India: Greenfield Airports In India – A Case Study Of The Bangalore International Airport

Last Updated: 21 July 2008
Article by Sumeet Kachwaha

*Transcript of talk delivered by Sumeet Kachwaha at the Inter Pacific Bar Association Annual Conference; Beijing, 2007.

Introduction and background:

When one looks at the current huzzle and buzzle around privatization of infrastructure in India, it is difficult to imagine that just about six years back, privatization was virtually unknown in India. The story started with the Road sector in the late 1990's but that too initially was not under the BOT Model. The project was funded by the Government through a 1% cess on diesel. Infrastructure bonds were floated where the Public Sector Corporations invested. It was only in this millennium that privatization, as properly understood was adopted as a Government policy.

Why privatize?

Look at the Airport sector alone. This sector has witnessed a growth of 35% on an average year upon year for the last six years (global growth is only about 9% per annum). The growth is fuelled by the robust economy and indeed infrastructure leads to economic growth thus completing the cycle. It is estimated that had the infrastructural gap not been there, India's GDP would have been 2% higher per annum - and indeed would have been at about par with the phenomenal growth China has achieved.

Currently the airport infrastructure is totally inadequate. It is fairly common for flights to hover around airports due to congestion, waiting to get landing permission or waiting at the ground in the queue to take off. To give an idea of infrastructure gap, the Delhi Airport as of now has a capacity to handle 12 million passengers per annum but it is actually carrying 16.5 million passengers per annum, which is expected to grow to 20 million passengers by next year.

Airport modernization is therefore some thing which we could have done with as of yesterday. The Government cannot cope up with the demand - and hence privatization is necessary.

Snap shot of the future:

We have two "green field" airport projects where the concession agreements have already been signed. These are for the international airports at Bangalore and Hyderabad, expected to be completed next year. We have two "brown field" airport projects for Delhi and Mumbai to be completed by 2010. We are in the process of inviting bids for 6 more green field airports in metro cities and 35 brown field airports in the non-metro cities. So one can see what a happening sector this is currently in India.

The Bangalore International Airport:

In this talk, I propose to take up the Bangalore green field airport which was signed off by India in July 2004 as the model for our discussion. In fact the next concession agreement for Hyderabad which was entered into six months later was virtually on the same lines and these two are the only green field concession agreements signed so far. There is no "Model Concession Agreement" announced by the Government for future projects (though it is proposed to come out with one some time in the future).

Structuring:

Though the concessionaire for the Bangalore airport is a private limited company, the Government through its agencies and instrumentalities holds 26% shareholding – (the break up being 13% by the Central Government and 13% by the State Government). This 26% shareholding ensures that the Government is able to veto certain "fundamental resolutions" which as per the Indian Companies Act require a minimum of 75% shareholders vote. For instance, issuance of new shares; change of directors; change of auditors etc. all require at least 75% shareholders vote. Hence the Government does retain some sort of control in the venture. Amongst the private players in Bangalore airport, Siemens of Germany have the majority 40%. Zurich airport holds 17%.

Description of the project:

Let me begin by briefly sketching salient features of the Bangalore Airport. The site is situated about 29 k.m. from Bangalore and covers about 4300 acres. The airport design allows a second runway to come up in the near future with a separation distance of about 2 k.m. between the two run ways. The run way would be approximately 4000 mtrs. in length with a width of 60 mtrs. The airport would be at par with a world class international airport.

A significant part of the project is permissible for "Non-Airport" activities. The concessionaire can develop up to 300 acres land commercially for any activity not connected with the airport. In this 300 acres the concessionaire is free to set up not only hotels or malls - it can even go for Special Economic Zones, manufacturing factories, country clubs, golf courses, power plant etc. Considering that this huge chunk of prime land comes to the concessionaire on a long term lease, virtually free of cost, it is easy to imagine that this would be the commercial backbone of the project.

Nature of the concession:

Basically the concession is for Development, Construction, Operation & Maintenance of the airport. The agreement allows the concessionaire to develop, construct, operate and maintain the Bangalore International Airport for a period of 30 years, extendable at its sole option for another 30 years (i.e. total 60 years). The land for the same is leased by the State Government.

