Egypt: Project potential

Author: | Published: 1 Oct 2008
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Globalisation is seen as being one of the most powerful forces shaping the modern world and a key to explaining the movement of human society into the third millennium. In light of current globalising trends and the concerted efforts of the overwhelming majority of states to attract foreign direct investment (FDI) and incentivise domestic investors to invest, solely or jointly, in infrastructure projects and goods and services, the term public private partnership (PPP) became a fashionable buzzword. Nevertheless, it should be noted that raising private equity to invest in large infrastructure projects is by no means a novel practice.

States and governmental entities are increasingly interested in cooperating with the private sector when ensuring the provision of an infrastructure or service. The interest in such cooperation, now commonly referred to as PPP, is partly due to state budgetary constraints, the benefit public authorities could gain from the know-how of the private sector and the potential for increasing the efficiency and quality of the services offered.

PPP programme

In line with Egypt's strategy to promote and increase private sector involvement in the country's economic and social development plan, particularly in the area of public utility services and infrastructure, the government has taken the initiative to introduce Egypt's PPP programme, which has culminated in the establishment of a PPP Central Unit within the Ministry of Finance. The PPP Central Unit is charged with coordinating the national PPP programme across ministries and public bodies and reports directly to the Minister of Finance and the Ministerial PPP Committee on the progress of PPP projects.

Before launching Egypt's PPP programme and policy, there were a number of PPP projects individually negotiated and administered in accordance with the applicable sector-specific norms and laws. However, since the establishment of the PPP Central Unit, PPP projects have generally been streamlined and the government, despite the absence of an overarching PPP law, is working closely with the International Finance Corporation (IFC) and other governmental and international advisers on a set of standard terms, conditions and procedures of contracting that could form the basis of a PPP contract utilised across the diverse public sectors. Furthermore, a specific action plan has been implemented to determine a number of infrastructure and services projects that could be offered to investors under a PPP structure. Examples of such projects include: (a) the Schools PPP, which will allow the General Authority for Educational Building to contract with professional service providers to design, finance, build, operate and maintain up to 2210 schools; (b) the New Cairo Water and Waste Water Treatment Plants projects; (c) the Heliopolis Hospital project; (d) the Abbasia Chest Hospital project; (e) the Alexandria University Hospitals project; (f) the Natural Gas Distribution project; (g) the Ain Shams 10th of Ramadan Railway project; (h) the Cairo/Alexandria Desert Road project; (i) the Port Said/Matrouh Road project; and (j) the New Subsidy Smart Card System project. Furthermore, some PPP projects have already been completed or are being considered and developed in the petrochemicals, transport/ports, mining and natural resources and energy industries.

Incentivising and empowering private investors to participate in PPP projects requires an objective assessment of: (a) project feasibility; (b) project achievability; (c) project scale and importance; and (d) project bankability. Such assessment is necessary to determining whether a PPP structure is possible and feasible.

PPPs, like other forms of project financing, are generally characterised by the existence of multi-stakeholders, namely: project sponsors, public sector licensor(s) and financing institutions (project lenders). In today's world, it is highly unlikely that investors would sponsor multi-million dollar projects solely on the basis of a private investor's equity. The general norm is that investors raise the required capital for the project by inviting lenders (banking and financial institutions) to contribute to the project funding subject to an agreed debt-to-equity ratio. Thus, project bankability becomes a decisive factor in determining the desirability of offering a project under a PPP model. The absence of appropriate appetite from banks and financing institutions severely threatens the ability to offer a project as a PPP.

Such principles and characteristics are not peculiar to the Egyptian PPP and project financing market. Furthermore, the overwhelming majority of the globally available project structures are available and possible under the Egyptian legal system. However, it is worth noting that the Egyptian government, as a matter of relatively recent policy, has opted to dispense with the build, own, operate and transfer (BOOT) formula, as the state wants to ensure that it retains all ownership and title rights over public assets from project inception and throughout the PPP/concession duration. Nevertheless, the structure of a PPP will vary depending on the amount of risk allocated to the private sector.

On a different note, Egyptian PPPs/concessions generally entail the establishment of a Special Purpose Vehicle/Company (SPV) in which the private investor becomes the principal shareholder. The SPV is the entity entrusted with project development and implementation. This structure, which is the norm in the Egyptian market, enables the investor (project sponsor) to obtain financing on a non-recourse or limited recourse basis where project lenders are granted full security only over the SPV assets and shares owned by the shareholders. Thus, the lender's exclusive security package would be ring-fenced to those assets and does not extend to the project sponsor or SPV shareholders' assets.

