COVID-19: Latin America's legal response to unforeseen events affecting long-term infrastructure contracts
COVID-19: Latin America's legal response to unforeseen events affecting long-term infrastructure contracts
The pandemic has put infrastructure contracts with private companies, usually for lengthy terms, to the test. We take a look at the legislation in Colombia, Peru, Mexico and Chile from the standpoint of unforeseen events and more specifically of the COVID-19 outbreak.
Due to being an effective mechanism for infrastructure, governments have chosen to use the private sector (private parties) in an arrangement where, through a transfer of risks, the government contracts with them to perform projects and for the necessary operation and maintenance services. Usually those contractual relationships are set up through concession agreements. These agreements transfer the risks associated with the project to the private company or individual, and there are various allocation policies, in which the principle as to who is in the best position to mitigate and monitor them may become an important factor.
A risk that is usually transferred to the private party in these arrangements is that related to funding the project. In scenarios of this kind, the private party generally has to find funding from debt or equity sources to be able to make the investments required by the project, allowing the government not to contribute to it, or to do so in a smaller proportion, with the private party taking on the risk of recouping its investment through revenues from operating the infrastructure.
Consequently, they end up being long-term agreements, to give scope for recouping the investment. In some cases they may be for terms of up to 30 years, and the main challenge for drafting them is to contemplate the tools that will be applicable during performance of the contract and which will enable the contracting parties to respond to any unforeseen events that may arise in the performance of their respective obligations.
Something that can be said in advance on this subject is that, despite a judicious study of various scenarios that may arise over the term of the contract concerned and an extremely thorough structuring process, it is impossible to foresee everything that may occur during its performance. For that reason, contracts need to be amended to adapt their efficacy to scenarios that may eventually affect them. In practice, it is very difficult for contracting officers to accept the risk of amending the contractual documents, because more often than not they prefer it to be the judges with jurisdiction over them that settle any dispute arising during their performance, rather than choosing to amend the agreement.
In some countries governments have created standard contract forms, and increasingly specialized their terms, after learning from experience gained in the past, in an attempt to make them more complete and inclusive. Despite the considerable efforts that have gone into them, those forms have not managed to cover every scenario that may present itself in the long term. The truth is no matter how lengthy an agreement, this alone is not enough for the parties to consider they have the support they need to react against any contingency arising during performance of the contract.
A specific example that has strengthened that view is the appearance of an event that had a worldwide impact and caused countries around the world to go into lockdown to protect the population, a scenario that not even the most expert mind was able to predict. This event, the COVID-19 pandemic, had a huge impact on concession agreements, which largely feed off the fees paid by users of the service that is provided, and their revenues fell drastically following movement restrictions for their users.
The pandemic severely hit land and air traffic, causing visible impacts on flows of vehicles and passengers which generate the funds needed to pay for the investments made. This added to the impacts associated with the performance of works, altered their time schedules, not only due to movement restrictions for workers, but also to the health safety measures that had to be adopted to be able to continue as far as possible with completing projects without putting workers at risk.
That exceptional situation which, as we have said, could not have been foreseen by the contracting parties, gave rise to a crisis scenario, to which it was difficult to respond. The agreements did not offer the perfect alternative for resolving the impacts caused, and disputes arose between contractors and owners, over finding the contractual balance and recognizing the occurrence of liability exemption or force majeure events.
Latin American countries contended with the situation in different ways, and it is a subject worth analyzing. In this article we look at how the countries where Garrigues has a presence confronted the impact of the appearance of COVID-19.
The concession agreement is a type of contract that is defined in Colombian law (Law 80 1993), as follows:
“Article 32. On government contracts. (…)
4. Concession agreement.
“Concession agreements are contracts concluded with government entities to grant to a person called concession holder the right to perform, operate, receive revenues from, organize or manage, in full or in part, a public service, or to build, receive revenues from, or upkeep, in full or in part, a works project or asset that is employed for public use or public service, in addition to any activities necessary for the adequate provision or functioning of the works project or service for the account and risk of the concession-holder and under the monitoring and supervision of the grantor entity, in exchange for payment which may consist of fees, rates, charges, increase in value, or of a share that will be granted to it in the revenues obtained from the asset, or of a periodical, single or percentage sum, and, generally, any other type of consideration that is agreed by the parties. (…)”
As may be noted from these provisions, an essence of that contract is the assumption of risks by the private party who will be responsible for providing the public service, which it will do under the government’s supervision and has the expectation of obtaining fair compensation for the management it has contributed, which may consist of any type of compensation validly agreed by the parties.
