Public-Private Partnerships in Brazil: Opportunities and Risks for Investors.

• efficient implementation of governmental programs and use of public resources;
• respect for the rights of private firms contracted to provide services as well as those of the end-users of the services;
• non-delegability of the government's regulatory powers;
• fiscal responsibility;
• transparency in decision-making procedures;
• fair allocation of risk between the parties; and
• financial sustainability of specific projects².

The statute is intended to avoid some of the downsides of traditional concession arrangements. In the past, a private concessionaire constructed and/or operated a public facility and was compensated by either of two methods: (i) fixed government payments or (ii) a percentage of (or all of) the concession's revenues collected from end-users³. Rarely was there a combination of both payment methods. The basic problem with such arrangements was that one party assumed the entire financial risk. In instances where the public sector paid the entire bill, limited budgets often prevented necessary investments. On the other hand, private investors were often unwilling to assume the financial risks inherent in relying exclusively on user tariffs for a return on their investments. The PPP model reduces the risk of both methods by combining them, at least in the case of "sponsored" concessions (see below). Neither the public nor private sector need assume the full cost and risk of the project. If, for example, half the project's costs are covered by guaranteed, fixed government payments, the investor's overall investment risk is reduced, and a greater portion of user tariffs may be counted as profits. The guaranteed payments attract private investment, enabling the public sector to undertake projects it could otherwise not afford.

Of course, the objective risk of the project is not reduced; it is simply apportioned between the public and private sectors, thereby effectively reducing their respective shares of that risk.

Applicability and Limitations

The PPP law applies to, and distinguishes between, two types of concessions: "sponsored" and "administrative". "Sponsored" concessions involve a private concession to construct public works and/or provide public services, in which the concessionaire will receive a portion of revenues from user tariffs, in addition to receiving guaranteed payments from the government⁴. For example, in a concession for the construction and/or administration of a roadway, the private concessionaire will receive a percentage of toll revenues, as well as fixed payments from the government to supplement those revenues. Should revenues fall short of expectations, the private concessionaire will at least be able to count on fixed payments to recoup part of its investment. Government payments in these "sponsored" concessions cannot exceed 70% of the total remuneration to the private concessionaire, unless a higher percentage is expressly authorized by law for a specific project.

In contrast, an "administrative" concession is one in which the private concessionaire provides services to the government and receives only fixed government payments, even if that concession incidentally involves constructing a public facility⁵. For example, in a concession for the construction and/or management of a prison facility or a low-income health clinic, the private concessionaire cannot rely on a sufficient revenue stream from inmates or indigent patients, and will depend entirely on government payments.

Both "sponsored" and "administrative" concessions are also regulated by Law 8,987 of February 13, 1995, the General Concessions Law. The PPP law does not apply to "ordinary" concessions, or those in which the government makes no payments to the private concessionaire, meaning that the private concessionaire's only source of income is the revenue stream from the end-users of the services or facility⁶. These "ordinary" concessions continue to be regulated by the General Concessions Law⁷.

In this sense, the "sponsored" concession is the more innovative form of concession, since the project's risk is apportioned between the public and private sectors, and the payments to the private concessionaire are apportioned between the government and end-users. On the other hand, both "administrative" and "ordinary" concessions follow the two traditional methods of compensation described above (i.e. fixed payments or revenue sharing). The fixed payments from the government in "administrative" concessions may, of course, be made on a periodic or lump-sum basis, either throughout or at the end of the concession's term, respectively.

The aggregate value of government payments made on all PPP contracts cannot exceed 1% of net tax revenues per fiscal year. More specifically, the federal government cannot even enter into a new PPP contract if the aggregate value of its payments on PPP contracts signed in the previous fiscal year exceeds 1% of the current fiscal year's net revenues or if the required annual payments over the next ten fiscal years exceed 1% of the projected net revenues for those respective years⁸. A PPP contract must have a minimum value of 20,000,000 Brazilian Reais and a term of between five and thirty-five years, including all extensions of the term (see below)⁹.

The Partnerships' Structure - the Special Purpose Vehicle

In the past, the arrangement between the public and private sectors was a purely arm's length contractual relationship. Under the PPP regime, the private concessionaire and the government are partners, potentially co-shareholders of a legal entity that will manage a facility, in addition to constructing, modernizing or expanding it, as the case may be¹⁰. Prior to the signing of any contract, a Special Purpose Vehicle ("SPV") must be created to manage and implement the project. The SPV may take the form of a publicly-traded company (Sociedade Anônima in Brazil) and must comply with all regulations relating to corporate governance and accounting standards¹¹. Under normal circumstances, the private concessionaire will hold the majority of the SPV's voting capital¹². There are, however, two situations in which either a lender or the government may "step-in" and take control of the SPV. Both involve the private concessionaire's default.

