Airports go private

Author: | Published: 1 Aug 2007
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Perhaps the greatest stumbling block in India's success story is its lack of adequate infrastructure. In sheer economic terms, it is estimated that the infrastructure gap is responsible for a loss of about 2% of India's GDP per year (year upon year). The Indian government is conscious of this and has (although belatedly) committed itself vigorously to addressing the infrastructure gap. A main area of focus is the airport sector. Adopting the PPP route, two concession agreements were signed in 2004 – both in the greenfield sector (for Bangalore and Hyderabad airports). Then, in 2006, two brownfield projects (for New Delhi and Mumbai airports) were signed. The Bangalore and Hyderabad airports are expected to be operational next year and the upgrades planned for Delhi and Mumbai are expected to be completed substantially by 2010. But this is just the beginning. Within the next six months, the government is poised to replicate these models for 35 airports all over India. This would not only bring about a sea change in the aviation sector, but would also change cityscapes wherever these projects are carried out – for along with the airport, the concessionaire gets to develop a large chunk of land for non-airport activities as well.

Below we discuss the Bangalore airport (greenfield) project and the Delhi airport (brownfield) project, which provide good examples of the mechanisms the government has put in place for the construction and upgrade of airports.

The private entity

The private operators selected are required to form a joint venture company. The government, as a matter of policy, retains (directly or indirectly) a 26% shareholding in the joint venture company (which, under the Indian Companies Act, enables the government to veto certain "fundamental resolutions" that require at least 75% of the shareholders' vote, (for example, issuance of new shares, change of directors, change of auditors). So, despite privatization, the government retains some minimum control. The private entities are required to hold a shareholding of at least 26% for seven years.

The concession

The concession is for the construction, development, operation and maintenance of the airport over 30 years (the concession period), extendable at the sole option of the concessionaire by another 30 years (that is, a total of 60 years). The state government leases the land to the joint venture company at a nominal rent.

The government has extended its full commitment and support to the projects; for instance, the Bangalore concession agreement states "GOI acknowledges and supports the implementation of the project". It also states that the government of India will not take any action in contradiction with the concession agreement that results in, or could result in, its shareholders or the lenders being deprived of their investment or economic interest in the project. All statutory and non-statutory bodies under the control of the central government will act in compliance with the concession agreement as if they were a party to it and the government of India will ensure that all statutory compliances required are granted promptly. The state governments have similarly entered into state support agreements. This is a unique feature in airport privatization concession agreements. The government does not have similar obligations in relation to the port or road sectors.

The concession agreement also insulates the concessionaire against competition by stating that no new airport would be allowed within a 150 km radius for 25 years from the date of airport opening and that the government will ensure that no other airport in India gets any unfair competitive advantage over the subject airport.

Upon expiry of the concession agreement, the airport will revert back to the government upon payment of compensation as stipulated in the agreement.

Income generation and fee payment

The concessionaire would have two main sources of income – income from airport activities and income from non-airport activities. The income from non-airport activities would be greater because the concessionaire gets, almost free of cost, a large chunk of land alongside the airport for any commercial development, as may be permissible in law. The concessionaire can set up malls, hotels, golf courses, manufacturing units or even a special economic zone. In Bangalore, the concessionaire got 300 acres of land for non-airport activities and, at New Delhi, 250 acres. This would really be the commercial backbone of the project.

The concessionaire also has a second stream of income, that is, income from airport activities such as landing fees and passenger fees. These fees ultimately have to be met by the users (that is, the travelling public), so they are regulated and require government approval. The government, in turn, benchmarks these fees, taking into account charges in place for other airports in India, and ensures that the fees are in accordance with the International Civil Aviation Organization's policies.

As regards fees payable by the concessionaire to the government, for Bangalore, the concessionaire is required to pay annually a fee amounting to 4% of the gross revenue. For New Delhi, (because the airport is already up and running) the fees obligation is greater. The concessionaire is required to pay an upfront (one time) fee of Rs1.5 billion ($37.5 million) and thereafter an annual fee equivalent to 45.99% of the projected revenue for the year (that is, pre-tax gross revenue less certain permissible exclusions). This amount was what the concessionaire bid, on the basis of which it was selected as concessionaire.

Construction

With greenfield projects, planning of the construction is pretty much left the concessionaire, as per the approved master plan. But brownfield agreements are far more specific. The agreement for New Delhi, for instance, stipulates development of a master plan within six months of the agreement. This must be updated and reviewed every 10 years. Any delay in submission of the master plan would entail liquidated damages at the rate of Rs2.5 million a day. The concession agreement then sets out certain types of works, called the mandatory capital projects (which are set out in a schedule). For instance, for New Delhi airport, a parallel runway is listed as one work, which must be completed within 24 months of the signing of the agreement (if it is not, liquidated damages would follow). There is also a category of works that fall under the head of "major development plan". These comprise projects expected to have a capital cost over Rs1 billion.