Starting out from the fact of the concession agreement being a bilateral contract, the same Law 80 of 993, in article 27, imposed on the government the obligation to maintain the balance in the equation of the contract, by having to restore the balance if, during the performance of the contract, unforeseen circumstances not attributable to the contractor arise which may give rise to an imbalance between the obligations agreed at the time of conclusion of contract concerned.
Law 1508 on public-private partnerships enacted in 2012 provided that concession agreements are regarded as true public-private partnerships.
Under that legislation, a number of selection processes were opened in Colombia to choose contractors, known as the fourth generation of concessions, in which some 30 contracts were awarded. The key characteristics of those contracts are to be found in the rules on access to compensation, following delivery of the operational infrastructure where such a delivery is required; the division of the project into functional units; the inclusion of a number of guarantees in respect of differences from expected revenues; and the inclusion of defined liability exemption events to validly be able to be exempted from the fulfillment of contractual obligations, due to the occurrence of external events beyond the concession holder’s reasonable control.
At a time when most contracts of this type were in the construction phase subject to strict project schedules and covenanted punitive consequences for the occurrence of unjustified delays in a liability exemption event, on March 12, 2020 the government, acting on recommendations by the Minister for Health and Social Protection (Minsalud), issued Decision 385 of 2020 declaring a state of emergency for health reasons throughout the country. Those measures involved complete restrictions on movement among other relevant orders.
In view of the described scenario, and the number of legislative provisions issued as a result, in March 2020 the National Infrastructures Agency (ANI), the authority granting the concession contracts, issued Decision 471 of 2020 by which it suspended the performance of contractual obligations under concession agreements, relating, among others, to activities concerning managing property, environmental or social matters, networks, project plans and equity instruments, among others.
The described landscape created an impossibility to fulfill contractual obligations when due, and concession holders were moreover compelled to incur expenditure associated with the implementation of health safety measures in their projects, without forgetting the impact caused by the restrictions on movement which had an effect of the collection of usage fees to pay for investments, after traffic numbers fell dramatically.
While the pandemic was still ongoing, several concession holders started to mark out the path for alleging the occurrence of force majeure, and so seek indemnification payments for the impacts caused; many of them even forayed into structuring alternative dispute resolution mechanisms. The ANI, however, accompanied by the Comptroller General for the Republic and the Colombian Chamber of Infrastructure, undertook the task of finding areas of common ground between the interested parties, by organizing negotiating meetings.
The result was a decision to recognize the existence of a liability exemption event, which was expressed in resolutions issued between October 2020 and February 2021. Similarly, the effect on certain contractual obligations was recognized, the time periods in project plans were extended, and costs were recognized in respect of a longer works phase. Furthermore, the ANI recognized the adverse effect on traffic, and created an interest-free compensation mechanism.
Most concession holders, with only a couple of exceptions, accepted the issued resolutions, which settled the disputes arisen as a result of COVID-19 without needing to take the case to the judge with jurisdiction for the contract. The government decided, in a bold move, to head off an uncountable number of claims, by implementing an adjustment in the contracts to be adopted across the board by all interested parties, which allowed them to be indemnified, partially at least, for certain harmful effects, and, as mentioned, it stopped COVID becoming a matter for the courts.
In Peruvian law, the bulk of the rules applicable to public-private partnerships are in the Constitution, in Legislative Decree 1362 (DL 1362) and its Regulations, approved by Supreme Decree No 240-2018-EF (DS 240-2018). The Constitution sets out general provisions on what is sometimes referred to as the sacred nature of contracts, by stating that “contractual terms cannot be amended by laws or other provisions of any kind”. It moreover recognizes the government's ability to conclude law-contracts, in which the government can give guarantees and certainty, and which cannot be amended by legislation.
Whereas the currently in force DL 1362 governs public-private partnership agreements, which it defines as long-term contracts, used to carry out projects related to infrastructure, public services, services related to public infrastructure and public services, applied research or technology. It also states that these contracts distribute risks and funds, to private parties, preferably.
The main characteristics of public-private partnerships in the Peruvian system, which are closely linked to their long-term contract status, are:
- First, recognition of the ability to amend the contracts (though not unilaterally), through addenda. Any amendments of this type must respect the economic and financial balance and the terms and conditions relating to open competition of the promotion process, and they must ensure that they do not alter the allocation of the risks of the project or its nature.
- Additionally, in relation to restoring the economic and financial balance of the contact, they do not contemplate all cases of unforeseen events, but rather refer only to an event in which that balance is significantly altered by a change to the laws, and each contract stipulates the percentage required for a significant alteration to occur.
