Summary

The present paper has the aim to show in which direction is going the Italian legal system with its economic operators, in relation to the project finance technique. I have chosen this topic basically for two reasons linked with two events happened on September and December 2008. First, on September 2008 was issued an amendment to the Code of Public Contract mainly focused on the project finance, trying to distinguish, truly, for the first time, the figure of the traditional contractor from the figure of the sponsor, but leaving too many confusion in the scenario of the awarding procedures that can be adopted by the public entities and second, on December 2008, a project in my home-town, interrupted in its constructing phase for long time, has started again. Because both the events are fairly recent, it is too early for drawing any kind of conclusion, but at a first glance, it seems that, from the Government side, there is much efforts in over regulating the awarding procedures, causing countless legal disputes between the operators, rather than in evaluating, also while dealing with the contractual aspects of the project finance, the possibility to realize needed works without being involved in the relevant costs, transfer the main risks to the private operators (this aspect requires not only good regulations but specially skilled public employees). In the first part of the paper I describe the legal framework of project finance, explaining the recent law reform, and in the second part, the practical one, I describe what have happened in the construction phase (still not ending) of a multilevel underground park projected in the centre of Bari, and I point out how in the concession agreement and in the constructor agreement the allocation of the risks of unforeseen events has been ruled.

The Legal Aspects of project financing

by Maria Verena Giannini

Studio Legale Campanale Bari Italy

1. Introduction to the Project Finance technique The expression Project Financing refers to a structured, complex economic and financial transaction consisting mainly in the provision of loan or other nonequity finance for the purpose of implementing projects sponsored by a private or public entity concerning the realization of works or the supplying of services. Projects may have different economics objectives, they can be used for many types of facilities, from manufacturing plants to telecommunications projects to toll roads to public arenas, mining and power generation facilities. The common elements of those different projects from a lenders point of view both in the public and in private sector is a financing structure which reflects the projected financial performance of the project, and permits the project loans to be repaid over such a period and in such amounts and, in the estimation of the lenders and project sponsors, will enable all projected payments of interest and other charges and all repayments of principal to be discharged out of the projected revenues of the project. Many financing structures may fall within the definition of project finance, and all structures share the single characteristic that financing depends not on the credit support of the project sponsors or the value of physical assets, but on the expectation of revenues generated by the project itself over time. Actually, project financing can be structured so that it is treated for accounting purpose as off balance sheet. To achieve this result, the project sponsors typically create a single purpose company to develop, own and operate the project; this operation generates a ring fence between the project to be realized and the general activities of the contractor. In fact, an advantage of using a single purpose entity is that there will be no liabilities or obligations that the single entity will bear which are unrelated to the 3

project and/or connected with the other activities of the sponsors, thus reducing the chance that the single entity will end up in financial difficulty. This is an advantage also for the banks: in fact the banks have the benefit to obtain repayment of their loans, wholly or mainly depending on the success of the project and its generated revenues. Implementing a private or public sector project will typically involve the following participants: - The project company will be a special purpose company, owned by the project sponsors, who takes over the project from the concessionaire company (usually the sponsor). - The project sponsor will promote the realization of the project and its operating phase and will provide the equity finance for the project, in the form of share capital; its main duty is to implement the project, including its technical, legal and financial structure. - The project lenders are the banks making loans for the realization of the projects. Banks also intervene during the drafting of the project as financial advisors and in order to provide the certification of the financial economic plan related to the projects. - The public authority has a relevant role during the planning of the works to be realized with the project finance technique and, during the planning and execution of the works it plays a role in relation to the financial and fiscal supports, granting the administrative measures needed for the construction of the works. - The contractors who will be responsible for construction works. - An operator, who, following the completion of the project, will operate and maintain the project.