The concessionaire has the burden to independently evaluate the scope of the project and be responsible for all risks which may exist in relation thereto. It is obliged to follow good industry practices and all applicable laws.

The Government on the other hand, undertakes to support the project. Article 5.4 of the concession agreement states that in so many words: ("GOI acknowledges and supports the implementation of the project"). It further states that the Government of India will not take any steps or action in contradiction with the Concession Agreement which results in or would results in its shareholders or the lenders being deprived or substantially deprived of their investment or economic interest in the project. Further all statutory and non-statutory bodies under the control of the Central Government will act in compliance with the concession agreement as if they are a party thereto and the Government of India shall ensure that all statutory compliances as may be required in relation to the project are granted promptly. This is a unique feature of the Airport concession agreements In fact the concession agreements in the Port sector or Road sector do not have similar obligations on the Government. The Concession Agreement also insulates the concessionaire against competition by stating that no new airport would be allowed to be set up within 150 k.m. radius for a period of 25 years from the date of airport opening and further the Government of India will ensure that no other airport in India gets any unfair competitive advantage as compared to the Bangalore airport. Again a unique feature to be found in the airport concession agreements alone.

Monitoring of the project:

It is provided that the Government shall not intervene in or interrupt in the design, construction, completion, commissioning, maintenance, monitoring or developing of the airport unless it is on account of national emergency or as per any existing law or for public safety. If intervention is on account of public safety, it shall be limited in time and for a period to be mutually agreed between the parties. The parties agree to set up a joint Co-ordination Committee comprising of representatives of the State and private parties to monitor the implementation of the project at all stages including post-completion.

The airport performance shall be monitored through passenger survey and as per the IATA Global Airport Monitoring survey standards.

Charges which can be levied:

As mentioned earlier the concessionaire is free to develop approximately 300 acres for non- airport activities (which indeed is to fund and finance the project). The charges here are not subject to Government control and will be free market driven. However Airport Charges i.e. which ultimately fall on the passengers shall be fixed with the approval of the Ministry of Civil Aviation. This would include passengers fees, landing charges, user development fees etc. These charges would be fixed on the basis of the current charges in place for other airports in India and shall be consistent with the International Civil Aviation Organisation's policies on charges for airports.

Heads of risks:

Before we get into an evaluation and allocation of risks let's just pause and see what is the nature of the contract. We are not looking at an ordinary construction contract. Airports are not mere place for aero-planes to land or take off. They involve public interest, convenience and safety. Besides construction of airport building, ATC tower, administrative buildings etc. they can encompasses mini-townships, commercial areas, Special Economic Zones (modeled on China's experience) and indeed manufacturing factories, golf course, country clubs etc. Therefore the project is both mammoth and diverse. Then we are not only looking at a mammoth and diverse project - we are looking at it over a period of 60 years!

How large is a period of 60 years in the life of a nation can perhaps be best illustrated if we consider that India was not even an independent nation 60 years back and indeed the history of civil aviation is probably not much more than 60 years. Unimaginable changes can and will take place in 60 years. So the public element; complexity and diversity of the project and the length of the concession agreement are all so vast, that it would be some what naïve to try and enumerate all risks associated with the project or indeed to try and address them through a contractual process of allocation of risks.

With this note of self – caution, I propose to briefly deal with allocation of risks in green-field airport privatization under the following 5 heads:

  1. delays and consequences of delay in the airport opening;
  2. change in law and the risks involved therein;
  3. termination of agreement due to default of either party;
  4. The role of the regulatory authority; and
  5. dispute resolution.

i. Delays:

The target date for airport opening is stipulated as 33 months from the date of financial closure and from this date (i.e. date of airport opening) the concession period is to start running. In other infrastructure sectors like Roads or Ports, the concession period starts to run from the date of signing of the concession agreement. This is the greatest incentive and at the same time coercive measure to ensure timely completion of the project. For example, if the concessionaire is able to complete the project even before the target date of opening, it gets its reward automatically in the form of the extra concession period it "earns" for itself and if he delays it, he eats into the concession period and therefore the profits. One would have thought this to be a fairly sensible approach of reward and punishment. However in the airport sector one finds the provision for delays to be rather soft on the concessionaire. Firstly the 33 months period for completion can be extended by as much as six months if it can be shown that the delay was on account of failure by Government of its obligations under the agreement (surely a very vague ground for extension, which if invoked would probably end up in dispute). After the six months extension liquidated damages kick in which are around US$ 2250 per day (once again a fairly nominal amount one would think considering the public interest involved in expediting the opening). Further, if for another six months the airport does not open then it becoming an "event of default", which has its own cure period etc. Finally – it will lead to termination of the contract. This gives easily up to 2 years or so to a defaulting concessionaire to extend the deadline without having the project cancelled on account of delay.