- Lastly, events of force majeure are treated as grounds for suspending performance of the contract, and the consequences need to be stipulated in the contract.
We have highlighted these three characteristics because they are related to the subject of this article: the consequences for public-private partnership caused by COVID-19 and the measures that the government has taken to reduce infections (border closures, stay-at-home orders, implementation of cleaning and disinfection procedures), which resulted in delays and higher costs for the completion of projects and lower revenues for concession holders, depending on the phase of the project.
In relation to the consequences of these measures for public-private partnership agreements, the approved measures on suspension of time periods did not suspend those contracts or the contractual obligations. In these cases, the provisions in the contract needed to be submitted to apply for suspension, in certain cases (as occurred originally, for example, in relation to projects in the construction phase).
The Ministry of Economy and Finance, in Official Communication 063-2020-EF/68.02, made a distinction between events of “force majeure” and events materializing a “regulatory risk”, such as those arising from the approval of legislation. The clauses on economic and financial balance in the contracts, which require certain percentages of alteration in order to apply, would therefore be applicable.
Elsewhere, in Executive Decision 003-2020-EF/68.0, the general principles of the government’s response to the potential impacts caused by the pandemic and the state of emergency in public-private partnership projects were approved. According to these principles, the first step is to apply the rules in the contract itself, with respect to any events that may be treated as force majeure (external event that was unexpected, out of the ordinary, unforeseeable, unpreventable, beyond the control of the parties and one which prevents performance of the obligation) or as materialization of a regulatory risk (change to the legislation that has a significant impact on the project’s costs or revenues).
If the contractual mechanisms are not sufficient, the option of making a contractual amendment may be elected, through approval of an addendum, subject to the limits and procedures in the law (Official Communication No 003-2021-EF/68.02). Lastly, it is important to note that those principles do not say what happens if there is no agreement between the parties over how to apply the mechanisms provided in the contract, or if a contractual amendment is not approved. In this case, the parties could be heading for a potential dispute scenario (which will be resolved by arbitration), in which other devices would be discussed, such as the theory of unforeseeability or civil law devices (such as undue hardship in relation to the obligation, for example).
In Mexico there are various pieces of legislation applicable to the different types of arrangements for public service and public property concessions, at both a federal and a local level, including railroad, highway, telecommunications, port, airport and water resource concessions, among others.
To make administrative concession arrangements with private parties a viable option a general principle of financial balance is recognized whereby the theory of unforeseeability is accepted in relation to them and the existence of fortuitous events and events of force majeure is recognized.
As a result of the effects of the health emergency caused by COVID-19, the Mexican government did not implement any special measures affecting construction or the operations of works projects or services under concessions because it regarded these as “essential”, with the exception of hygiene and infection prevention measures with a few operational restrictions, although they allowed the concessions to continue.
The arrangement for concessions in Mexico is an administrative decision empowering a private party, for the account and under the orders of the government, to operate a public asset or provide a public service on an uninterrupted, regular, uniform, general and mandatory basis, to meet a collective need.
Therefore, although it is not a contract, through the concession, private parties and the government enter into long-term rights and obligations, as determined in the respective document together with the terms and conditions on which either the service must be provided or the asset must be operated. The concession holder’s primary obligation is to provide the public service or operate the assets under the concession.
Where the concession is for a public service, it must be provided without interruption, meaning that if it is not, the concession expires as a general rule and the concession holder has to perform, additionally, all the necessary works to ensure for services, that the conditions in which they are provided do not alter, and for assets, that they do not deteriorate.
In relation to the fulfillment of obligations, the concession document also usually specifies that the occurrence of a fortuitous event or event of force majeure relieves the concession holder of liability for fulfillment of the obligations stated in the concession document . In this cases, a specific procedure is described which normally consists of notifying the granting authority, providing information, and implementing mitigation measures.
Although the usage fees are set by the granting authority in a unilateral decision (after being proposed by the concession holder in some cases), they cannot be set arbitrarily, because the financial balance of the concession must be taken into account by reference to the cost of the project, as well as a portion of reasonable profit. In relation to this, the concession documents normally contain a procedure for amending the document and restoring the financial balance of the concession. In a few cases, the law determines the principles that need to be implemented for setting usage fees.
The concessions, in turn, determine the grounds for their revocation, which usually consist of ceasing to fulfill the terms and conditions, not paying the determined fees on a timely basis, licensing the rights attached to the concession without the requisite authorizations, performing authorized works, among others, which do not apply if there is a fortuitous event or an event of force majeure.