2. The Italian Progetto di finanza While defining the project finance technique, the Italian legislator uses the concept of realization of public facilities without financial burden for the Government 4

(art.153 of the Government Decree n. 163/06). In Italy, Project finance technique is a way of financing and realizing public works in order to put an end to the public funds shortage and the infrastructure gaps that leave Italy behind other industrialized countries. In the Italian system it is allowed only Build Operate Transfer agreement, that designates a method of financing public sector projects for which the Government is unable or unwilling to make public finance available, but which the Government nevertheless wishes to see implemented. The solution is to grant a concession to a private sector sponsor to operate the project for profit for a fixed period of time provided that the sponsor agrees to build the physical assets required to operate the project and either accepts a limited legal interest in the relevant assets which will be extinguished at the end of the operational period or, if the sponsor owns those assets, to transfer ownership of the assets to the Government at the end of the concession period. In this scenario, Build Operate Transfer projects can only exist in relation to assets which generate revenues, that the sponsor can apply first to meet all the implementation and all the operational costs of the project (including paying off project loans) and second to give itself and its co-investors the required return on their investments. All this must be achieved within the concession period and before handing over the project assets to the Government. Within the projects financed with this technique, the distinction between opere calde and opere fredde has its own prominence. The distinction depends on the financial self-reliance of the works or services, opere calde are facilities with inelastic demand, for which it is possible to apply a price for the services to the final customers, thus opere calde are capable to generate a cash flow and therefore sensitive revenues to repaid investments, unlike opere calde, the expression opere fredde refers to facilities in sectors where the social function is dominant, therefore it 5

is not possible to apply reasonable rates and/or it refers to facilities in sectors with highly elastic demand; in both cases there are not sensitive cash flows and so those opere do not generate enough revenues to repay the investments: the public financial support is necessarily deemed for the success of the structured project. Considering the legal aspects of the financing technique, the feature is that the project financing is not recognized as one of the typified contractual categories provided for by the law, but it involves a number of different contracts, such as supplying, security, company and construction and operation agreements, by which the structure of the project financing technique is built. In this perspective, the efforts requested by the project finance experts are not contained in a specific subject, but they are contained in the valorisation of the contractual network generated by the contractual relationships, which, on different levels, are parts of the financial transaction. Having this features in mind, the Italian legal framework for the project finance should aim to grant legal and regulatory stabilization and clarity in the relationship between public entities calling for a tender and the pool of private entities keen to realize/supply public works or services.

3. The Italian legal framework Regarding the project financing technique, the Italian Legislator mainly had disciplined two legal issues, both strictly connected with the relationship between public entities and private operators: the first aspect concerns the procedure of awarding a tender and the second is related to the concession agreement that gives the project company the right to carry out the project. The awarding procedure for a project financed in project financing, since its introduction in the Italian system, has followed the procedure for a public works

contract and concession, only in September 2008 the role of the sponsor has started to be distinguished from the one of the contractor. As far as the second issue is concerned, the Legislator has enlarged the toils of the concession agreement making it suitable for a project financing with project finance. Both the two mentioned aspects are regulated in the Code of Public Contacts concerning works, supplies and furniture (Government Decree n. 163/06), a consolidating act, collecting all the acts of law, regulations and government decrees issued on public works subject.

3.1 Awarding procedure The Code of Public Contracts has been recently modified, mainly with relation to the application of project finance technique. Actually, in September 11th 2008, it has been issued the Government Decree n.152 which provides for significant amendments of the rules on project financing, in order to find the comments by the EU1 and in order to simplify the previous procedure too much confused, according to most commentators2.

The amendments to the Code of public contracts are due primarily to the necessity to conform the national law on project finance with the remarks of the European Commission (decision of 31.01.2008 regarding provisions of the Code of public contracts in violation of EC directives n. 2004/17CE and 2004/18CE). In the above mentioned decision, the European Commission pointed out the violation of the par condition between the operators, due to the illicit vantage point of the sponsor who doesnt take part to the tender but it is automatically admitted to participate to the second phase of the awarding procedure, by competing only with the two operators who have filled the best offers during the first phase of the awarding procedure (see note n. 2, describing the awarding proceeding before the reform). The second remark concerns the violation of the directive n. 2004/18/CE on the coordination of procedures for the award of public works contracts, public supply contracts and public service contracts, with regards, particularly, to the principle of equal treatment. 2 Here it follows brief outlines about the discipline of the project finance before the issue of the Government Decree n.152/2008: By special notice, considering the works included in their triennial public works plan, the awarding public entities gave notice of the works which were considered feasible with private funds, as well as of the standards to be used for comparing the received proposals. The proposals presented by the private operators have to be exhaustive: including a feasibility study, a preliminary project, a proof of agreement, a certified economic and financial plan. The proposals were estimated by the awarding public entity which identifies the ones of public interest through checking the feasibility of the works and the analysis on the technical specification of the projects. Once the proposals of public interest had been identified, the awarding public entity called each proposal for a tender (the sponsors did not take part) based on the preliminary project presented by the sponsor and to be effected according to the criteria of the most economically advantageous offer. The purpose of the tender was to identify the two best

