Can PPPs work for procuring front line assets? - Government Contracts, Procurement & PPP

Despite Australia being considered an early trendsetter for public-private partnerships, the PPP procurement method has been used for only three Defence projects¹– none of these being for front line assets.

At first glance, PPPs seem a good solution for procuring front line assets – a way of upgrading Australia's defence capability while also driving cost savings. The UK Ministry of Defence has signed over 50 PPP deals – so should Australia do the same?

The reality is, front line assets are not like other assets. There are unique risks that make them more challenging to procure via a PPP.

1. DESIGN RISK AND UNINTENDED USE

In a PPP the Government states its requirements in output terms and the contractor designs the solution, thereby transferring the design risk to the contractor.

By contrast, if the Government wants to acquire a new cargo aircraft capability, it is easier for it to identify the type of aircraft (e.g. A400M) instead of describing the attributes it is looking for (e.g. the necessary flight envelope).

By specifying the type of aircraft, the Government thereby assumes the design risk (which is not the general premise of the PPP model).

Another potential sticking point is that Defence may require the asset to be used differently than as agreed at contract signature. For example, if the Government commits troops to a conflict, the asset may be used more frequently or in a harsher environment (such as in desert operations) than originally envisaged.

However, the contract is unlikely to be varied before the asset is urgently deployed. The asset's use outside of the agreed contractual parameters may lead to disputes around the cause of any deterioration and the responsibility for restoring the asset.

2. INSURANCE & LIABILITY

Insurance and liability arrangements are part of every procurement (whether a standard procurement or a PPP). However, a PPP involves more detailed thought given that the owner of the asset (the contractor) is not the end user of the asset (the Government). Interests of the financiers also need to be considered.

These issues become more complicated with a PPP for a front line asset, given that:

the operator of the asset will sometimes be the contractor (in peace times), a third party (whenever third party usage is achievable) and other times the relevant Government entity (during military operations);
the location of the asset (eg war zones) can expose it to unintended damage;
the use of the asset is unique and unlike any non-military asset (eg: tanks roaming around desserts); and
overseas jurisdictions may impose sanctions on owners of assets, notwithstanding that a foreign government is in control of the asset.

3. THIRD PARTY USAGE

One of the drivers for considering PPPs (as noted in the National PPP Guidelines) is the opportunity for third parties to also use the asset, thereby reducing the net cost to Government.

However, the Defence Procurement Policy Manual (DPPM) acknowledges that, "third party utilisation of Defence materiel will typically not be feasible".

Even if the asset is able to be configured to remove the military components, intricate insurance, liability, maintenance, and recall arrangements need to be considered.

4. PAYMENT MECHANISM

Unlike a standard procurement, in a PPP, the contractor bears the costs of the project (as provided by the financiers) and the government pays the contract sum in instalments, although does not usually take title to the asset.

Guidance on PPP payment mechanisms for social infrastructure (eg schools) and economic infrastructure (eg roads) is set out in the National PPP Guidelines. However, front line assets do not fall into either of these categories and importantly, unlike roads or schools, they are not static – rather they are designed to move.

Tailoring the payment mechanism for front line assets requires thinking about some unique issues, such as:

payments that apply to peacetime and war scenarios;
circumstances where the ADF uses the asset of another country's Defence Force (instead of the contractor's asset); and
pooling and interchange of spare parts in times of emergency (either with other Defence Forces or under commercial arrangement such as the International Airlines Technical Pool).

5. FINANCIER LIABILITIES ON TERMINATION

There is no liquid market for front line defence assets, so when a project is terminated it's unlikely the assets can be freely sold. Financiers therefore need to grapple with how the liabilities of the contractor will be extinguished.

6. REPOSSESSION

If the contract is terminated at a time when the assets are outside Australia, the contract must allocate responsibility (both in terms of the practicalities of retrieving the asset and the associated costs) for returning the assets to Australia and deal with situations where there are encumbrances that need to be discharged before repossession can occur.

7. TIME AND COST

Recent examples in the UK show that it can take a great deal of time to procure defence assets through the PPP model. The procurement process for the Future Strategic Tanker Aircraft deal with the UK's Royal Air Force took approximately 8 years.

An extended negotiation period may lead to the undesirable situation where the new capability does not enter service until a period after the outgoing capability has been retired.

There is also a risk that during the procurement time, exchange rates and financing costs may fluctuate.

SO, ARE PPPs SUITABLE FOR FRONT LINE ASSETS?

The DPPM mandates the PPP model must be considered for all defence projects with a capital cost greater than $50 million and where there is opportunity to enter into a long term contract (e.g. 15-30 years).

However, it also acknowledges that PPPs may not be suitable for front line assets due to the unique challenges in apportioning risk between Government, the contractor and financiers.

Despite the complexity, we should expect that the pressure to manage defence acquisition spending will spur some momentum to get the PPP model working for these assets.

Footnotes

¹The new Defence headquarters at Bungendore (HQJOC) and Phases 1 and 2 of the Single Living Environment Accommodation Precinct (Single LEAP 1 and Single LEAP 2).

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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