The Public Work Concessions industry in Chile has developed a remarkable presence and had a profound impact on the Latin American state's economy. It is frequently cited as a good example of a successful concession model for emerging economies.

Chile's current legal framework - established by the Ministry of Public Works Decree 900 in 1996 - has produced 52 concession contracts so far, totalling nearly US$9 billion. Rodrigo Yáñez, a lawyer working with the non-profit think-tank Instituto Libertad, writes that it is particularly interesting to analyze the impact of legal changes introduced to Chile's framework by a recent bill sent by the government.

The circumstances

Chile's procurement system was severely criticised by the administration due to its dispute resolution and renegotiation scheme. After an award that condemned the State in a case against a multinational penitentiary concessionaire consisting of Besalco, Italy's Astaldi and France's Sodexho, the former Public Works Minister Eduardo Bitrán stated the acts of the tribunal were completely "unexplainable and absurd."

In addition, the government was also concerned by two other groups of jail concessions, which ended up in a negotiated - and expensive - end of contracts.

The reasons behind the rejection of the dispute resolution system by the administration relate to the current nature of the tribunal (aex aequo et bono), attributions to suspend the effects of administrative resolutions, and the Statute of Limitations terms established by law.

With respect to contract modification, it has been said that renegotiations in this model are often far beyond a reasonable rate. According to some studies, nearly 25 per cent of the total investment in public work concessions has been subject to an ex-post agreement - a fact which the local association of concessionaires (COPSA) differs, situating the renegotiation rate at 14 per cent.

The situation has been referred to as an under the table kind-of-settlement, unacceptable according to the government, which frequently refers the case of an urban toll road in Santiago that added major sewer and subway public works to the original contract without publicly competing or bidding for it.

As of May, the legislative discussion of the government's bill is fairly advanced in the Congress. This article will continue to analyze three of its main aspects:

• the "Service Level" concept
• the creation of the Concessions Council
• new compensation provisions

The "Service Level" concept

This was discussed deeply at the Public Works Commission of the Senate. Article number 1 provides that concessions granted after the bill enters into law must consider the obligation of the concessionaire to comply with service levels, technical standards or both, as provided in the concession contract, for the different stages and conditions of the concession.

The key concern during the discussion was the uncertainty and higher risks that the service level concept could introduce in future contracts, in case its content - unilaterally determined by the administration in the bidding terms - ends up relating to unbearable or absolute conditions; for instance, a guarantee that a toll road must maintain a traffic flow that allows a minimum speed at any time.

For some Senators, a certain service level was necessarily related to technical standards compliance. In response to this, the Minister of public works at that time said that this concept only moved to grant concessionaires more freedom in their obligations compliance, giving them the choice to decide the instruments needed to meet a certain service level standard and underestimating the chance of the administration to require unbearable or absolute conditions - since this aspect is freely assessed by the market or possible investors before bidding - making it as simple as the following: if the State transfers excessive risks to the contract, no one would bid on it. 

As requested by some Senators, the Minister added further details of the concept's meaning for the bill's legislative discussion record.

The Public Works Concessions Council

The Public Works Concessions Council is an advisory council presided by the Minister of Public Works and four other counsellors named by him. It has a technical background, which considers prior reports on decisions of the Minister distinguishing between those that are mandatory and those that could be requested by the Ministry.

It is one of the functions of this Council to coordinate and listen to the views of other Ministries and state agencies related with public works concessions in their respective fields (schools, penitentiary facilities, hospitals, etc). When it comes to mandatory reports, the Council must submit and publish its opinion with respect to the following administrative acts:

• To declare of public interest those public work concession projects filed by private parties or projects that originate as private initiatives (if selected or declared of public interest by the Ministry - and thus part of its PPP infrastructure portfolio - the private parties receive a bonus score when they bid for it afterwards).
• To determine that a private initiative project gets executed through a mechanism other than a public work concession (as a regular public work, for instance).
• To analyze the projects of public initiative that will be considered to be executed as public work concessions.
• To apply the exception established by the new article 19 of the public works concessions act, which provides for the release of a public bid - during the exploitation phase - of additional works requested by the State that surpass 5 per cent of the official budget of the project or US$370,000.
• To hire the concessionaire for new works beyond the newly introduced maximum of additional works during the construction phase - 25 per cent of the official project's budget - given the new circumstances under which that work is allowed (a necessary redesign of the concession).
• Analyse the characteristics and legal/economic regime of the different concession contracts to be released to market.

On the other hand, and only upon request by the Ministry of Public Works, the Council must release its opinion with regard to:

• additional works as provided by the new articles 19 and 20 (works unilaterally requested by the State or mutually agreed)
• the convenience to renew a concession contract
• call for a public bid when a concession has been put to an end due to a severe default by the concessionaire of its obligations
• release its opinion in other anticipated termination causes
• any other subjects submitted by the Minister that are related with the field of public work concessions

New compensation provisions

There are new compensation rules in different provisions of the bill to regulate the amounts paid by the State to the concessionaire in several cases.

The first of them, as provided in the bill's new article 19, happens when the concessionaire claims a damage arising from an act of the State (as a wide concept) as long as it occurs after the concession's adjudication date, it was unnoticeable by then, it does not constitute a general legal provision that exceeds the particular concession industry, and significantly alters the economic regime or balance of the contract.

In the current law, this concept is broader since it grants compensation for any unexpected circumstance - a concept that the administration looked to restrain.

Then, also in article 19 as well as in article 20, there are compensation provisions with regard to additional works providing that they must maintain a net present value that equals zero considering the applicable discount rate - providing for a financial concept of it - as well as the new risk and economic effects of those additional works on the original project.

The compensations mentioned in paragraphs two and three must express themselves in one or more of the following:

• subsidies
• voluntary payments made directly to the concessionaire by benefited third parties
• present value modification of the concession's total net revenue (when it is adjudicated as such)
• concession term or tariff adjustment
• the modification of other instruments of the economic regime of the contract

With regard of compensations for early termination situations, the new bill provides that if the contract is terminated due to a severe default of the concessionaire obligations (Article 28), the State - if it chooses not to auction the remainder of the concession term (case in which the market itself would value the project and therefore the compensation) - has to pay the defaulting concessionaire the value of the necessary investments effectively incurred by it that are not amortized plus proved normal financial costs of those investments, interests and indexation accrued to the payment day.

Finally, there is a new anticipated termination clause introduced by the bill. If during the construction phase there are new circumstances that deem the concession unnecessary or demand its reshaping with additional works that surpass 25 per cent of the official original project budget, the administration can put the contract to an end compensating the concessionaire with an amount that equals the value of the necessary investments effectively incurred by it - excluding financial costs - and taken to future value plus a percentage of the expected net revenues of the concession expressed in present value and related to the advance percentage achieved in the construction phase.

These legal changes are just three of many other introduced by this bill, including:

• major dispute resolution reforms such as the inclusion of a permanent technical panel similar to Dispute Review Boards (DRB) frequently used in some common law countries for massive construction contracts
• the modification of the arbitral tribunal nature from aex aequo et bono to one that is restricted to law
• a new judge nomination system with names contained in lists previously selected by Chile's Supreme Court and Antitrust Tribunal
• new Statute of Limitations terms
• a new sanction system against defaulting concession users

This profound change to the concession regime is expected to increase transparency, accountability and certainty of the parties involved in this system. However, it has also raised concerns about the risks introduced by some of the concepts such as increased regulation to the industry and a possible unbalance of the State as a contracting party. The last word on the matter will ultimately be uttered by investors bidding for contracts after this bill comes into force.

Instituto Libertad is a non-profit organisation of private rights in Chile.