In March 2020, the Federal Executive published in the Official Federal Gazette (DOF) the decision declaring a health emergency by force majeure due to the pandemic caused by COVID-19. It also published in the DOF the decision adopting extraordinary steps to cope with the health emergency, including temporary suspension of work in non-essential public, social and economic activities.
The activities that were regarded as essential (and therefore able to continue operating) included those necessary to upkeep, maintain and repair critical infrastructure ensuring the production and distribution of indispensable services; namely, drinking water, electricity, gas, oil, gasoline, jet fuel, basic sanitation, public transportation, hospital and medical infrastructure, among others that could be listed in this category.
Moreover, no measures were adopted that resulted in concession holders not collecting fees or other revenues for the use of public services or assets, or in the government not agreeing to pay the concession holders’ revenues which before COVID-19 they obtained from users. Airport and port activities were regarded as essential, so the government did not adopt any special measures affecting concession holders or users.
As a result of all the measures described above, with the exception of very specific or exceptional cases, to our knowledge no granting authority or concession holder has filed a request or claim in respect of an event of force majeure due to the health emergency caused by COVID-19. On the date of writing, depending on the entity or place where they are carried out, economic activities have been allowed to continue and have resumed, subject to a number of health measures to protect workers and users.
It is now being debated whether public works concession contracts allocate all or part of the catastrophic risk or risk caused by an unforeseen event (the COVID-19 pandemic) to the government. Any contracts of this kind that were awarded before January 20, 2010 (publication date of Law 20.410) may still rely on article 19 indent 3 of the Public Works Concessions Law, which sets out the theory of unforeseeability in the following terms: “The terms of the tender shall specify the form and time period in which the concession holder may request a review of the usage fee system of its readjustment mechanism or of the concession term, where supervening reasons so justify, and may do so for one or more of those factors at the same time. Where these matters are not covered in the concession terms, any disputes arising between the parties shall be subject to the provisions in article 36 of this law”.
In contrast, concession holders whose contracts were awarded after January 20, 2010 (post 2010 concession holders) are subject to the current article 19 indent 1 of the same law, which defines a restricted case of decisions by a public authority that have an effect on the contract: “The concession holder may apply for compensation in the event of a supervening decision by a public authority that so justifies, only where it fulfills all of the following requirements: the decision occurs after the concession has been awarded in a tender procedure; it could not have been foreseen at the time of the award of the concession; it is not a statutory or administrative provision enacted with general effects, which falls outside the scope of the industry to which the concession concerned relates, and alters significantly the financial arrangement in the agreement.”
However, in the few cases that are currently being heard by the technical and arbitration dispute resolution bodies, the post 2010 concession holders have relied on article 71 of the Concessions Regulations to support their claims, and these regulations continue to contain very similar provisions to those contained in the former article 19 indent 3, mentioned above. Despite this, the government has submitted in those cases that the legislation concerned was repealed by the entry into force of Law 20.410. This has meant that there are no known cases in which, in or out of court, the government or one or more concession holders have reached an agreement over how to distribute the adverse effects caused by the pandemic or by the measures adopted by the authorities which slowed or stalled not just movement, but the economy as a whole.
In the administrative jurisdiction, COVID-19 prompted a rapid reaction by the Directorate-General for Public Works Concessions (service attached to the Public Works Ministry), whose director issued on March 20, 2020 an instruction applicable to all public works concession contracts (official communication ORD. No 394), to contend with the effects that any measures adopted by the health authority might have. That directorate-general conveyed the following principles:
- Consider the situation caused by COVID-19 as an event of force majeure.
- Order that the effects of that force majeure on fulfillment of the agreements must be determined in each case, by reference to the effects that arise, and each concession holder will have to submit the facts that substantiate the impact on the contract.
- Announce that the Directorate-General for Public Works Concessions will analyze those applications for extended time periods swiftly so as to grant them with the shortest delay.
As may be seen, the authority’s instructions did not lay down any special rule other than those contained in the respective concession contracts – none of which stipulate or cover events such as the pandemic –; they did not go further than covering the potential effects only on the time periods agreed by the concession holders for the fulfillment of their obligations. And nothing is mentioned about potential financial support or allocation of losses by the government, whether in respect of loss of revenues from construction, overheads due to the longer length of the works phase, greater direct costs due to the supply chain not working properly, loss of revenues, etc.
It may be concluded from this that the government did not feel it was called upon to help its public works concession holders absorb the adverse effects caused by the pandemic. The measures ordered by the national and regional authorities preferred to let anyone who feels that their rights have been affected take their case to dispute resolutions bodies, for them to have the last say, always on a case by case basis.