Emerging Trends in the Financing of Project Development and Building Delivery Systems

1 Emerging Trends in the Financing of Project Development and Building Delivery Systems 1

by Lisa B. Andrzejewski, Esq. and Keisha S. Palmer, Esq. 2 “As budget constraints persist and the need for infrastructure development continues to rise, public private partnering in all its variations is expected to steadily increase.”

Motorists in the United States spend more than 5.5 billion hours annually in traffic, which results in $120 billion in wasted fuel and lost time. 3 There are 240,000 water main breaks annually due to the deterioration of water systems causing significant property damage and costly repairs.4 Fourteen million children in the United States attend deteriorating schools and at least two-thirds have unhealthy environmental conditions. 5 Due to budget deficits, 73% of hospitals have delayed investments in much needed capital projects. 6 The needs for infrastructure development are acute and yet, federal, state and municipal financing is being squeezed and cannot support the increasing demand. Innovative alternative delivery programs are developing for project construction and financing to begin to plug the holes. Public private partnerships are a means of financing public infrastructure by accessing private capital through various models and financing vehicles.

The United States Department of Transportation defines public private partnerships as “contractual agreements formed between a public agency and a private sector entity that allow for greater private sector participation in the delivery and financing of transportation projects.” 7 Despite this broad definition, public private partnerships are most often associated with the largescale, long-term agreements whereby a private partner invests its own assets and delivers a public service (often based in transportation infrastructure) in exchange for exclusive rights to the private partner. This model, which has been widely used and successful throughout Europe for both transportation and social infrastructure projects alike is becoming common for transportation projects in the United States and is slowly emerging in social infrastructure projects.

1 This article is Chapter 4, excerpted from the book, The Future of the Design and Construction Industry: Construction Industry Conversations (Kathy Cowles, Zoraida Ferguson & Nancy Greenwald, ed. 2018).

2 Lisa B. Andrzejewski , Esq. is Counsel at Robinson + Cole where she is a member of the firm’s Construction Group.

Keisha S. Palmer, Esq. is a partner in Robinson + Cole’s Business Transactions Group.

3 Urban Land Institute, ULI Public Development and Infrastructure Council, “Enabling Infrastructure Investment – Leveling the Playing Field for Federal Real Property,” November 2016 at 8.

4 Id. 5 Sara Robertson, “Crumbling Schools don’t provide strong foundations for America’s students,” National Education Association, Dec. 9. 2011, http://www.nea.org/home/49988.htm.

6 American Hospital Association. Hospitals Continue to Feel Lingering Effects of the Economic Recession. Available from the AHA. 7 U.S. Dep’t of Transp. Fed. Highway Admin., accessed from https://www.fhwa.dot.gov/ipd/p3/defined/.

2 While ideal for certain types of construction, this project delivery system may not be the only, or best solution for each public private engagement. After all, the goal of public private partnerships is to respond to the unique needs of the local governments and states. Therefore, public private partnership models should be (and in fact are becoming) customized to accommodate the specific investment goals and objectives of the project owner. Consequently, there are a growing number of alternative partnership options available to state and private entities for new construction and building maintenance and new options for partnership will continue to emerge as governments partner with private entities.

Driven by budgetary deficits and a growing need to repair a failing infrastructure in both transportation and “social construction”, such as schools and government buildings, the United Kingdom was on the forefront of development for public private partnerships. Countries in the United Kingdom realized that the conventional design-bid-build model in which the public agency is responsible for managing the financing, design, construction and operations and management services was failing to meet the growing need for infrastructure development because of limited public funding. The outgrowth of this problem was the development of a public private program model, which transfers some or all of a construction project’s responsibilities to a private entity skilled in design, construction, finance and/or management. In a public private program, the private entity assumes the project risk, however, also has greater control over all phases of the project, including funding. The private entity is rewarded for its performance, innovation, efficiencies, on time delivery and/or receives long-term rewards in the form of concessions. The general practice of payments from public funds beginning after construction is completed reduces upfront financing costs for the governmental entity and provides incentives to the private entity for acceleration of the completion schedule. The public sector benefits from on time, on budget programming at a higher overall quality. The use of private financing also frees up government funds for other vitally needed public services.