The first situation is the private concessionaire's default on a loan agreement (with either a private financial institution or one controlled by the Brazilian government), in which case the lender may "step-in" and acquire majority control¹³. This right, granted to a lender, is a classic "step-in" right, since it is enforceable upon the private concessionaire's default. Article 5, §2 of the statute permits the inclusion of a contractual clause that will specify the conditions under which the government can authorize a transfer of a majority stake in the SPV to a lender when the private concessionaire encounters financial or performance problems. This type of clause will be included to allow for a rescheduling of the SPV's debts or to ensure the performance of the contract. The lender will, in any event, most likely have a provision in the loan agreement that governs its "step-in" rights. The PPP statute merely grants the government some control over the circumstances in which the lender can exercise its rights vis-à-vis the private borrower.

A second situation is one in which the government intervenes in the concession and assumes control of the SPV in order to assure the adequacy of the public services, as is also authorized by the General Concessions Law. By way of example, this may occur when the private concessionaire defaults on a loan and/or mismanages the project to the extent that it affects its profitability or liquidity¹⁴.

The private concessionaire's controlling interest in the SPV is not freely alienable. The private concessionaire cannot sell a majority stake (presumably to an unrelated private third party) without the express authorization of the government¹⁵.

Understandably, the government desires to retain at least some control over who is ultimately responsible for the project. Both the pre-bid documents and the contract may govern the conditions under which a controlling interest may be transferred, outside the default and "step-in" provisions¹⁶.

Although the SPV will technically be the owner of the facilities during the term of the concession, title to the facilities will revert to the government at the conclusion of the concession (which can be no longer than thirty-five years).

No more than 70% of the SPV's "funding sources" (fontes de recursos financeiros) can come from the public sector¹⁷. Funding sources are defined as loans and capital contributions to the SPV¹⁸. If private pension funds and/or state-owned companies are included among the funding sources, this limit is raised to 80%¹⁹. Both the 70% and 80% limits can be raised to 80% and 90%, respectively, when the project takes place in underdeveloped regions of Brazil not normally attractive to private investors²⁰.

The Brazilian National Monetary Council will issue comprehensive guidelines for private lending to PPP projects, from both banks and private pension funds²¹. The Secretariat of the Brazilian National Treasury will issue guidelines for the consolidation of public accounts spent on PPP projects, for the purpose of compliance with the 1% budgetary limits (see above)²².

The Regulatory Framework - The Management Committee (CGP)

The PPP law delegated the drafting of detailed regulations governing the program to the PPP Management Committee (Comitê Gestor de Parceria Público-Privada or CGP). Created by presidential decree on March 4, 2005, the CGP will be comprised of one representative each (a permanent representative and his/her alternate) from the Ministry of Planning, the Ministry of Finance, and the President's Chief of Staff²³. The representative of the Ministry of Planning will serve as the Chair²⁴. The CGP will meet at least once per month, or as frequently as meetings are called by the Chair. A representative from the ministry or agency sponsoring a project (hereinafter referred to as the "sponsoring ministry") must be present and must participate in any meeting at which the CGP will analyze that project²⁵. The Decree does not specify whether these non-member participants have a vote at these meetings. The Chair may also request that representatives from another government ministry or agency, or of the private sector, participate in the meeting, although these participants will have no vote²⁶. The CGP can also create temporary special commissions, for the purpose of evaluating specific projects, and can request that government or private-sector personnel participate in these commissions as well²⁷.

The CGP will promulgate its own internal regulations and issue its decisions in the form of resolutions. When circumstances warrant, the Chair may analyze issues independently of other CGP members, but must present such issues to the full CGP at the next scheduled meeting²⁸. Sponsoring ministries wishing to undertake projects must submit their requests to the CGP for its approval. These requests must be accompanied by (i) a report from the Ministry of Planning attesting to the project's merit, and (ii) a report from the Finance Ministry confirming that the project's costs will not exceed the 1% budgetary limits²⁹. Although the sponsoring ministry will draft the pre-bid documents and the contract to be signed, the CGP will verify that these documents comply with the requirements of the PPP statute and with any further requirements that the CGP may issue in the future³⁰. Unanimity of the CGP's voting members is required for the opening of a bidding process, the approval of pre-bid documents (Editais), and the signing of all contracts³¹.