All the above are subject to review and approval by the government. While strict time lines are stipulated for submitting plans for approval, the Airport Authority of India (AAI) or the government concerned is not obliged to revert with their approval/ suggestions within a particular time. This can lead to a situation where work begins (as it has to, to meet the deadline) but belatedly is not approved or requires some modification. It seems that something like this has already happened in Bangalore where, according to press reports, the government authorities have required modifications to the master plan, a good three years after signing the agreement – a development that is bound to delay the project and lead to cost overruns.

Adherence to standards

The concessionaire is required to:

  • adhere to good industry practices;
  • adhere to development standards and requirements. These are specified in a schedule. For instance, it is stated that the airport must conform to the ICAO Aerodrome Design Manual, the Airport Services Manual, and the National Building Code of India;
  • adhere to operations and maintenance standards and requirements. These are also set out in a schedule. For instance, it is stated that the relevant standards prescribed by the ICAO (Chicago Convention) must be followed;
  • adhere to objective service quality requirements, for example, security checks should not take more than 10 minutes and check-in should not take more than 10 to 20 minutes.

Monitoring the project

The agreement has an aggressive manifold monitoring mechanism in place:

  • The Concessionaire is required to achieve ISO 9001-2000 certification. This is to be done within two years of the agreement coming into force. If this is not achieved, liquidated damages will follow.
  • Objective service quality requirements are stipulated as mentioned above and, if they are not met, liquidated damages will follow.
  • Subjective service quality requirements are set out, which will be measured using a passenger feedback survey, as per IATA/ACI/AETRA guidelines. If a certain specific rating is not achieved within the stipulated time, again liquidated damages will follow.
  • Lastly, development standard requirements are stipulated and if these are not achieved, again liquidated damages follow.

In the greenfield sector, the approach is far simpler and monitoring is only through passenger surveys and joint committees. Also (unlike the brownfield sector), liquidated damages do not necessarily follow but if the rating is consistently below the stipulated norm (and if the targets are not met), it might become an event of default leading to termination.

Dispute resolution

This complex agreement, which is expected to have a life span of 60 years, has no dispute resolution mechanism in place. Dispute resolution is essentially through ad hoc arbitration under the Indian Arbitration Act with the venue at New Delhi. No Dispute Review Boards are stipulated; indeed not even a mechanism for conciliation is in place (although it is stipulated that, before invoking arbitration, parties must use "reasonable endeavours" to settle their disputes amicably). It is also stipulated (the Bangalore concession agreement states so expressly) that, once the regulator is in place, the arbitration agreement is overridden and the dispute stands as referred to the regulator.

Areas of concern

With this brief overview, it might be appropriate to make some observations about the process and mechanism in place for privatization. The areas of concern can be many. To begin with, it is a complex arrangement. It is not merely a large construction project, but also involves issues of public interest and safety. It has a lifetime of 60 years and one can only speculate upon the changes that might take place in such a vast time span, rendering large parts of the contract otiose.

The regulator

In infrastructure projects involving the public, an independent regulatory authority has become necessary. Accordingly, it is envisaged that an independent regulatory authority would be set up to regulate all aspects of the airport. This regulator will be invested with vast powers. It would not only lay down or regulate standards, approve charges or impose penalties but it would also settle disputes: between the public and the government and/or the concessionaire in relation to the airport, and between the concessionaire and the government.

The Cabinet has approved the Airports Economic Regulatory Authority Bill 2007, which will set up the regulator. The powers cast upon the regulator could diminish the power of the parties' contract. Ultimately, the fate of the project will depend upon the regulator.

India has had a mixed record of setting up regulators. Regulators have worked well in the telecom sector, but they have not been successful uniformly. Roads were the earliest part of India's infrastructure to be privatized and it was envisaged that there would be a regulator. However, not even a draft Act is in place yet. The story is the same for ports, and oil and gas. The radio-broadcasting sector has been privatized for about 15 years now but has no regulator. In the power sector, regulators have been put in place at the state as well as at the central level but their record so far is not encouraging.

The nuances of airport governance through regulators are yet to be worked out. The regulatory philosophy has yet to develop. How independence, transparency and accountability will be assured is yet to be addressed. The government is still debating preliminary issues. One set of thinking is that, instead of multiple regulators for multiple sectors, India should have only two or three regulators. One would, for instance, deal with all types of carriage (roads, airports, ports and transmission lines) and another would deal with content (electricity, voice data). Another idea is that energy, communication and transportation should be under one regulator. It would seem, India is years away from having an independent regulator that can fulfil the enormous and all-encompassing role visualized for it under the concession agreements. Until that happens, there will be ad hoc decision making lacking transparency and leading to disputes that might hamper the privatization process.