One would think that where the total time for opening is 33 months, to allow such a large period before termination is perhaps not justified.

ii. Change in law:

It is obvious that a concession agreement over a long period of time cannot guarantee against change of law. The concession agreement divides and treats the subject of change of law in two categories – the first is where a change in law entitles the concessionaire to some compensation and the second is where it does not entitle the concessionaire to any compensation.

The "no compensation" cases or case where the concessionaire is not entitled to any benefit on account of change in law are those which relate to any of the following 4 types of statutes.

  1. any non – Federal (or State) law
  2. any environmental law
  3. any labour law, or
  4. any tax law

Hence change of law under any of these statutes would not entail any compensation to the concessionaire for any loss which may be occasioned to it. In tax laws however there is a further refinement. If there is any tax benefit which is currently allowed to the concessionaire, it cannot be taken away by change of law without corresponding compensation. For instance, one benefit the infrastructure sector (including private airports) enjoy is a 10 year income tax holiday which can be availed of at any time during a 15 year period. Save for such current tax benefits, the Legislature is free to amend its tax laws to the detriment of the concessionaire and the concessionaire has no relief against the same.

As regards the second category laws i.e. other than the above four, it is envisaged that if there is any change of law, which results in a financial loss or burden in connection with the development or operation of the airport and the affect to which exceeds over US$ 200000 in any given year, then the concessionaire may notify the Government and propose amendments to the contract so as it is put in the same financial position it would have been, had there been no such change in law. If the parties do not agree to the amendments necessary, the matter would be settled through the Dispute Resolution Mechanism.

It would be noticed that this some what limited insulation against change in law is only in relation to "airport activities" and does not cover the "non-airport activities". More significantly it leaves it to the parties to hammer out an agreement as would suffice restitution. This is not very satisfactory, as typically Government bureaucrats are ill-suited and may be naturally reluctant to take upon themselves the delicate balancing act. There would be delays in decision making or decision making would not be free from controversy or it may be ad hoc and lack transparency and invariably it would be short of expectations. All this would lead to dispute. Perhaps a more efficient mechanism to deal with this may have been to set up Dispute Review Boards (DRBs) till such time as the Independent Regulator is in place.

iii. Termination of the agreement due to default:

The Agreement enumerates the "events" which would tantamount to "events of default" for either party. Once an event of default (as defined) takes place, a 120 days cure, period is stipulated in the first instance. If there is no cure a notice of termination may follow. Once notice of termination is issued, two consequences would follow: (i) Government would acquire the airport and all rights, interest and titles of the concessionaire relating thereto, and (ii) have the option to acquire and take over the non – airport activities. It is to be noted that the airport would be taken over even though the termination may be due to the Government's own default.

After take over of airport comes the issue of compensation. If it is the concessionaire's default then the only compensation allowed to it is: (i) 100% of the outstanding debt and (ii) value of investment of the concessionaire in the non-airport activities taken over by the Government consequent upon take over.

If on the other hand, it is a Government's default (and yet the airport is taken over) then the compensation is more liberal. It includes: (i) the outstanding debt or "Settlement Amount" (as defined) whichever is higher. Settlement Amount would include the net current asset; gross fixed asset; intangible asset etc. (ii) value of investment in the non - airport activities which the Government decides to take over and (iii) damages.

iv. Role of Regulatory Authorities:

In infrastructure projects involving the public an independent regulatory authority has become necessary. Accordingly the Concession Agreement envisages that an Independent Regulatory Authority would be set up to regulate any aspect of the airport activity. Very vast powers are envisaged to be cast upon the Regulator. The Regulator would not only lay down or regulate standards, approve charges, impose penalties etc. – it would also settle disputes - not only between public and the Government and / or concessionaire in relation to the airport but also between the concessionaire and the Government.