Every six months, the CGP will report to the various sponsoring ministries regarding the progress of active PPP projects administered by them or falling within their respective areas of regulatory jurisdiction³². The CGP will file similar progress reports annually with the Brazilian Congress and with the Brazilian Federal Court of Claims³³. If necessary to prepare these reports, the CGP has the authority to requisition documentation regarding the performance of PPP contracts from the private parties or sponsoring ministries that are signatories thereto³⁴. The CGP must also approve the overall PPP Plan and define priority sectors for PPP projects³⁵. As mentioned, the immediate focus will be transportation infrastructure critical to exports (ports, railroads, etc.).

The CGP's two administrative arms will be the Technical Commission and the Executive Secretariat. The Technical Commission will do the GCP's "real work" of defining priority sectors and studying PPP projects in detail. It will issue detailed recommendations as to pre-bid procedures and as to criteria for the approval of Editais and contracts³⁶. Similar to the plenary CGP, the Technical Commission will have representatives from the Ministries of Planning and Finance, and the President's Chief of Staff, although there will be two representatives (two permanent and two alternate) from each. Also serving on the Technical Commission will be one representative each (a permanent and an alternate) from the Ministries of Development, Industry and Foreign Trade, Transportation, Mines and Energy, National Integration, and the Environment, as well as a representative from the BNDES, the Banco do Brasil and the Caixa Econômica Federal³⁷. As with the plenary CGP, the Technical Commission will be chaired by its representative from the Ministry of Planning³⁸. It may also solicit the input of other government agencies or the private sector to assist in analyzing projects³⁹. A sponsoring ministry, if not one of these standing members of the Technical Commission, must also be represented in meetings analyzing contracts administered by that sponsoring ministry⁴⁰. The CGP Decree leaves unclear the voting powers of these additional participants.

A bureau of the Ministry of Planning, called the Economic Council (Assessoria Econômica), will serve as the CGP's Executive Secretariat. The Executive Secretariat will fulfill basic administrative and clerical functions such as scheduling the CGP's and the Technical Commission's meetings and drafting their reports on the performance of contracts⁴¹. Most importantly, the Executive Secretariat serves as the liaison between the Technical Commission and the sponsoring ministries submitting their proposed projects for the Commission's consideration. The Executive Secretariat also monitors parties' compliance with the CGP's guidelines, although it is the Technical Commission that establishes the form and content of the periodic reports on the progress of contracts⁴².

The CGP also regulates the crossover between PPP's and the Brazilian privatization program. If a PPP project is needed in addition to or in support of a privatized service or asset, the ministry or agency overseeing that specific privatization is authorized to submit the project to the CGP⁴³. If approved, the project will be governed by both the PPP legislation and the regulations of the privatization program⁴⁴.

The Guarantee Fund

To ensure government payments under PPP contracts, a guarantee fund (Fundo Garantidor de Parcerias Público-Privadas - FGP) has been created. The federal government, either directly or through independent agencies or public foundations, is authorized to contribute up to six billion Reais to the fund⁴⁵.

The FGP's assets are dedicated specifically to the PPP program, and cannot be used for general public spending. Although the FGP is technically a "private" entity, the PPP statute mandated that it be managed by a financial institution controlled by the Brazilian federal government, which will also have the authority to represent it in legal proceedings⁴⁶. The government has selected Banco do Brasil to manage the FGP⁴⁷. To fulfill this role, Banco do Brasil has created a subsidiary, Banco do Brasil Distribuidora de Títulos e Valores Mobiliários (BBDTVM)⁴⁸. As per the PPP statute, BBDTVM will now be responsible for the profitability and liquidity of the FGP's assets⁴⁹.

Like any private company, the FGP will approve its by-laws and internal regulations at shareholders' meetings⁵⁰. Capital contributions to the FGP may be made in the form of cash, government bonds, real property or personal property, including the shares of government-owned companies⁵¹. As of September 2005, the FGP's capital contributions consist of shares of fifteen blue-chip Brazilian companies, among which are Embraer, Petrobrás, Usiminas, Banco do Brasil and Companhia Vale do Rio Doce⁵². The FGP's guarantees are issued proportionally to each shareholder's respective shareholding percentage and shareholders' liability for the FGP's aggregate guarantee obligations is limited to the amount of their capital contributions⁵³. The FGP will not pay profits to its shareholders, but guarantees them the right to withdraw their entire shareholding investment, up to the limits of the amounts not already encumbered to honor guarantees⁵⁴. The shareholders, by vote at a meeting, may dissolve the FGP, but only when all of the fund's guarantee obligations have either been paid to, or waived by, PPP creditors⁵⁵. The FGP's assets, if any remain, will then be distributed to shareholders proportionally to their shareholding interests as of the date of dissolution⁵⁶. Of course, the FGP may not issue guarantees that, in the aggregate, exceed its total available assets⁵⁷. The FGP may set aside certain assets specifically earmarked for certain projects - known as "waterfall accounts" - which cannot be encumbered to satisfy the fund's general obligations⁵⁸. These earmarked assets, if real estate, must be registered in the local Real Estate Registry or, if assets other than real property, in the local Cartório⁵⁹.

