By John Hays and Patrick Estill
The Commonwealth of Kentucky is moving forward with its project to demolish and replace key parts of downtown Frankfort, including the Capital Plaza Tower. As part of the project, a private developer will “finance, design, develop, construct, lease-back to the Commonwealth, and maintain” a more than 385,000-square-foot office building expected to accommodate 1,500 employees. Here are few tips for private developers/contractors considering a large build-lease P3 like the Capital Plaza project.
1. Assess (and quantify) the risks early on.
Typically in P3 projects, a private partner takes risks ordinarily borne by the public sector under traditional public project delivery models. While this efficient risk allocation is often cited as a benefit of P3s, you should know how it affects you before you put your name in the hat for a large project. Build-lease projects, which may carry long-term operations and maintenance obligations, entail different risks than traditional turnkey projects. Contingencies such as changes in long-term demand or labor costs, may be important in these projects. Mapping out and quantifying these risks—even if it requires hiring a consultant on the front end—can be invaluable once you get to the competitive negotiation stage.
2. Know the realities and limitations of the project and its financing.
On a related note, you should also be aware of the realities and limitations of the build-lease project, especially as it relates to financing. You need to evaluate the financing risks, the possibility that the public partner might withdraw from the project, and where that would leave you. Governmental lease-purchase transactions are an established form of financing, but an important part of the risk analysis is how essential the project is to the public partner. For example, a lease-purchase deal may be a sure thing for a fire station, but not so for a public golf course. Developers/contractors should evaluate the likelihood that the public partner will be willing to stick with the private partner, even as additional project expenses arise.
You can approach these concerns by, among other things, careful project selection, incentives for the public partner to stay in, and picking the right lender. Lenders who have done similar deals are desirable, as they may better understand any limitations on working with a public entity and related contingencies. You can also build certain protections into the agreement to address these contingencies. For example, the government is often not as agile as the private sector. Years can pass from a development agreement to a shovel in the ground, causing construction and financing costs to go up. Deadlines, incentives, and penalties can be built into the agreement to address these risks.
3. Consider potential partners and structuring your side of the deal.
Another question to consider early is how the deal will be structured on the private side. Some P3s may call for the private partner to design, build, finance, operate, and maintain the public project (a “DBFOM” deal). That’s a lot of obligations, and it takes a lot of expertise. As the potential private partner, you should consider how best to structure your side of the deal. For example, sometimes a special purpose entity (e.g., the “Concessionaire”) is formed to enter the agreement with the public partner. Separate design-build and operations-maintenance contractors may then be used. Other times, a joint venture may be appropriate. Every deal is different. What’s important is that you consider the structure (and involve the right advisors if needed) early rather than later so you can structure the deal in a way that provides the best project delivery, response to the proposal, and protection to you.
John Hays and Patrick Estill are attorneys with Jackson Kelly PLLC’s Lexington