The United Kingdom’s public private partnership model proved to be successful. Between 1990 and 2009, more than 1,300 public private partnership contracts were executed, representing more than €250 billion in capital assets. 8 A study by the Performance Based Building Coalition reports that before the use of public private partnerships, 73% of government construction programs in the United Kingdom ran over budget and 70% were late. 9 By 2003, only 22% of public private partnership projects in the United Kingdom were over budget (as a result of changes in public sector client requirements) and only 24% were late. 10 In addition to projects being completed faster and cheaper, since financing was largely private, the public sector was no longer responsible for costs associated with delay. From roads, to highways, to schools, the governments’ 8 R. Alexander Schmid and Scott W. Kramer, Ph.D., “Public-Private Partnerships: What Can the United States Learn from Europe?” Associated Schools of Construction, 2013.

9 The Performance Based Building Coalition, http://www.p3buildings.org/benefits-of-public-privatepartnerships/what-is-a-public-private-partnership/ 10 Id.

3 use of this alternative project delivery method was a means for providing necessary repair and development for public sector construction projects. 11 In 1992, the United Kingdom developed the first government regulations for public private partnerships. 12 The Private Finance Initiative provided a regulatory framework for these partnerships to reduce liability on the government when and if the government elected to transfer control to the private sector entity.

In addition to the numerous public private partnerships for infrastructure programs, the United Kingdom recognized the imperative to repair its educational facilities and again looked to public private programming as an alternative contract, construction and financing solution. “Building Schools for the Future” was a massive and ambitious undertaking by the British government to revitalize dilapidated public schools throughout the country. The goal of the program was to combine private and public financing in order to build hundreds of new schools and facilitate the improvement of a thousand others. Under the plan, over 50 deals reached financial close and over 400 schools were rebuilt. Over 1100 other schools were improved and the critical backlog of school repair projects in the UK was reduced dramatically. Total investment in the program reached approximately $6.7 billion.” 13 Europe has been in the forefront of this delivery trend. Since 1990, the United Kingdom has lead innovation in this model and has enacted approximately 67% of all European public private partnerships. 14 Europe’s experiences have provided a roadmap for nations worldwide. Many countries have followed Europe’s lead. For example, according to the Canadian Council for PublicPrivate Partnerships’ database, 206 public private projects have been initiated since 1991, for a total project value of more than USD$63 billion. 15 The 10-Year Economic Impact Assessment of Public Private Partnerships in Canada (2003-2012) reported that public private projects generated CAD$51.2 billion in direct economic output, 290,680 direct FTEs 16, CAD$7.5 billion in tax revenue and CAD$9.9 billion in cost savings. 17 Between 2003-2012, Canada has completed 88 social infrastructure projects, which are crucial to the development of sustainable communities such as schools, universities, hospitals, prisons and community housing. 18

11 R. Alexander Schmid and Scott W. Kramer, Ph.D., “Public-Private Partnerships: What Can the United States Learn

from Europe?” Associated Schools of Construction, 2013.

12 Id.

13 Performance Based Building Coalition, http://www.p3buildings.org/benefits-of-public-private-

partnerships/public-private-partnerships-case-studies 14 R. Alexander Schmid and Scott W. Kramer, Ph.D., “Public-Private Partnerships: What Can the United States Learn from Europe?” Associated Schools of Construction, 2013.

15 The Performance Based Building Coalition, http://www.p3buildings.org/benefits-of-public-privatepartnerships/why-utilize-public-private-partnerships 16 FTE stands for “Full Time Equivalent.” It is a measure of the hours worked by employees.

17 Id. 18 Id.

4 Taking the lead from its neighbors to the North and across the Atlantic, the United States is beginning to explore various alternative delivery and financing options for public construction projects. The Associated General Contractors of America reports that for each $1 billion invested in nonresidential construction, another $3.4 billion is added to the GDP 19, about $1.1 billion to personal earnings and approximately 28,500 jobs are created or sustained. 20 Public private partnerships have started contributing to this growth. Since 2008, more than $18 billion worth of transportation related public private projects have been constructed in the United States thereby adding to the GDP, personal earnings, and job creation. 21 Notably, over $5 billion in tax-exempt bonds with lower interest rates have been invested in these projects. 22 While these statistics are encouraging, progress, particularly at the federal level, remains measured. In fact, public private projects remain a relatively small part of the total funding for US infrastructure projects. For example, between 2007 and 2013, public and private partnerships were valued at approximately $22.7 billion across transportation related partnership programs, which represents just 2% of the overall capital investment in highways during this same period. 23 Although alternative delivery models are advancing, the ability of the federal government to use public private partnerships remains limited due in large part to the federal government’s inability to enter into project-specific, long-term financial obligations to access private capital. 24 For example, based on the current rules of appropriation and limitations of capital expenditures, the government’s property investment policies favor long-term leasing (rather than capital or assetbased funding) which results in higher overall spending and bypasses public investment financing strategies. 25 That said, the Transportation Infrastructure Finance and Innovation Act has facilitated the use of public private partnerships for highway projects and the 2014 Water Infrastructure Finance and Innovation Act will potentially allow the availability of public private programs in water and wastewater. 26 To date, however, the Federal Government has yet to expand public private partnership legislation to include the repair, renovation and new construction of government-owned facilities. In 2016, under the Obama Administration, the House of Representatives and the Senate introduced the Public Buildings Renewal Act of 2016 (S.3177/H.R. 5361) to provide new public and private sector partnering opportunities for building and rehabilitating government-owned facilities such as public schools, colleges and universities, post offices, prisons, courthouses, libraries, hospitals, 19 GDP stands for “Gross Domestic Product.” It is a key indicator to measure the health of a country’s economy and represents the total dollar value of all goods and services produced over a specific time period.