The FGP may issue the following types of guarantees:

• surety bonds;
• pledges of personal property or of an interest in the FGP's assets, although the beneficiary cannot take possession of such property until after an enforcement action;
• mortgages on real property owned by the FGP;
• placing assets in trust for the beneficiary, although, again, the beneficiary cannot take possession of such assets until after an enforcement action;
• other contracts that serve as guarantees, provided that they too do not transfer title or direct possession until after an enforcement action; and/or
• personal or secured guarantees, secured by specifically earmarked assets of the FGP⁶⁰.

It is anticipated that surety bonds will be the most common guarantee issued by the FGP⁶¹.

Except as otherwise provided in the contract, the private concessionaire may bring an action to enforce the guarantee (i) 45 days after a payment is past due on a bill submitted to, and accepted by, the sponsoring ministry⁶²; or (ii) 90 days after a payment is past due on a bill submitted to, and not expressly rejected by, the sponsoring ministry. The FGP must then make payment to the private concessionaire within fifteen days⁶³. If the FGP itself does not honor its guarantee, the private concessionaire may encumber the FGP's own assets to satisfy the obligation⁶⁴. Once the FGP has honored a guarantee and paid the private concessionaire, it will acquire subrogation rights against the sponsoring ministry⁶⁵.

The Process -the Edital and Bidding Documents

Before a project is authorized to solicit bids, the sponsoring ministry must undertake a "technical study" of the pros and cons of using the PPP regime⁶⁶. Essentially, in order to qualify for PPP status, the technical study must demonstrate that a PPP is the most efficient method for the undertaking and that it will comply with applicable fiscal and budgetary regulations⁶⁷. This technical study is an internal one, conducted by the sponsoring ministry, separate and in addition to the certification of merit from the Planning Ministry and the budgetary green light a project receives from the Finance Ministry, both of which are also prerequisites for CGP consideration (see above).

Similar to a Request for Proposals (RFP) in United States public-sector procurement, the Edital in Brazilian law is the basic pre-bid document containing the terms and conditions of a concession or other government contract. The PPP statute leaves many details regarding the selection of bidders to the discretion to the sponsoring ministry. These details, as well as provisions related to optional contract clauses (see below), must be specified in the Edital. While the CGP sets the overall rules for the bidding process, the sponsoring ministry prepares the Edital and submits it for the CGP's review and approval, as noted above. The sponsoring ministry then conducts the bidding process, evaluates proposals and selects the private concessionaire. The sponsoring ministry, not the CGP, is the public-sector signatory to the contract and is accordingly responsible for making periodic payments and monitoring the private concessionaire's performance during the contract's term⁶⁸. The sponsoring ministry must send to the CGP a semi-annual report on the progress of the contract and the project. This report, in turn, is incorporated into the CGP's annual reports on all PPP contracts made to the Brazilian Congress and the Federal Court of Claims (see above)⁶⁹.

Prior to the bidding process, a draft of the Edital, along with a preliminary draft of the contract to be signed, must be published (i) in an official government publication, (ii) in major daily newspapers and (iii) on government websites⁷⁰. A period of at least thirty days for public comment will follow publication⁷¹. Seven days after the closure of the public comment period, the final Edital may be published⁷². The draft Edital must identify the main points of the project, including term, estimated value and scope of work73. The final Edital will include a final draft of the contract for the review of prospective bidders.

The Process - Evaluation Criteria

The sponsoring ministry may require pre-qualification of bidders as to their technical ability to perform the work and may evaluate proposals based on (i) price alone; or (ii) a combination of price and technical ability, according to a weighted scale of factors delineated in the Edital⁷⁴. The Edital may permit bidders to amend their proposals or correct pro-forma errors therein, up to the submission deadline⁷⁵. The Edital may also require the bidder(s) to post a bid bond and to submit disputes to arbitration or other means of alternate dispute resolution⁷⁶.