Though such prevailing practices in Egypt are generally consistent with international PPP and project finance practices, certain legal, political, regulatory and practical challenges exist and merit further scrutiny. Aligning Egypt's PPP practices and policies with the well-established global PPP policies and practices without sacrificing the fundamental and prevailing local norms and principles has produced a number of vexing issues and problem areas, the most important of which are: (a) procurement procedures; (b) SPV shareholding structure constraints; (c) risk allocation; (d) availability payments; (e) termination compensation; (f) project bankability and direct agreements; (g) legislative reform; (h) project permits; and (i) change in law and dispute resolution provisions.

Procurement procedures

PPP projects in Egypt pass through a number of phases, the first of which, after the due diligence and development of the business case phase, is the procurement process, which culminates in choosing the successful qualified bidder in a competitive and transparent process. The principal challenge for the procurement process is the legislative framework governing the procurement process. In this respect, it is worth noting that the Egyptian Procurement Law 89 of 1998 may be applicable to the tendering and procurement process, as it is generally applicable to all tenders undertaken by governmental entities, but there is a strong argument that such law does not explicitly provide for its application to the procurement of concessions in general. Thus, if a project takes the form of a BOT or similar process, it could be argued that the provisions of Law 89 of 1998 may not apply, even though many public entities and the Egyptian State Council (Administrative Courts) have, in many cases, developed an inclination towards the application of Law 89.

The problem with Law 89 is that it does not match the fabric of the PPP process and may act as a deterrent to private investors because of the state-centric, protective model it propagates. Accordingly, the stringent procedural constraints enshrined in Law 89 may present a serious challenge to structuring the bidding process in a manner appealing to investors.

SPV shareholding structure constraints

As mentioned, it is a generally accepted practice, and in some cases a legal requirement in Egypt, that the successful investor establishes an Egyptian SPV that is entrusted with the development and implementation of the project. However, the SPV is actually a shell company and the successful investor, which becomes the majority shareholder in the SPV, remains the main driving force. This makes the PPP contract a personal consideration contract, which presents a further challenge to the project: that is, the investor's right to dispose of its shares in the SPV. In this case, though the SPV, as a legal entity, remains the project sponsor, there is a risk that it is also the majority shareholder investor, whose identity and abilities were the decisive factor in awarding the PPP contract, which could be detrimental to the project.

In order to overcome such risk or challenge, the state has, in some PPP/project finance contracts, insisted on the inclusion of a restrictive clause that restrains the principal investor from disposing of a certain percentage of its shares. This means that a certain shareholding threshold is maintained by the principal shareholder. Failure to observe this restriction may qualify as a fundamental breach, entitling the state to terminate the PPP contract.

Risk allocation

Under a PPP contract, the project risks should be allocated to the party best able to manage and mitigate those risks. Furthermore, the state generally resorts to a PPP model to be able to pass on certain risks to the private investor. In turn, the investor seeks to obtain project financing for a number of reasons, among which is risk sharing with the project lenders. However, lenders generally refuse to assume any commercial risk and constantly strive to minimise the risks associated with their provision of financing. Mark Twain, the great American author, observed that: "A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain."

On this account, the risk allocation matrix of a PPP project is a challenge subject to rigorous negotiations to determine and allocate project risks among project partners. Generally, nine different groups of risk can be distinguished: (i) development risk; (ii) completion risk; (iii) cost increase risk; (iv) performance risk; (v) operation risk; (vi) market risk; (vii) political risk; (viii) environmental risk; and (ix) credit risk.

In a nutshell, while the project sponsor (investor) will normally bear the risks of detailed design, construction costs and overruns, operational cost-effectiveness and financing, the state will normally bear the risks of scoping, zoning/planning and specific changes in the law. Nevertheless, risk allocation represents a significant challenge for the state and private investors, especially with respect to PPP projects undertaken in developing nations such as Egypt.

Availability payments

Among the most important issues for PPP investors and project lenders are payment mechanisms, as they affect project revenues, cash flows and overall business feasibility. Availability payments are a clear example of an incentivising mechanism that boosts project appeal and bankability and mitigates usage risks. However, governmental undertakings to make availability payments represent an additional burden on public funds. Furthermore, excessive availability payments may have an adverse impact on performance levels and service quality as they could negatively affect the investor because he is receiving an excessive availability payment to cover his investment costs.

Thus, a balance needs to be struck in order to mitigate any negative risks arising from the challenge of opting for this payment mechanism, as well as the risk of miscalculation. This balance should be in line with the main purpose of availability payments, which generally seek to fund the cost of capital (debt service and returns to shareholders) and the lifecycle capital costs of the new facility. Furthermore, availability payments should be tied to project output specifications, milestones and performance levels in order to ensure the offering of steady, high quality, value-for-money services, which is the ultimate aim of offering a project under a PPP model.