Two points are noteworthy here – the first is that extremely vast powers have been cast upon the Regulator, to the extent which would ultimately lead to fading away of the parties contract. Ultimately the Regulator will be the bed rock on which would depend the fate of the project. The second point is that the Regulator is not yet in place. The draft for enacting the law in this regard is still at the discussion level with the Government. Once the Cabinet approves it, a Bill will be drafted and placed before Parliament, which will then be debated. It will go through several sub-committees of Parliament. So we are at perhaps 3 years or so away from the stage when an Independent Regulator is constituted. Further, the history of an Independent Regulator in India is not very encouraging. Roads were the earliest to go for privatization and it was envisaged that they would have a Regulator – but there is not even a draft Act in place here. Same is the story for Ports and Oil and Gas. The radio broadcasting sector has been privatized for about 15 years now but there is no Regulator there as well. In the power sector Regulators are there in the State as well as the Centre level but the track record is not very encouraging. In short, we are years away from setting up an Independent Regulator (ensuring foremost his independence) then providing for transparency, accountability etc. in its working. The nuances of airport governance through Regulators is yet to be worked out. What will be the regulatory philosophy has yet to be developed. There is yet to be consolidation and standardization in the field. The Government is still debating preliminary issues as to the constitution and composition of the Regulators. One set of thinking is that instead of multiple regulators for multiple sectors, we should have only 2 or 3 Regulators. One would for instance deal with all types of carriage e.g. roads, airports, ports and even transmission lines – the other would deal with electricity, voice data etc. Another theory is that energy, communication and transportation should be under one Regulator. It would seem that we are years away from having an independent Regulator as can fulfill the enormous and all compassing role visualized for it is under the Concession Agreement and till that happens there will be ad hoc decision making lacking transparency and leading to disputes which may hamper the growth and privatization in the sector.

v. Dispute resolution:

Normally one would not except to hear about Dispute Resolution on the subject of risk allocation but here we have a some what unusual situation. The Concession Agreement envisages that Dispute Resolution shall be through ad hoc arbitration, under the UNCITRAL Rules and under the Indian Arbitration Act with the venue at New Delhi. This is of course not unusual by itself – as ad hoc arbitration is more common in India, compared to Institution arbitration. The peculiar feature in dispute resolution is that once an independent Regulator is put in place, the arbitration agreement shall stand overridden and disputes shall be referred to the Regulator. In other words, parties would no longer be able to go for arbitration. The only exception envisaged (to resort to the Regulator) is where sums are payable under an indemnity guarantee by the Government of India, to the concessionaire relating to Airport Charges (as defined). Here resort to arbitration is permissible (but not otherwise). There are two types of problems I envisage. First, international parties committing huge funds in a foreign jurisdiction will have far greater confidence in arbitration in a neutral country under the Rules of a neutral Arbitral Institute. This basic expectation is taken away under the airport Concession Agreement. The second issue is that once the Regulator is put in place (even if it is assumed that it would be independent and would efficiently deal with the disputes) it would naturally be subject to the hierarchy of the Indian legal system - which would mean that it would be subordinate to and amenable to the Writ jurisdiction of the High Court. Besides, writs by High Court, any decision of his can be appealed to the appellate authority. In short, one is therefore looking at three or four stages in dispute resolution. First, the decision by the regulatory authority, followed by decision of the appellate authority, followed by a Writ to the High Court followed by a discretionary appeal to the Supreme Court. Given the delays under the legal system, dispute resolution would become inefficient and expensive. Perhaps the Government should have segregated pure contractual disputes between the concessionaire and the Government and reserved these for international arbitration (which would have been as per the expectations of the international investing community also). The Regulator should step in only where public interest is involved. Dispute Review Boards should have also been envisaged in the Concession Agreement in a project of this type.

Conclusion:

To briefly conclude, India is firmly on the path of privatization in the airport sector. However the Concession Agreements do need a further in-depth look. Hopefully there would be a Model Concession agreement in the near future which would bring uniformity and address some of the issues which need a second look.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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