The new procedure for awarding a tender in a project financing consists in a unique tender offered by the public entity, aiming to identify the sponsor. The notice of the tender, depending on the value of the works, has to take place on a national or communitary level. At the base of the tender, a feasibility study related to the project to be realized, is layed down by the contracting authority. The characteristic of the works to be effected are provided in the feasibility study as well as in the disciplinary of the tender that indicates the location and description of the works, the urban destination and typologies of services to be supplied. The offers presented by the tenderers must contain, as in the previous procedure, a preliminary project, a proof of agreement, a certified financial economic plan, the characteristic of the service and the operations. The auction is conducted on the basis of the most economically advantageous tenders criteria. After examining the offers, the public body writes down a classification, and appoints as sponsor the offerer who has presented the best offer according to the pre- fixed criteria. Afterwards the public entity proceeds in approving the preliminary project presented by the sponsor. Should the public entity request changes in the planning, the sponsor has to effect them. The concession will be awarded to the sponsor, in two cases: (i) if the project needs not any modification or (ii) if the sponsor agrees to modify the project and, in case, to adapt the financial economic plan; contrariwise, if the sponsor denies to amend the project, the public entity can invite the competitors following in the list to accept the requested changes to the project. The last step is the stipulation of the concession agreement with the sponsor or another following competitor who has accepted the plan changes.

offers that would have been admitted to a second tender where the sponsor took part. The tender was then awarded to one of the three tenderers.

The above mentioned discipline still looks like reorganize the position of the sponsor nearer an operator who wins with the best offer (i.e. an Italian classic method of awarding a contract) and always farther from the peculiar image of the project financing operator who tosses out a suggestion of making work (inside the plan a public entity) with his own project. With the modified article n.153, comma 15, the Legislator has included an alternative procedure for selecting the contractor, which grants the sponsor a preemption right. Shortly, the contractor is selected in two phases: first, the operator who submits the best proposal becomes the sponsor; in a second step, on the basis of the preliminary project submitted by the sponsor, the best offer is selected. At this point, the sponsor may exercise its pre-emption right, granting himself the possibility to become the contractor, by adapting its economic offer to the best offer selected at the second step. The clear intent of the Legislator, by giving the pre-emption right to the sponsor, is to attract private operators to the project finance technique. Both the described procedures are characterized by the impulse of the Government which publishes the tender in order to select the sponsor. The law reform envisages further procedures for selecting the contractor, which are practised by initiative of private operators. Particularly, article n.153, comma 16, of the Government Decree n.163/06, as amended by the latest Government Decree n. 152/08, envisages that for certain public works contained in the public entities triennial programme, for which the public entity does not provide the publication of the tender within 6 months from the approval of the programme, the private entities, spontaneous, can submit their own proposals. Thereafter, the procedure goes on as it follows: The Government publishes a notice including the standard of

estimation of the private proposals; 9

the possible proposals revised and the new proposals are estimated by

the Government, that indicates the proposal of public interest; after this selection, the public entity can chose between the following

options: a) if the preliminary project needs some adjustment, a competitive

dialogue will be opened; b) if adjustments are not required to the preliminary project chosen, the

