Common areas of confusion in the practical operation of PPPs

The government and private capital co-operation model, or public-private partnership (PPP), has been fervently applied in China for many years. However, the lead author has found that because China’s legal framework for the development of PPP projects is not sufficiently sound, there remain numerous misunderstandings in the course of practical operation.

Confusion about the build-transfer (BT) model and PPP. The issuance of the Notice on Putting a Stop to Illegal Financing Activities by Local Governments (document No. 463) has spooked local governments and investors, and they have started to avoid using the letters BT in their co-operation projects. Local governments and investors are tending to favour using PPP to describe their projects’ financing model – even if they are using the BT model.

In the practice of various countries, the commonly seen BT financing model is in fact one of the numerous means of implementing PPPs. BT complies with the three main features of the PPP model. First, BT normally involves a government handing responsibility for investment in, and financing and construction of, an infrastructure project to an investor that, once the project is completed, transfers it to the government, for which the government pays a repurchase price, thus realising a co-operative partnership between government and enterprise.

Benefit sharing

Second, the investor can also charge a reasonable percentage of profit, and the government, through the BT model, not only can compensate for and ease financial pressures but can also rapidly improve public service facilities, thus realising a win-win and benefit-sharing situation for governments and enterprises.

Finally, in the BT model, not only does the investor face such risks as project lawfulness, government creditworthiness, changes in laws and regulations, etc., but the government likewise faces investor financial capacity, construction period, project quality, project safety, runaway cost and other such risks, thus realising a sharing of risks between government and enterprise.

The BT model and fund advance plus construction. A co-operation model that requires the investor to first invest and construct, and the government to then effect repurchase, can easily lead people to mistakenly believe that at the core of the BT model is the investor advancing the funds and carrying out the construction.

Significant differences

However, there are a relatively large number of differences between the BT model and fund advance plus construction: (1) because of government participation in the BT model, it is a civil law act with administrative aspects, whereas fund advance plus construction is purely a civil law act; (2) the investor in the BT model owns the project before transfer to the government, whereas in fund advance plus construction the contractor never owns the project; (3) the investor in the BT model is the project owner, whereas the party that advances the funds and carries out the construction in fund advance plus construction is the project contractor; (4) the investor in the BT model earns both construction profit and investment returns, whereas the party that advances the funds and carries out the construction in fund advance plus construction only earns construction profit; and (5) under the BT model, the government is usually required to provide repurchase security, whereas in fund advance plus construction there is no issue of the party that advances the funds and carries out the construction requiring the owner to provide security.

Security provided in the form of reserve land. PPP projects, particularly BT projects, usually require the government to provide security and reserve land, as a resource controlled by the government has governments at every level vying to use it as a principal means for securing financing. Although mortgage registration can be carried out for reserve land, the Administrative Measures for Reserve Land and the Notice on Strengthening the Administration of Land Reserves and Financing, from the Ministry of Land and Resources, place strict limitations on the conditions for carrying out mortgage registration for reserve land.

Investor misunderstanding

The requirements in respect of the qualifications of the mortgagee, the matter secured, purpose of the financing, etc., in particular make it difficult for project investors to become the mortgagee of reserve land, leading investors to the misunderstanding that security provided in the form of reserve land is necessarily invalid.

However, the lead author is of the opinion that if the competent land authority is able to carry out the mortgage registration procedures for the project investor, the act of providing such security and the security contract are not necessarily invalid.

All of the current regulations on the provision of security in the form of reserve land are ministerial-level rules, regulations and regulatory documents of the Ministry of Land and Resources, which are relatively low in the hierarchy of validity, and violation of such documents does not necessarily lead to the invalidity of a mortgage contract or mortgage rights.

Furthermore, pursuant to the current principle of publication of registrations of rights in rem in immovable property, if registration of a mortgage is lawfully secured from the land authority, it has publication validity, and the validity of the mortgage registration cannot be lightly denied on the basis of the ministerial-level rules, regulations or regulatory documents.

Dispute resolution clauses. In contract negotiations, investors should not overlook the choice of dispute resolution method. In recent years, the dispute resolution method, as their last line of protection, has been garnering greater attention from investors.

Local impartiality?

Local governments will usually request that disputes be referred to a court or local arbitration commission for resolution. Accordingly, procedures at first instance and appeals involving governments and enterprises are usually conducted in the province where the local government is located. Considering elements of local protectionism, it is worth discussing whether the court can act in a fair and impartial manner.

As for local arbitration commissions, many are institutions subordinate to the local legislative affairs office, making their independence questionable. Accordingly, the approach that is the fairest for both the local government and enterprise is the joint selection of an arbitration institution that is not subordinate to any level of local government, and referring disputes to independent experts in concessions for determination.