Dispute resolution

The projects seek to involve large foreign operators and foreign financial institutions. A well-considered dispute resolution mechanism is crucial to attract and encourage them to make long-term commitments. Under the concession agreements, dispute resolution is proposed through ad hoc arbitration, under Indian law, with the venue in India. There ought to be Dispute Review Boards and there ought to be a proper mechanism for conciliation. Lastly, there ought to be arbitration through neutral arbitral bodies. A regulator is not suitable for resolving pure contractual disputes. If such disputes were to be referred to the regulator, it might become a matter of concern. The regulator would naturally be subject to the hierarchy of the Indian legal system – which would mean that it would be subordinate and amenable to the Writ jurisdiction of the High Court. Besides, there would be provision for appeal to an appellate authority. In short, one is looking at three or four stages in dispute resolution (a decision by the regulator, followed by a decision by the appellate authority, followed by a Writ to the High Court, followed by a discretionary appeal to the Supreme Court). Given the inherent delays under the Indian legal system, dispute resolution would become inefficient. Perhaps the government should have segregated pure contractual disputes between the parties and left these for international arbitration (which would also have met the expectations of the international investing community).

Inconsistent approach

Lastly, one might highlight the vastly inconsistent approach between the greenfield and brownfield sectors. Take for instance, the stipulation for liquidated damages. In the greenfield sector, even if the opening of the airport is delayed (something that ought to be a matter of serious concern), the concessionaire is allowed six months' grace if it can show that the delay was on account of failure by government in the performance of its obligations (a provision that is easily susceptible to abuse). After this, liquidated damages follow for the next six months at the rate of only $2250 a day (surely a nominal amount considering the consequences of delay). In contrast, in the brownfield sector, the concessionaire faces a prospect of liquidated damages of over $62,000 a day merely on account of delay in submission of the master plan beyond the stipulated period of six months – even though the concessionaire would already have submitted an initial master plan before the agreement (on the basis of which its bid was selected). Brownfield operators run the risk of paying liquidated damages (ultimately leading to termination of the contract) on at least 20 different counts – many of which are beyond their control (for example, security delay or check-in delay). Airport security is a matter within the control of the state and check-in is within the preview of the airlines. It seems unreasonable to penalize the concessionaire for it.

A greenfield operator pays liquidated damages on only one count – that is, a delay in opening the airport. Here, delay for six months mount ups to even less than half a million US dollars. Contrast this with the $10 million a brownfield operator might have to pay for a similar delay of six months in submitting its master plan.

The government has been unduly harsh on the brownfield operators and somewhat lax in the greenfield sector.

Lack of consistency in approach shows a rethink on the part of the government (as the greenfield contracts preceded the brownfield contracts by about two years). It also shows that the government is not being as surefooted as it ought to be in matters of this type. While it might be desirable to sign-off on the next lot of concession agreements, speed should not be at the cost of false steps. Once the agreements are signed off, it might be too late to retrace matters. The government should take a closer look at the agreements so that the sector can progress speedily without major hiccups.

The authors wish to acknowledge with thanks the assistance rendered by Vasanth Rajasekaran for this article

Author biographies

Sumeet Kachwaha

Kachwaha & Partners

Sumeet Kachwaha is a founding partner of Kachwaha & Partners. Kachwaha has extensive experience in commercial law, construction, and power and other infrastructure areas. Among the complex cases he has been involved with is the Union Carbide Bhopal gas leak case – the largest damages case in the world (which involved the cross-border issue of multinational liability).

Kachwaha has been commended for his "command of the law" by the Chambers Global guide, and has been nominated as a "highly recommended dispute resolution practitioner in India" by Global Counsel 3000 and as a "leading individual" for dispute resolution by Asia Pacific Legal 500.

Kachwaha is a co-vice chair of the Dispute Resolution Group of the Inter Pacific Bar Association (IPBA). He is also a member of the working group constituted by the Construction Industry Development Council (CIDC), on Development of Construction Laws in India.

Kachwaha is a regular speaker at various international conferences on issues ranging from infrastructure laws, construction laws, dispute resolution and international arbitrations. He recently spoke about airport privatization in India at the IPBA annual conference in Beijing.

Kachwaha's recently published work includes "The Indian Arbitration Law: Towards a New Jurisprudence" The International Arbitration Law Review (Sweet & Maxwell, 2007) and "Arbitration Law of India – A Critical Analysis" Asia International Arbitrational Journal (Kluwer).

Ashok Sagar

Kachwaha & Partners

Ashok Sagar is a senior and experienced litigator with 30 years' experience.

He has practised before a wide cross-section of courts and tribunals in India, including the Supreme Court of India.

Sagar has considerable experience in indirect taxation (customs, sales tax, excise) and complex litigation. Among the high-profile cases he has been involved with are the ITC excise case (the largest excise litigation in India) and the Union Carbide Bhopal gas leak case, the largest damages case in the world.

Within the firm, he heads the taxation group and is also part of the infrastructure group.

Kachwaha & Partners is a full-service law firm with offices in Delhi, Bombay and as associate office at Chennai.