20 The Associated General Contractors of America, https://www.agc.org/learn/construction-data 21 Al Maloof, “BiPartisan Federal Legislation is a Potential Boon for P3s,” Construction Executive, December 2016.

22 Id. 23 Bruno Werneck and Mario Saadi, “The Public Private Partnership Law Review,” Law Business Research, Ltd., March 2015.

24 Urban Land Institute, ULI Public Development and Infrastructure Council, “Enabling Infrastructure Investment – Leveling the Playing Field for Federal Real Property,” November 2016 at 7.

25 Id. 26 Id. at 7-8.

5 laboratories, research facilities and health care facilities. The bills would have allowed state and local governments to invest in public building improvements through the use of exempt facility bonds, a form of tax-exempt financing. Under the Act, state and local governments would submit a detailed funding application to the Treasury Department for review and approval of funds for a project. Once approved, the governmental entity would have two years to issue the bonds. Any allocated funding not used during that two-year period would go back to the federal government.

Unfortunately, neither bill advanced. The Trump administration renewed the Act for 2017 (S.326/H.R. 960), however, as of February 2018, the bills have not advanced beyond introduction.

Public Private Models The models described below are some of the most commonly recognized public private project delivery and financing methods for the design, construction, maintenance and financing of transportation and social infrastructure improvement projects. In the United States, federal and state regulations have developed to encourage increased private entity involvement in public sector construction and maintenance projects while simultaneously minimizing the financial strain on the public taxpayer.

1) Design Build Operate Maintain (DBOM) Under a DBOM model, the public owner secures private financing and executes a single contract with one private entity to be responsible for design and construction as well as long-term operation and/or maintenance services. The DBOM contracts are generally awarded by competitive bid based on a guaranteed maximum price (GMP) for design, construction and maintenance of the facility for a specified period of up to 20 or more years. This approach creates a single point of responsibility for design and construction, which in turn, derives benefits of more expedient project completion. Additionally, since the same private entity will be responsible for maintenance, long-term longevity and maintenance considerations are incorporated into project design. Examples of transportation projects using DBOM include: Hudson-Bergen Light Rail, Hudson/Bergen Counties, NJ, Las Vegas Monorail, Las Vegas, NV, Tren Urbano, San Juan, Puerto Rico. 27 2) Design Build Finance (DBF) Under a DBF model, the public owner awards one contract for the design, construction and full or partial financing of a facility. Responsibility for the long-term maintenance and operation of the facility remains with the project sponsor. In this model, the project sponsor can completely or partially defer payment during the construction phase. With DBF projects, the project sponsor may issue a procurement asking bidders to provide the cost for developing the project today, with