public entity may b.1) approve the preliminary project and call a tender for public works, inviting the sponsor to the tender, b.2) approve the preliminary project and call a tender for public works, giving the preemption right to the sponsor who can adequate its offer to the most profitable one. Such procedures aim to give an impulse either to the achievement of public works which have been foreseen in the public planning and to the private initiative. Economic operators, in fact, can promote their initiative every time the relevant public entity doesnt announce the contract within 6 months from the approval of the programme. Ruling the private initiative, the law seems to foresee an obligation by the public entity to publish the notice, in order to promote the procedure aiming to choose the concessionaire company. In these provisions of the law, the role of the sponsor is rehabilitated, as the sponsor may propose his own offer with a preliminary project; furthermore, a simple exam of the works included in the programme, on which the public entity has not published an announcement, allows the private operators to have relevant rooms of proposals. At last the Government Decree n. 163/06 as amended by the government Decree n. 152/08 rules a matter that is very important and interesting for the business world. 10

Private operators are allowed to submit proposals of public works which are not foreseen in any relevant planning of public entity. In other words, private operators, with specific qualifications, can propose an offer with a feasibility study to the public body in relation to works which were not included in the acts of planning. The public entity, receiving those proposals, is obliged to estimate them within a period of 6 months from their submission, after that, the public entity can include the feasibility studies of public interest in its own programme, and can go on choosing one of the above described procedures (listed in article 153 of Government Decree n. 163/06 as amended by the Government Decree n. 152/08) in order to identify the concessionaire company. Consequently the reform bounds the public entities to estimate the private proposals received -in the past, indeed, no obligation was envisaged - in order to examine and estimate these kinds of proposals. At a first glance, the new provisions introduced by the law reform have their weakness in the number of procedures that can be followed in order to select a concessionaire, but they give the sponsor a proper and peculiar role. The risk relies in lack of certainty and stability within the relationship between public entities and private operators and in a more difficult management by the public entity, not yet skilled in project finance technique, that could generate, as it currently does, legal disputes.

3.2 The concession agreement Regarding the second issue relevant to project finance and concerning the contractual and legal structure of the operation, the discipline introduced by the Italian Legislator considers the construction and operation agreement the best suitable legal format for the project finance.

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Law n. 163/06 defines the construction and operation agreement as the agreement entered into by a concessionaire and an awarding entity, where the consideration in favour of the concessionaire consists in the right to operate and exploit the works commercially. On a part with what happens in the project finance, the government administration reaches its public scope, without any financial burden. Unlike what happens in the project finance, where both the preliminary project and the economic and financial plan are prepared by the sponsor and the latter points out the elements relating to the concession to the government administration in the construction and operation agreement, the government administration prepares the preliminary project and autonomously defines the elements to be indicated in the competitive tender for the awarding of the works. Considering those differences, the Legislator has introduced the necessary modification to the traditional system of the construction and operation agreement in order to adapt it to the characteristics of the project financing technique. An important modification pertains to the enlargement of the concession including the definitive and working plans. Actually, the rigid separation between planning the works and executing them was recognised as one of the impedimental limit to the realization of any works in project finance in Italy. In fact, in project finance, sponsors and lenders are really interested in taking part to the planning phase of the works. In this phase the work details and costs, on which to build the balance in the investment plan, are established. Therefore, considering that financial, economical and technical planning are strictly connected, adapting the financial plan to an already defined technical project, as a basis for a tender, would have resulted really restrictive. As said at the beginning of the present work, the sole concession agreement is not enough for having a clear and safe project finance operation from lenders, sponsors and awarding entities point of view. Actually, the underlying contractual framework of a 12

project is all important. It allocates risks between the various commercial parties and so determine the risk profile that will be presented to the proposed lenders of the project. A network of contractual relationship well established and balanced is necessary for having a project finance operation being successful. For example in a construction and operating agreement, the provisions contained in the concession agreement have to match with the provisions contained in the construction contract, otherwise the allocation of risks and the project contractual structure itself wouldnt be successful. In practice, the success of a project financing depends on a proper allocation of each risk to the project participant who is best able to manage and mitigate the risk. Where the risk is not properly allocated, obtaining project financing for the project is likely to be more complicated and more expensive for the project sponsors. Focusing on risks contractual allocation, we have examined the documents of the tender, including the concession agreement, and the construction contract for a project finance of an underground car park in Bari, Italy3, and we have verified the strength of the contractual provisions concerning the risks allocation. The results have been satisfying, showing that there is a perfect match in risk allocation between the concession agreement and the construction agreement, which prevents uncertainty on the party of the project finance structure who will bear the costs of unforeseen events.

