Review and outlook of the Chinese market in the later PPP period

By Wang Jihong, Han Jiangyu, Zhong Lun Law Firm
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For investors, looking back at the public-private partnership (PPP) enterprise in 2018, at the turn of the year, leaves them with little comfort. In this year, following four years of unrestrained growth, and together with the closely spaced issuance of a series of regulatory documents and the rectification of numerous PPP projects, and their removal from the PPP database nationwide, PPP projects have gradually moved into a cooler and more rational, regulated growth period.

王霁虹 中伦律师事务所合伙人
Wang Jihong
Partner
Zhong Lun Law Firm

Objectively speaking, the above-mentioned measures have genuinely resolved such non-compliance issues as the failure to complete, for certain PPP projects, the “two assessments and one plan” (fiscal capacity assessment, value for money assessment, and preliminary implementing plan) concerning whether procurement exceeds the red line of the government’s fiscal capacity for expenditures of 10%, the illegal raising of debt and provision of security, etc., and their effect on the phenomenon of overuse and misuse of PPPs, and on the prevention and mitigation of government debt risks, have been notable and positive, and will be conducive to realising the steady and long-term development of PPPs.

However, in practice, due to a deviation in the understanding of policies and regulations by certain local governments and authorities, and a crude and simplistic “one size fits all” approach, implementation of PPP policies has become exceedingly unbalanced, and rectification of PPPs has gone overboard, giving rise to a string of legal issues.

Another marked feature of PPP projects in China during the cooling-off period is that, as governments brandish their power more assertively, procurement documents carry a greater number of unreasonable terms, greatly narrowing the room for private investors to find financing, and throwing off the balance in negotiating positions of the two parties.

Han Jiangyu Associate Zhong Lun Law Firm
Han Jiangyu
Associate
Zhong Lun Law Firm

A number of PPP projects in which the authors were involved recently were forced into suspension or even termination due to rectification compelled by the public party, giving rise to great difficulty to resolve controversies and disputes. For example, one local government implemented a new PPP policy forcing rectification of a large number of existing build-transfer (BT) projects that were in the course of implementation into the PPP model, resulting in material changes to the original commercial conditions, and termination of the existing contracts.

The local government of another place rectified PPP projects for which contracts had already been executed, and removed some of them from the PPP database, making the securing of financing for such projects impossible, and making settlement of the preliminary costs difficult to reach after the projects were compelled to terminate.

The local government of a third place, after rectification of PPP projects that were being constructed and implemented, and removal of some from the PPP database, compelled the conversion of the same into the direct contracting model and invited bids anew “in accordance with the law” to select new contractors.

All of the rectified PPP projects in various places face identical or similar questions. With whom does the fault for termination of the contracts lie? Is a breach of contract by the public party constituted? Is the payment of compensation therefore required? How are the completed works to be priced? How is the return on investment to be calculated? How are the preliminary costs to be settled? By whom is the bank loan interest/penalty interest and liquidated damages for prepayment to be borne?

Because the investment in a PPP project is often in the hundreds of millions, or even billions, of renminbi, the investor and the public party often find it difficult to reach a consensus, and particularly under the pressure of audits, roving inspections and discipline inspections, neither side is willing to yield lightly to the other.

Ultimately, they have no choice but to take the least-favoured route, dispute resolution, realising the resolution of their controversies and conflicts through litigation and/or arbitration. And the frequency with which PPP disputes have arisen and litigation/arbitration has occurred has made the PPP investment environment appear to be even more unstable and unsettled, shaking investor confidence.

It can be anticipated that the coming five years, in which many of these projects will be entering their payment phase, will be the high-water mark for the occurrence of various types of PPP project disputes.

From the guiding ideas from the 2018 Central Economic Working Conference on investment in the infrastructure sector in the coming year, it can be seen that PPP projects will continue to be promoted in a steadfast manner in 2019. To ensure that problems such as the bandwagon effect, “one size fits all”, and overcorrection do not arise again in PPPs in China, the authors make some recommendations.

China needs to further accelerate the pace of establishing systems. Co-ordinating the relationship between the Ministry of Finance and the National Development and Reform Commission to quickly issue a unified Law on Public-Private Partnerships. This law could fundamentally resolve the PPP issues of governance emanating from multiple authorities and multi-headed administrations, resolve the issues of contradictions in the PPP policies of different authorities and the ambiguity in their authority, and resolve the issue of the conflict between PPP projects and current laws and regulations in terms of land, taxation, financing, financial affairs, company establishment and operation etc., so as to achieve seamless complementarity with relevant authorities and relevant laws and regulations.

New PPP policies need to get away from a lack of sufficient prior consideration, excess frequency of issuance and race-like publication and implementation. The lawfulness and practicability of PPP policies need to be strengthened to avoid the simplistic and inappropriate approach in the implementation of PPP regulatory documents in the past.

Additionally, we would recommend that it be emphasised in new laws, regulations and policies that local governments at every level establish a correct view of rule by law, in which rights and obligations are consistent with one another, doing away with the habit that “the new official disregards the accounts of the previous official”, promptly change the current clear imbalance in the positions of the public party and private party in negotiations and the clear lack of fairness in their rights and obligations as set out in PPP contracts, and demand, in the course of the performance of the contracts, that governments throughout the country strengthen their contract spirit and bear the contractual obligations and responsibilities incumbent upon them to create a good business environment and restore investors’ confidence in the PPP market and public parties.

Wang Jihong is a partner and Han Jiangyu is an associate at Zhong Lun Law Firm

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