27 U.S. Dep’t of Transp. Fed. Highway Admin., accessed from,

https://www.fhwa.dot.gov/ipd/p3/defined/design_build.aspx

6 payment of that amount promised at a later time. 28 However, this delayed payment places greater risk on the private design-builder who is reliant on the future payments. Rather than deferring payments, another option in the DBF model requires the private design-builder to provide selffinancing and/or to borrow funds from existing commercial lines of credit to front the implementation costs until the sponsor issues repayment. The Internal Revenue Service (the “IRS”) offers some tax-exempt options for the design-builder. For example, when the designbuilder arranges for bonding and secure creditors, the design-builder may qualify for tax-exempt debt issued through a nonprofit benefit corporation pursuant to IRS Revenue Ruling 63-20 or a constituted authority pursuant to IRS Revenue Ruling 57-187. 29 A DBF arrangement is legally a purchase of construction services for which payment is deferred until a later date, so it is not considered to be a loan or debt under usury law. 30 Examples of projects using DBF include: Cleveland Innerbelt, Cleveland, OH, 95 Express, Miami, Fl, 1-4/Selmon Expressway Connector, Tampa, FL, 1-485 Charlotte Outer Loop, Charlotte, NC, Innerbelt Eastbound Bridge, Cleveland, OH, 1-75 Roadway Expansion (iROX), Collier and Lee Counties, FL, Northwest Corridor Project, Atlanta, GA. 31 3) Design Build Finance Operate Maintain Concession (DBFOM) Under a DBFOM model, the public owner bundles the responsibilities for designing, building, financing and operating the project to private sector partners. While there are many variations of this model, all DBFOM projects are either partly or wholly financed by debt leveraging revenue streams dedicated to the project, with concession benefits as sources of revenue. 32 Concession benefits may be in the form of direct user fees such as tolls, rent, lease fees or direct payment for services generated by a franchise or business on the public owner’s property. Compensation may also be the form of a right to collect periodic payments from the public entity based on performance (e.g., payment is triggered at milestones in the agreement if the infrastructure is operating as required). In some DBFOM models, the public owner pays the private partner preestablished “availability payments,” which are rent-like payments based on extended periods of time. The payments are made if the contractually obligated construction or performance specifications are met. When the public entity makes periodic or availability payments, the payments come from public funds. 33 Additionally, some form of public money through grants or a right-of-way may be incorporated into the design builder’s compensation. 34 “Ultimately, any cost premium from privately financing a project must be offset by other project execution

28 U.S. Dep’t of Transp. Fed. Highway Admin., accessed from

http://www.fhwa.dot.gov/ipd/p3/defined/design_build_finance.aspx.

29 Id.

30 Id. 31 Id.

32 U.S. Dep’t of Transp. Fed. Highway Admin., accessed from http://www.fhwa.dot.gov/ipd/p3/defined/design_build_finance_operate.aspx.

33 Robinson + Cole, Public Private Partnerships from the Surety’s Perspective, Berkley Surety Group, February 2015.

34 Robinson + Cole, Public Private Partnerships from the Surety’s Perspective, Berkley Surety Group, February 2015.

7 efficiencies derived from the private partner’s participation, such as design or construction innovations or lifecycle operations and maintenance cost savings.” 35 “Given the ability of public sector agencies in the United States to issue low-interest tax-free debt, it is often more costeffective for public project sponsors [e.g., Department of Transportation, toll authorities, transit agencies, local governments] to issue debt than their private sector partners.” 36 In this model, as with the DBF model, the private partner may also be required to invest in the cost to construct the facility. In exchange, the public owner may agree to a long-term rental after construction. Since the private entity may not receive any payments until construction is complete, financing may be required through federal credit assistance, loans, private equity, or bonding to cover capital and project development costs. Federal financing tools such as qualified private activity bonds, however, help lower the borrowing cost for the private partner. 37 The parties may also establish a nonprofit public benefit corporation established pursuant to IRS Revenue Ruling 63-20 or constituted authorities pursuant to IRS Revenue Ruling 57-187. 38 Examples of numerous DBFOM transportation specific projects can be found on U.S. Department of Transportation Federal Highway Administration maps. 39 Federal and state laws and regulations (including tax regulations) obviously have a profound influence in shaping public private partnerships. A detailed discussion of current federal tax rules and state legislation concerning public private partnerships is included as Appendix A. The Future of Public Private Partnerships As budget constraints persist and the need for infrastructure development continues to rise, public private partnering in all its variations is expected to steadily increase. Public private partnering offers needed alternative delivery and financing options for the design, construction, and maintenance of publicly owned facilities. State regulations for public private partnerships offer assistance for developments in transportation and/or social projects such as universities, hospitals and courthouses. Where state legislation does not exist, public agencies and private entities are developing creative solutions to contracting, development and financing. New developments in management contracting pursuant to new IRS revenue procedures provide greater flexibility to government agencies and private entities for maintenance contracting. The widespread state legislation, the expansion of federal tax-emptions and the frequency of new partnership programs are strong indicators that public private partnerships in all its variations are achieving successful outcomes and will continue to make inroads in the U.S. market as they have worldwide.

35 U.S. Dep’t of Transp. Fed. Highway Admin., accessed from http://www.fhwa.dot.gov/ipd/p3/defined/design_build_finance_operate.aspx.

36 Id. 37 Id. 38 Id. 39 U.S. Dep’t of Transp. Fed. Highway Admin., accessed from https://www.fhwa.dot.gov/ipd/p3/resources/p3_concessions_map_newbuild.aspx.