Adapting DBFMO contracts in court

This article was originally published in the September 2016 issue of Project Finance International.

On July 6 2016, financial close was achieved in respect of the project financing of the new district courthouse of Amsterdam, which will be realised via a public-private partnership (PPP). This is the fifth PPP accommodation project to reach financial close in the last two years, which is an example of the steady and continuous pipeline of PPP projects in the Netherlands.

The contracting authority for this project, the Central Government Real Estate Agency (Rijksvastgoedbedrijf), awarded the DBFMO contract for this project after a tender based on a competitive dialogue to the NACH¹ consortium consisting of Macquarie Capital, ABT, DVP, KAAN Architecten, BiUM and Bouwbedrijf MJ de Nijs & Zonen, in collaboration with Heijmans and Facilicom. Under the DBFMO contract, NACH undertakes to design, build, finance, maintain and operate the new building over a period of more than 30 years.

Project finance

As with all recent PPP projects, the project will be financed through a special purpose company (SPC) that will be the counterparty to the contracting authority. Through this SPC a syndicate of lenders will provide a financing of over €300m that will be made available during the course of the project in accordance with a drawdown schedule that has been tailored to fit the expected expenditure from time to time in order to limit financing costs for the consortium.

For this project, the equity of the SPC has been provided by an investment bank, Macquarie Capital, instead of, as has been customary until now, by the building companies that form part of the bidding consortium. This equity will be provided in the form of debt subordinated to the financing provided by the financing banks.

During the construction phase, the financing will be provided by international banks Sumitomo Mitsui Banking Corporation and MUFG. The construction phase carries the highest risk for lenders as repayment of the financing is dependent on the cashflow that the project will generate following completion.

As is typical for any PPP project, the financing is structured to limit the risk to the financing banks by means of a combination of security provided over the assets of the SPC, including routing of all cashflow through one of the banks, contractual information and consent rights towards the consortium and step-in rights in respect of the DBFMO contract and subcontracts to enable the lenders to safeguard the successful completion of the construction phase and continuation of the project.

After completion of the construction phase, the funding for the operating phase will be provided by Nederlandse Waterschapsbank NV, refinancing the loans of the two banks. In addition, a group of insurance investment companies represented by MEAG Munich Ergo AssetManagement GmbH will provide term loan financing through the entire duration, including construction, of the project.

Standardised contract

The DBFMO contract for the new courthouse is based on the standardised DBFMO agreement, version 4.1. The standardised DBFMO agreement has been developed over the course of the past seven years², during which period several consultation rounds took place between the contracting authority and the construction companies, lenders and investors that are active in the Dutch market.

The fact that the standardised DBFMO agreement is used as the basis for PPP accommodation projects means that the parties involved – contracting authority, bidding consortia and financiers – have security upfront on the material provisions of the DBFMO agreement.

Due to the standardisation in place, bidding consortia are aware – even before they enter a tender – what in general terms the risk allocation between the parties will be, how the payment mechanism shall work and how delay events, compensation events and force majeure events can impact planning and budget.

This upfront security has a positive impact on the success of the tender procedure. Experiences from earlier projects have been fed into the standardised DBFMO agreement to keep it concrete and up-to-date. However, as with all standardisations, one has to be careful that project specifics are not overlooked or underestimated.

The use of the standardised DBFMO agreement should not prevent the possibility to discuss project specific aspects that require an amendment to the standardised DBFMO agreement. In our experience this is not the case. During the dialogue sessions between the contracting authority and the bidding consortia, the use of the standardised DBFMO agreement provides the ability to focus the discussions on those specific items, ensuring that the DBFMO agreement is tailored to the needs of the specific project.

Tailored to project specifics

The project specifics for the new district courthouse of Amsterdam are as follows. The project comprises the development of an area of approximately 60,000m2. As such, the project is one of the largest PPP accommodation projects in the Dutch market. About 19,000m2 of this area is specifically allocated to the district court’s core business, for example courtrooms, interrogation rooms and a reception area.

Furthermore, the area consists of 25,000m2 office space, 9,000m2 of parking space, and a 7,000m2 so called “strategic reserve”. The strategic reserve is an integrated part of the design of the building, but this part of the building will not be realised until there is a need for such extra space in the future. This reserve is therefore part of the scope of works for the project, meaning that the consortium is required to take the reserve into account in the design and the construction of the building. This was a requirement from the contracting authority in order to ensure that the strategic reserve can be “easily” realised in the future.