Termination compensation

Termination of contracts is always a hot topic, as it ends the life of the contract and breaks the parties' relationship. In the special context of PPPs, one facet of termination is of paramount importance for the Egyptian market as it represents a significant challenge to well-established legal norms: that is, the issue of termination compensation payable by the state in the case of a materially uncured event of default by the project company or investor.

Under a classical PPP/project finance model, project lenders retain the right, but not the obligation, to step in and cure an event default attributed to the project sponsor. However, the challenge arises when an uncured event of default by the project sponsor qualifies for termination. In this case, it is an agreed international practice that the state or its public entity licensor undertakes to compensate and indemnify the project lenders by paying a termination compensation covering the discharge of the senior debt to ensure that the lenders' rights are not prejudiced or squandered.

In the Egyptian market, this practice represents a challenge to well-established norms of liability, as it seems quite unfair for governmental entities to bear the financial burden in a case where the project company has defaulted and no cure has been offered. In that case, the governmental entity is the aggrieved party and its payment of any termination compensation to discharge the senior debt cannot be justified on the basis of contractual or tortious liability. This can only be justified on the basis of an explicit contractual provision that continues to cause problems within the Egyptian market, as such termination compensation seems, in that specific case, unjust from a purely legal perspective as it passes the termination risk to the governmental entity.

This issue is traditionally problematic in non-or limited-recourse project financing, which is generally the norm these days. Thus, novel solutions should be sought to align Egyptian practice and policy with international practice without the sacrifice of public interests. It may be the case that such specific risk should be passed on to the private investor, who should then compensate the lenders for the unremedied breach.

Project bankability and direct agreements

As mentioned above, project bankability is an indispensable factor when offering a project as a PPP. Bankability involves an in-depth assessment of diverse issues and factors and generally represents a challenge to PPP projects in developing nations and emerging economies. Thus, the development of a comprehensive business case is a necessity in this regard.

In some instances, even within the Egyptian market, an adequate understanding of the project financing culture is lacking within governmental entities. In many instances, they do not want to deal or negotiate with lenders, which could be, in some instances, detrimental to the project structure. The traditionally prevailing perception within some governmental entities is that an investor should provide all the necessary equity for the project without depending on external lending. Such an obsolete perception is questionable in today's business world.

This cultural challenge is directly linked to another challenge pertaining to the issue of concluding a direct agreement between the licensing governmental entity and the project lenders. In Egypt, an examination of the current state of affairs reveals that such direct agreements are rejected. One solution to resolve this dilemma is to include within the PPP contract specific provisions granting the project lenders certain rights as third party beneficiaries. This interim structure will remain as the general norm in Egypt until a cultural transformation occurs, following which governmental entities would be willing to enter into direct agreements with lenders. In fact, such agreements might in some cases offer a better understanding between all stakeholders and would ensure project unity, which would have a positive impact on project bankability.

Legislative reform

Among the significant legal challenges facing PPPs within the Egyptian market is the absence of an overarching PPP law. To date, all existing PPPs and project finance transactions have been offered under diverse sector-specific laws, as mentioned. This has generated problems with respect to uniformity, regulation and procurement procedures.

Thus, there is an urgent need for an adequate PPP law that dispenses with the traditional procedural problems existing in the Egyptian market. However, this law should not adopt a specific PPP model and should remain neutral to allow market forces to determine the best and most feasible structures.

That said, it should be noted that an Egyptian PPP Law is being drafted and is expected to be issued soon.

Project permits

Another significant challenge to the Egyptian PPP and project finance market is the existence of an intricate web of permits and licences required before and during project implementation.

Though the IFC has entered into a number of memoranda of understanding with Egyptian governmental entities with the aim of simplifying the licensing and permitting process, much remains to be done in this regard as each project is required to seek numerous permits from diverse public entities. This process is both time-consuming and costly. It is worth noting that the most important project permits in Egypt are the environmental permit and the ministry of defence permit. The project permits challenge is one that could deter some qualified investors, especially if the project involves land acquisition.

Change in law and dispute resolution provisions

Applicable law and dispute resolution provisions are of paramount importance, especially to PPPs. Though it is a generally accepted norm that the law of the host state governs the PPP contract, especially as it relates to a public utility or service, one specific aspect of the applicable law merits further consideration as it represents a significant challenge: that is, the Change in Law provision.

