them legally defensive?


Mohanty: There are two parts to it. If the concessioner from his side still holds the view that it is still within the contract of the force major or change of tariff then it should be established through a legal process or an arbitration process. But if it is a process of renegotiation due to whatever circumstance, it has to be a little more equitable as far as the equity of side is concerned. As it is told a public private partnership, then equity has to be shared at this stage because the contract is renegotiated between the government and the private party.


The third party, to make it amply clear, may go beyond it. If there is a revised terms and conditions, might be it is not a bad idea to put it to another bid and if another third party operator is willing to bid and improve those terms which is being offered. This will give an equitable platform to everyone.


Q: So this does not solve immediacy of the problems.


Kapur: I think three things to be looked at. One is differentiating between projects that have actually been invested and are ready to go versus those that are yet to. Differentiate those from where there is culpability of the bidder versus those which are outside their control. There is in fact a very constructive study of a thousand concessions in Latin America, which was done by World Bank 2004 Book, which brought out that around 46 percent of all bid out contracts are renegotiated the world over. So India is not unique to this reality, as Mohanty said. In fact it is instructed to see that there are three kinds of basic renegotiations. One is where an investor comes in and believes that he has the monopoly control and exploits it, should be discarded.


Second is where somebody has a stranded investment but the government plays hooky and doesn't allow the changes that have to be interfered with.


Third is where there are externalities like foreign exchange variation Mexico, Brazil saw, which was found to be legitimate by that study also. They said that best to put through an autonomous 3rd party, which gives a reasoned decision like CERC and determines which is subject to judicial review. So I think my perspective would be distance ownership from the asset, focus on public interest involved in the infrastructure goods and then rework the asset depending on who is at fault.


Q: How can we make future contracts secure? How do we work the current contracts whether it is NHAI or whether it is CERC?


Rao: I think in future we should not have this kind of long-term levelised tariffs. We should provide for, as Kapoor has told you, for adjustments as we go along and that should be built into the contract. But not average tariff for the next 25-30 years.


Kapur: First and foremost, government should understand public-private partnership (PPP) means equal participation from both public and private party. You cannot wish everything away. You cannot put disclaimers. You will have to take hands on role as a partner as an when exigencies outside control of parties comes up and find a solution. So one is, provide a proper risk allocation and risk mitigation. For example in the power sector, you are relying on imported coal which is a natural resource of a foreign government. You will have to take care of the fact that when you can nationalise your coal, the other country can also and you have to deal with that reality.


Secondly, please make sure that you have contract readjustment clauses, which are put through total scrutiny on the Chilean model of least present value of revenue so that nobody takes an unfair advantage and the consumer interest is also safeguarded.


Third, most importantly, provide a time bound mechanism in all sectors so that you are able to decide matters in 2-3 years time and hopefully get the respect of courts as Rao has said. SC had repeatedly has said we do not want to interfere with regulators and expert bodies like Appellate Tribunal because they are doing their job considering all the financial, technical, commercial and legal issues together. So those are the basic solutions otherwise it is sagacity and willingness to solve problems.


Q: In future contracts, how can the government proceed differently?


Mohanty: Existing contracts - there should be a time bound process for contractual disputes to be settled. Today it is taking 5-10-15 years that takes the project into this type of loop. So, that is the urgent requirement on which a time bound contractual dispute should get established and through a defined process. Today the process of arbitration, lower court, higher court then SC takes a lifelong time, by that time the economic value of the project gets destroyed. That is the most serious problem today.


In my opinion, the second part is infrastructure project over 30-40 years period with a standard concession agreement is not a reality. So you have to have customized concession agreement for each project looking at the context and imponderables on certainties of what might come in that project. So a customized concession agreement will address most of the issues when you look at those things.


From the discussion we can conclude that contractors are not always stuck because of government intransigence or unpredictable prices often they have bid wrongly.


In case of Adani Power, dissenting Central Electricity Regulatory Commission (CERC) member Jayaraman clearly puts the blame on the bidder. In his note he says “Adani quoted nil against the escalation option, while competitors wanted the option to escalate the tariff if their costs changed.” Jayaraman also points out that Adani’s contention is that his pricing is unviable because his coal price rose from USD 36 to USD 65 because of a change in Indonesian rules, but Jayaraman and the Haryana discoms point out that if one works back from the tariff quoted by Adani on the basis of costing used by the Gujarat Electricity Commission (GERC) – the tariff of 2.34 per kilowatt is viable for coal prices up to USD 67.


In the GMR case too experts, point out that the financial sweeteners offered by National Highways Authority of India (NHAI) bear no relation to the problem of delayed clearances suggested by GMR as the reason for renegotiation, more important mid-stream changes in contracts will be challenged by the discoms and by perhaps the competitors.

So any change of contract to be made legally defensible must penalize the company at least partly by writing down their equity. Secondly, Mohanty's idea that reworked contracts should be rebid again is worth considering. But let us remember time is running out for the country. One way or another we need to save and build India's infrastructure.

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