The Contract - Required Clauses

While many details of the contracts are yet to be defined by the CGP's regulations, the PPP statute itself specifies several clauses that are required in every PPP contract. In addition to the contractual clauses mandatorily included in any concession agreement in Brazil, PPP agreements require clauses pertaining to the following:

• a term of between five and thirty-five years;
• penalties applicable to both parties for non-performance and default;
• allocation of risks among the parties, including provisions as to Acts of God, Force Majeure, Acts of State, and extraordinary economic risks;
• the means of payment and of indexing (i.e. increasing) contract prices and tariffs to compensate for inflation;
• the means by which the levels of quality and modernity of the services will be maintained;
• the terms that define default by the government on its payments, the means and timeframe for cure of such default and the means by which the private concessionaire may enforce its rights;
• objective criteria for evaluation of the private concessionaire's performance;
• performance guarantees by the private concessionaire, proportional to the risks involved in the undertaking;
• a sharing with the government of the financial gains realized by the private concessionaire as a result of reduced credit risks; and
• a provision authorizing the government to inspect assets that will revert to its possession and ownership, and authorizing the government to withhold payments in the amount proportional to damages to such assets⁷⁷.

The Contract- Optional Clauses

The PPP law permits, but does not require, the following provisions to be included in a contract:

• the terms under which the government may authorize the transfer of a controlling interest in the SPV to lenders (see above);
• creation of a budgetary payment reserve to cover the government's payment obligations; and
• indemnification of the private concessionaire for the early termination of the contract⁷⁸.

There are several means by which the government can effectuate its payments to the private partner:

• cash payments;
• assignment of credits (other than tax credits);
• grant of rights vis-à-vis the federal government
• grant of rights over government assets; and
• other means permitted by law⁷⁹.

The contract itself may also include provisions guaranteeing the government's payments. These payment guarantees should not be confused with the guarantees provided by the FGP; they are made by the sponsoring ministry itself, as assurances of its obligation to compensate the private concessionaire. These guarantees can take the following forms:

• assignment of the project's revenue stream directly to the private partner;
• establishment of "special funds", provided for by law, or use of existing special funds;
• payment bonds issued by private insurers;
• guarantees issued by international organizations or financial institutions not affiliated with or controlled by the government;
• guarantees issued by a guarantee fund or state-owned company created for this specific purpose; and
• other means permitted by law⁸⁰.

The government may not pre-pay for any services called for in the contract, but may make periodic progress payments, as certain services, or portions thereof, become available⁸¹. As an example, on a concession to operate a port facility for thirty years, the government may make monthly payments for services rendered each month. As another example, on a project to build or modernize ten piers at that port facility, the government cannot make any payments upon the signing of the contract and before work starts but may make periodic progress payments proportionate to the five piers completed mid-way through the contract. A private concessionaire can also earn extra, merit-based compensation, that is, the contract may provide for variable payments tied to performance⁸².

Prognosis

A major force behind the PPP legislation was former Planning Minister and current BNDES President Guido Mantega. During his term as Planning Minister, he introduced the draft statute to the Brazilian Congress in November 2003 and was President Lula's principal lobbyist for its passage. As BNDES President, he will administer the principal government lender to PPP projects. Of the twenty-three projects on the government's "wish list" through 2007, five are now considered top priorities: (i) the North-South Railway; (ii) the São Paulo Railway Ring (Ferroanel); (iii) the rail connection to the Port of Paranaguá; (iv) the BR-116/BR-324 highway; and (v) the "ring road" around Rio de Janeiro⁸³. Mantega believes that Brazil will have the advantage of learning from the experiences of other countries that have implemented similar PPP programs and will be able to avoid their mistakes. Examples of such mistakes are the eighteen-month delay in commencing the first project in the United Kingdom after passage of British PPP legislation and the huge cost overruns that plagued Portugal's transportation projects⁸⁴.

An obvious shortcoming of the PPP legislation is the relatively small financial commitment made to the FGP⁸⁵. Considering the scale of infrastructure projects needed throughout Brazil, a limit of six billion Reais seems insufficient. To date, only 4.2 billion Reais of that limit have been contributed to the FGP. It is possible, however, that the success of early projects may attract additional, private capital to the FGP.

Finally, much of the Lula administration's economic development agenda remains stalled due to the continuing congressional investigation into the governing Workers' Party corruption scandal. While the investigation had delayed, for several months, the regulation and capitalization of the FGP, the stage is now set for the implementation of much-needed improvements to Brazil's physical infrastructure. It is anticipated that the Editais for the first several projects will be issued in early 2006⁸⁶. As the projects progress, we will be able to observe and evaluate the effectiveness of Brazil's PPP legislation.

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¹Law 11,079 of December 30, 2004, art. 1, available at www.senado.gov.br or at https://www6.senado.gov.br/sicon/PreparaPesquisaLegislacao.action.

²Id. at art. 4.

³Note that, under traditional concession arrangements, fixed government payments were due to a private concessionaire within thirty days after completion of construction services, when the services had been procured via competitive bidding.