In its most recent version, the Change in Law provision entails an undertaking by the governmental entity to compensate the investor in the case of any materially adverse governmental action or change in law that would disturb the economic equilibrium of the PPP contract and potentially render the project commercially unfeasible.

This clause is of paramount importance for investors and project lenders participating in a PPP in a developing nation, as it is usual that such economies lack the stability needed for the duration of a project. In Egypt, such clauses are the subject of heated debate regarding their scope. This represents a challenge to the PPP and project finance market.

On a different note, dispute resolution clauses in PPP contracts are generally standard boilerplate clauses that ultimately refer the dispute to arbitration, usually in London, Paris or Geneva. Such clauses are generally mirrored throughout all project and finance documents to ensure uniformity and consistency.

In Egypt, the challenge presented by such dispute resolution clauses materialises in relation to the seat of arbitration and possibly, in some cases, the language of the proceedings. Generally, Egyptian governmental entities refuse to opt for arbitration abroad and in a foreign language, as this is considered a breach of sovereign rights as a matter of policy. This is certainly inconsistent with the project lenders' requirements, which usually entail arbitration in a neutral forum and in a foreign language (usually English). However, though such clauses are subject to extensive negotiations, it has become evident that Egyptian governmental entities have accepted the well-established international norm of arbitration as the prevailing dispute resolution mechanism for the settlement of project-related disputes. Recently, the Egyptian government has, in a number of projects, accepted a foreign seat of arbitration and a foreign language for the proceedings.

It is worth noting that Egypt possesses a solid potential to attract more and more private investors to undertake infrastructure, public utility and services projects in a manner that would maximise the benefits reaped under a PPP structure.

Nevertheless, it must be recognised that certain practical and legal challenges have arisen. It became vital to address such challenges in a manner that would align Egyptian PPP/project finance practices with well-established international practices and policies. However, a balance must be struck between global and local practices in a way that neither threatens the investors' appetite and the projects' bankability nor undermines the prevailing legal, political and social edifice of the Egyptian market.

In light of this, the following factors represent a recipe for the success of PPP projects in Egypt: (i) the provision of strong national and political support; (ii) the development of a comprehensive and adequate business case for each project; (iii) an in-depth analysis of associated risks and a proper allocation of risks among stakeholders; (iv) a well-structured, transparent and competitive procurement process; (v) a transformation of the prevailing project finance culture in Egypt in order to accept innovative solutions and explore new structures and options; (vi) the professional and efficient monitoring and development of value-for-money strategies by governmental entities; (vii) a simplification of the permitting and procedural framework; (viii) the training of governmental officials; (ix) the provision of an adequate legislative environment and the enactment of an appropriate PPP Law in light of international practice and with the proper adaptation to positive local conditions; and (x) the development of a comprehensive project database allowing the critical evaluation of existing precedents.

Author biography

Dr Mohamed S Abdel Wahab

Shalakany Law Office

Dr Abdel Wahab is an assistant professor in the department of private international law, Cairo University, Egypt, and holds a number of visiting posts in Egypt and abroad. Abdel Wahab is a partner in and co-head of Shalakany Law Office's project finance/PPP and arbitration groups and is the vice-chairman of the Chartered Institute of Arbitrators (Cairo Branch). He is also a legal adviser to the board of the Cairo Regional Centre for International Commercial Arbitration and a consultant for international legal affairs to the Information Technology Industry Development Agency at the Ministry of Communications and Information Technology. Moreover, Abdel Wahab is an adjunct professor and faculty coordinator for the Indiana University LLM programme at Cairo University.

Abdel Wahab has developed extensive expertise in project finance and public private partnerships, as well as international commercial arbitration, where he has acted for both the Egyptian government and foreign investors.

Abdel Wahab is a member of the United Nations Expert Group on Online Dispute Resolution and holds over 45 prizes for academic achievement. He acts as legal counsel on a number of large project finance transactions handled by the firm and has participated in drafting the Arabic version of the UNIDROIT Principles of International Commercial Contracts.

Abdel Wahab is a regular speaker at national and international conferences and is also a founding member of the Egyptian Arbitration Forum and the Egyptian ADR Association. He is an active member of several legal and professional organisations and associations, including the British Institute of International and Comparative Law, the Honourable Society of the Inner Temple, the Chartered Institute of Arbitrators, the International Law Association, the Association of Internet Researchers, the Socio-Legal Studies Association, the Society of Legal Scholars, the Internet Society Researcher, as well as being an associate fellow of the Society of Advanced Legal Studies.

Tel: +202 27288888
Email: mohamed.wahab@shalakany.com