The works are related to the construction and operation of an underground car park in Bari granted by the Municipality of Bari to a private entity. On 30.06.02 the sponsor (A.T.I. DEC BARIPARK, where A.T.I. stand for enterprise temporary association) made a proposal for planning, constructing and operating a multilevel underground parking in Cesare Battisti Piazza, including of making improvements to the area of the Piazza. On 21.07.03 a tender was published having as base the preliminary project of the A.T.I. DEC BARIPARK, approved by the Municipality of Bari. By the procedure of tender, on 05.05.2004 A.T.I. DEC BARIPARK was awarded, consequently, the concession for planning, construction and operating a multilevel underground park in Cesare Battisti Piazza with relative services of improvement of the area was relied to the A.T.I. DEC BARIPARK. The concession agreement between the Municipality of Bari and the A.T.I. DEC BARIPARK was entered into on the 29.11.2004. In the agreement, A.T.I. DEC BARIPARK reserved the faculty to start a project company (Gestipark Battisti s.r.l.), after the signature of the concession. On 04.11.2005 Gestipark Battisti s.r.l. signed a comprehensive turnkey construction contract with DEC S.p.A. On 14.12.2005 the concessionaire sent the definitive project to the Proceeding Responsible in order to obtain the final approval. On the 27.09.2005 the definitive project was duly approved by the Municipality of Bari. On 11.11.2005 the Municipality recorded that Gestipark Battisti S.r.l. took over from A.T.I. DEC BARIPARK the concession agreement. The works area was delivered on 02.05.2006, the completion of the works was fixed in 12 months from the date of delivery, that is 01.02.2008. The executive project has been approved and validated on 27.04.2006. Gestipark Battisti.

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During the excavations for laying the foundations of the underground parking, a water bearing-layer was found, as it was foreseen in the planning phase and attached in the preliminary project, the concessionaire had plan a method to drain the water away from the construction site. Even if duly planned, the excavation phase had unexpected implications: during the excavation works there were found culvert and pipes unknown, at the planning stage, by the contracting Municipality and by the concessionaire; during the excavation works, in the walls of the building around the Piazza occurred some cracks; as a precautionary measure, the University of Bari (one of the building around the construction site) asked for putting the works on hold till a technical committee would had expressed an opinion that would have become binding for the constructor. Before starting the waterproofing works in the construction area and the necessary water draining activity, the competent authority denied the permission to carry on the water draining works in the construction area, as planned in the project and, alternative measures become necessary to be planned by the constructor in order to drain, during the working period, the water out of the area. This new draining system, consisting in construing an underground water pipe from the construction area to the see, 8 km circa, was approved by the competent authority on 31.05.2007. On 20.07.2007 the Public Prosecutor of Bari ordered to seize the area of the construction of the water pipe, under the assumption that a Regional environmental Law was breached. Even if the Order of the Court was related to the water pipe construction, this measure caused the interruption of the excavation works in the construction area.

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The interruption of the works (due to the Public prosecutor decision) lasted more than one year, only in December 2008 the construction area of the water pipe was released from seizure and the excavation works could re-start.

Over this period, a new seismic regulation come in force and all the public works project to be realized after 2004 have to comply with it, Cesare Battisti works as well.

All those issues, the construction works were stopped for 3 years, the original plan for excavation works had to be amended according to the opinion of the technical committee, the water draining system had to be planned and realized in a different way from the one originally planned and the original plan had to comply with the new seismic law, caused the concessionaire asking for modifications in the financial and economical plan presented by the sponsor at the time of the offer (2002) and approved by the contracting Municipality at that time. Considering that, an analysis of the contractual contents of the concession and of the construction agreement would lead to understand if the risks, as far as the outlined issues is concerned, are efficiently allocated between the public operator, the project company and the constructor or room is left to uncertainty. In this contest, considering that the risk we are dealing with is essentially a construction risk, in order to have an efficient project finance structure, the construction risk4 should be allocated to the constructor. Generally speaking, this implies that (i) the construction contract must be turnkey. No aspect of the construction and design should remain on charge of the project company. In the Cesare Battisti case, either the definitive project and the executive one

The construction risk covers events like late delivery, additional costs, non- respect of specified standards, technical deficiency and external negative effects. This definition is provided by the Eurostat decison on treatement of PPPs, 11, February 2004, which is applied to long-term contracts in areas of activity where Government normally has a strong involvement.

