Keeping contract operational a challenge

On October 26, 2016, when the Allahabad High Court ruled that Noida Toll Bridge Company could no more levy toll on an important road stretch connecting Delhi, it was yet another instance of a contract with the government as a party turning out to be as risky as a contract with any other entity. The court order was based on a provision in the contract itself and said the company had more than recovered its investment.
 
Contracts for public-private partnership (PPP) projects have provisions for termination on account of non-achievement of project milestones, failure to make due payments to the government, material breach of contract, change in ownership of the concessionaire not being in compliance with the agreement, bankruptcy or insolvency of the concessionaire, materially false representation, etc.

 
Rahul Arora, associate partner, HSA Advocates, says, “If termination is challenged, the rights of the parties may be subject to consideration by the arbitrator or the court. The specific directions of the arbitral tribunal or court to rectify the issues being faced by the project, and the extent to which certain provisions of the contract are held to be unenforceable, go a long way to determine its consequence on the project.”
 

In his view, the Delhi-Noida bridge project has not been terminated. “Only the selection of the concessionaire, collection of user fee and method for calculation of total project cost were held to be arbitrary and contra the settled law and public policy. These were severed while allowing the remainder of the contract to stay in operation,” says Arora.

 
The extension or reduction of the concession period obviously depends on what was agreed to in the contract. There was a mechanism in the contract for the concession period to be reduced if the concessionaire recovered the cost of construction and reasonable profit, after verification of the revenues by an independent auditor.
 
Importantly, Arora points out, reducing the concession period being on account of a recovery of investment is a common practice in infrastructure contracts. The standard approach adopted in PPP-based concession agreements is to proportionally increase (along with a cap) or decrease the concession period in accordance with the recovery of investment of the private entity  in case the same happens before or after the concession period as originally envisaged in the contract.   

 
Though this may be true, keeping the contract operational without toll collection may be problematic and lead to waning interest from the company. Besides, as Ramesh Vaidyanathan, managing partner, Advaya Legal, says, when toll collection is prohibited by a court, the contract between the contractor and the government can be deemed to be ‘frustrated’ or rendered impossible to perform. In such a situation, the private contractor may not have any remedy against the government unless the contract provides for it.
 
According to Vaidyanathan, it sends out a troubling message to investors that the sanctity of a contract may not be respected by the Indian legal system.

 
Arora, however, disagrees. He says ex facie, such judicial intervention may raise the apprehensions of private investors, but investor sentiment may not experience a negative effect because this is a peculiar case, wherein not only is the total project cost recoverable by the concessionaire based on a formula that appears to be flawed, but also the concession period was infinitely extendable in case of non-realisation of the costs within the originally stipulated time period of 30 years.
 
Arora, however, adds that in light of the fact the return cycle and the commercial viability of projects are key considerations for investors, the effect on investor sentiment cannot be underplayed.

 
Regulatory instability could act as a deterrent for potential investors, who expect that the government will take care of possible bottlenecks prior to tendering by robustly drafting and streamlining covenants in contracts with the existing laws, carrying out detailed viability analysis of the projects and reviewing previous negative experiences. 
 
There are also instances like Reliance Industries and Reliance Natural Resources Ltd, where the contract provision of arm’s length pricing could not be implemented because the government cited a Supreme Court ruling that established the supremacy of government policy and ownership. The price of natural gas, under the changed policy, came to be administered by the government itself.

 
Vaidyanathan says courts typically only intervene in price setting when the process of discovering prices is flawed or arbitrary.
 
Experts point out that lack of bidding makes contracts vulnerable. Contracts not bid out by governments come in for scrutiny and are more prone to be questioned.
 
Arora points out the Delhi-Noida project was awarded by way of the MoU route, without Noida Authority providing any just reasoning for doing so, which also contravenes the competitive award mechanism  provided for under Article 14 (right to equality) of the Constitution. “It is found to be unfair and unjust, although the court has not nullified the concession agreement since construction of the project is over and it is operational for several years,” he says.

 
Arora says though prima facie the court may appear to have overruled the contractual terms between the parties, the terms of a contract must be in accordance with the existing law. “However, interference of the judiciary in such cases should not be characterised as ‘judicial overreach’ since the issues such as streamlining of contract terms and tendering conditions with the applicable law and public policy should be addressed by the government at the stage of tendering itself.”
 
In the 2G spectrum case, telecom licenses were cancelled on the ground that there has been violation of Article 14 of the Constitution; in the coal block case, too, allocations were declared void by the Supreme Court on account of the allocations being against the due process of the law.

 
Vaidyanathan says such disputes can be prevented to a large extent through better work by the ureaucracy, especially during the tendering process.
 
There should also be increased focus on independent audits and higher standards for bidders. Especially in the case of tollways, there should be an initiative to harness technology and build new-age IT tools to allow the monitoring of traffic on a real-time basis. This will provide the government and the public data to understand if the toll is worth the money or if the concessionaire is understating revenues to make excessive profits.