An interesting aspect of this particular project is that even prior to achieving financial close, the first phase of the project had already commenced. This initial phase consisted of demolition works to make room for and to construct a temporary courthouse. This part of the project falls outside the scope of the DBFMO contract. A separate tender was called in relation to the demolition works and subsequent construction works for the temporary location. This tender was won by the DPCP consortium³ on the basis of a DBMR contract⁴.

Once the relocation from the old courthouse to the temporary courthouse is completed, NACH will start with its own demolition works of part of the old courthouse. The old courthouse consists of six towers – Towers A through F – of which Towers E and F will remain intact. Towers A, B, C and D will be demolished and the new courthouse will be realised on these towers’ current location. The intended timeframe is to start demolition and preparatory construction works in January 2017 and construction in August 2017. Availability of the new district courthouse is scheduled for September 2020.

A particular risk that comes into play when the scope of works involves demolition is the possibility of asbestos being present in the building. In the event that asbestos may be present in a building or an object, rules and regulations apply that determine quite strictly which actions have to be undertaken. One of these actions includes the obligation to carry out an asbestos survey prior to demolition. Although for certain types of asbestos there is no risk when it is present in a building, construction or demolition works could cause the asbestos to become exposed.

If the asbestos is exposed over a longer period in time there is a risk that asbestos fibres could be inhaled and this can lead to life-threatening illnesses. To avoid these health risks, it is detrimental that asbestos is detected upfront and removed in accordance with the applicable rules and regulations. This will require – among others – the removal of the asbestos by a certified company and/or the requirement to notify the competent authorities of the demolition works.

If asbestos is present at a location, it is imperative that the removal process is carefully factored in the construction planning with the necessary time buffers to be able to deal with asbestos that might be present at the location.

Another risk that should be considered when demolition is part of the scope of work, is the possibility of unexpected obstacles that are present underground. When these obstacles, such as piling, are not foreseen, they can have an impact on timing and costs and can have an overall significant impact on the progress of the construction works.

Specific risk allocation

Given the project specifics described above, one of the standardised provisions in the DBFMO agreement became increasingly important, being the risk allocation between the consortium and the contracting authority regarding the presence of unforeseen asbestos and unexpected obstacles in the underground.

This risk allocation illustrates a key difference between the standardised DBFM (used in PPP motorway and PPP lock projects) and the DBFMO agreement as used by the Dutch government. In both agreements, a definition for Supplied Information (Verstrekte Gegevens) is included.

The Supplied Information is information that is supplied by the contracting authority in relation to the location where the project will be realised and can include, for example, explosives surveys, soil surveys or reports on the cables and conduits that are present underground. The contractor will have to take this information into account when designing, planning and pricing the project. The key difference between the standardised DBFM and DBFMO agreements is that under the DBFMO agreement a deviation from the Supplied Information or certain occurrences that were not included in the Supplied Information are included as a compensation event. This is not included in the standardised DBFM agreement.

When a particular event or situation is labelled as a compensation event, and such an event or situation occurs, then the financial loss incurred by the contractor as a result thereof will be compensated by the contracting authority. The compensation includes – among others – the additional capex, delay costs (in relation to the financing agreements such as commitment fees, agency fees, interest on principal) and a market conform surcharge on general costs. Therefore, if certain unforeseen events or situations occur, which could not have been derived from the Supplied Information, it will be the contracting authority who will bear the risk.

Back-to-back principle

In the tradition of DBFM(O) agreements, the consortium will pass down all its obligations relating to the design, build, maintenance and operation (DBMO) of the building down to a subcontractor, in this case the DBMO contractor. This is well-known in the Dutch PPP market as the “back-to-back principle”. Under this principle, all obligations and risks the consortium has under the DBFMO agreement (save for the financing obligations) will be borne by the DBMO contractor. In addition, any rights the consortium has or any relief of obligations it receives under the DBFMO agreement will also be passed down. Therefore, the aforementioned system of compensation events will also benefit the subcontractor.

Focus on the future

As said, the financial close of the district courthouse in Amsterdam meant that the fifth PPP accommodation project in the past two years can commence. An impressive feat in itself. The Dutch PPP pipeline provides in the short term just for one more, larger, PPP accommodation project, being the Michiel Adriaanszoon de Ruyter Naval Barracks at Vlissingen.

The focus of the PPP projects in the coming year will be more on the motorway and lock projects. The Blankenburgtunnel, the expansion of the A13/A16 motorways and the renovation of the Afsluitdijk are under way. Therefore, the Dutch PPP pipeline still provides for many more interesting projects for investors, construction companies and financing institutions to get involved in.