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were realized directly by the constructor, but the preliminary project was provided by the project company and had been considered an essential document for the realization of the works; (ii) Completion of the works must occur within a fixed time, and (iii) completion under the construction contract can only occur when completion also occurs under the concession agreement, this is the case in the construction contract analysed, in addition (iv) the force majeure events should be limited, or at least the contractor should be able to claim force majeure, an increase in price or an extension of time to the extent that the project company is able to claim force majeure, an increase of price or an extension of time on the same grounds under the concession agreement, and so it is provided for in the analysed contract, last thing, (v) the project company should pass through all the liquidated damages if completion is not achieved by a fixed date to the constructor, and Cesare Battisti construction contract so provides. In the construction agreement for Cesare Battisiti park the contractor is not able to claim an increase of price for any reason whatsoever, unforeseen or unexpected events; in case of interruption of the works the construction would be able to claim only for an extension of time to the extend that the project company will be able to claim an obtain an extension of time. Furthermore the contract provides that the constructor is responsible of planning, constructing and operating the park in compliance with the laws in force, even if amendments occur during the execution of the works or the operation of the park. Summarizing, the construction contract drafted for Cesare Battisti park is well coordinated with the concession agreement and release the project company from the major risks connected with the project and construction phases; basically, it has built up as a wagering contract.

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On the other hand, the concession agreement between the Municipality and the project company allocates the risks of the occurrence of unforeseen events to the Municipality, showing the same bank-friendly trend of the construction agreement. In fact, the project company bears almost no risks related to unforeseen and unexpected events that may occur in the planning phase, in the construction phase and in the operating phase. Those risks are allocated to the Municipality: any unforeseen events, changing in laws, missing authorisations and permissions, unforeseen changes in the expected vehicular movement, etc, would imply a redressing in the economic and financial balance. Still remain imposed on the project company liquidated damages if the project of the works or the completion of them are not achieved by the contractual fixed dates, but only in case of default by the project company. In all probability, this contractual networks represents a pretty good position for the sponsors, for the project company and for the lenders, because they are in the position to ask for a redressing of the financial and economical plan in case of unforeseen events during the planning phase, during the construction phase and during the operating phase, but it is dubious that this position should be the ideal position for the public operator, that has to bear the risks of all the unforeseen events occurring, or of events failing to occur, from the signature of the concession contract till the end of the concession period.

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Bibliography

Il PPP ed il patto di stabilit europeo Limpatto della decisione Eurostat sulle operazioni in Public Private Partnership Relazione finale sottocommissione PPP, Patto di stabilit ed aspetti contrattualistici Roma, 7 giugno 2006

Il Project Financing per le opere pubbliche Edizioni Simone 2006 PPP e PF: Il quadro normativo Estratto della Relazione sullattivit svolta dallUnit Tecnica Finanza di Progetto nel 2006 presentata alla Camere

Contratto di progettazione, costruzione e la gestione del parcheggio sito in Bari alla Piazza Cesare Battisti sottoscritto in data 29.11.2004 tra il Comune di Bari e la A.T.I. DEC

Contratto di Appalto per la progettazione e la realizzazione del parcheggio sito in Bari alla Piazza Cesare Battisti sottoscritto il 04.11.2005 tra la Gestipark Battisti S.r.l. e la DEC S.p.A.

Project Finance a legal guide Graham D.Vinter 1998 Sentenza del Tribunale Amministrativo Regionale per la Puglia Sez. 1 Bari n. 3877/04

Interview of the Site Engineer of Cesare Battisti project, Mr. Filippo deCristofaro, and of Mr. Antonio Colangelo, engineer by DEC S.p.A.

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