by Howard Zweig and Karl Camillucci
Taft Stettinius & Hollister LLP is an IMA B2B Partner
Increasingly, Universities in need of new facilities have turned to public-private partnerships (commonly known as “P3s”) as an alternative to traditional delivery methods for the design, financing, construction and management of various types of buildings, including student housing, classroom space, laboratories and athletic and exhibition facilities. Compared to projects procured through a typical design-bid-build process and financed directly by a university, P3s offer many advantages, including a streamlined procurement process; more efficient project design, construction and delivery; and privatized financing, operations, management and maintenance of the completed facility. While these attributes of P3s are valuable, P3s also pose distinct challenges. Fortunately, universities considering P3s can overcome these challenges by knowing potential pitfalls and planning accordingly.
Five Potential Challenges of P3s:
- P3s Are a Long-Term Commitment
Universities and their staff should understand that P3s require a long-term commitment and are difficult to restructure after closing. In many P3s, a university will ground lease land to a non-profit that will own the completed project for a term of 30 years or more. Terms of that length are necessary to underwrite affordable construction financing and to cause the project to be attractive financially to the university’s partner or partners who will own, operate and maintain the completed facility. After a P3 transaction is closed, materially changing the terms of the transaction is extremely difficult without buying out bondholders or lenders. When considering and structuring a P3, universities should anticipate long-term needs and the practical implications of a long-term commitment to the project. After the P3 transaction has closed, university leaders should make sure that they and their successors understand the university’s and its partners’ continuing rights and obligations with respect to the P3. Additionally, the university should have systems in place to assure that the university monitors the project and its partners and complies with its obligations. A senior university official or officials should be responsible for this monitoring and compliance so that all relevant university staff have clear, centralized direction over time regarding how the university will hold partners accountable and perform its obligations with respect to the P3.
- P3s Involve Some Loss of Control
In P3s, universities must cede some control over the facility to their partners – i.e., the owner, developer or manager of the project – especially after the project has been constructed. Of course, there are ways to assure that a university participates in important decisions regarding the design, financing, construction and management of the project. In many cases, however, a university’s partners in a P3 are responsible for day to-day decisions regarding operations, maintenance, budgeting, collection of revenue, payment of expenses and on-site programming. After closing a P3 transaction, a university may not be able to renegotiate the allocation of control between the university and its partners. Before entering into a P3, therefore, universities must thoroughly consider and identify the decisions over which they would like to retain control or influence and work with counsel to negotiate appropriate provisions in the relevant transaction documents. Additionally, to avoid conflict with partners, senior leaders of the university should have policies and procedures in place to assure that relevant university staff understand the university’s role with respect to the operation and management of the project.
- P3s May Involve Uncertain or Aggressive Underwriting Assumptions
Universities should thoroughly vet the underwriting analysis prepared by their underwriting partners to assure that the project will be financially feasible. In many P3s, the university will identify a particular revenue source to be generated by the completed project as the primary means of repaying bonds issued to finance construction. An underwriting firm will prepare a pro forma analysis that includes revenue and debt service projections over the term of the bonds. These analyses often rely in part on historical data from the university and other universities regarding revenue generated by similar facilities, as well as other data. Universities should scrutinize these assumptions carefully, especially if a university does not have an extensive track record operating the type of facility that will be constructed and operated through the P3. Universities may wish to consider advocating for more conservative revenue projections to provide a “cushion” in the event that actual revenues are lower than projected revenues. Although this strategy may reduce the size of the debt that can be financed, it will reduce the risk that actual revenues are insufficient to pay debt service. The consequences of insufficient revenue can be dire. In some cases, universities may be responsible for paying any shortfall between the amount of available revenue and the amount of debt service due (see below). Such payments may force the university to divert funds from other important uses, which may compromise the university’s mission or disrupt its operations. Even if the university is not required to pay the shortfall, the university may be required to take other actions to increase revenue available to pay debt service. Those actions may also be costly or disruptive to university operations. In the worst-case scenario, if debt service cannot be paid, the university’s partner may default on its financing, which could cause the bond trustee to foreclose on the project. Few good options exist when revenue is less than projected to pay debt service. Proper vetting of underwriting assumptions before closing is critical to protect universities.
- P3s May Involve University Liability for Revenue Shortfalls
Because many P3s are financed by the ground lessee, rather than directly by universities, university staff may believe that they have little responsibility for the payment of debt service on the bonds issued to finance construction. In fact, universities often have significant obligations to assure that revenue is available to make debt service payments. Such obligations vary by project and can fall anywhere along a continuum from an upfront contribution of cash, to a full guaranty of debt service payments, to lesser obligations designed to assure minimum utilization of the facility (including, without limitation, in the form of master leases, occupancy guarantees and first-fill agreements), or a combination of such obligations. Performance of these obligations can have a significant impact on a university’s finances and operations. Failure to be aware of and prepared to comply with such obligations could be an existential threat. Universities must have policies and procedures in place to assure that senior officials with appropriate expertise are aware of the university’s obligations in the event of any revenue shortfall; take proactive steps to identify potential weaknesses in revenue as soon as possible (and preferably before any shortfall occurs); have the authority to take necessary actions to prevent a shortfall, and, if necessary, have the authority to comply with the university’s obligations in the event of any shortfall.
- P3s Require Succession Planning
Perhaps of greatest importance, most P3 projects will outlast the tenures of the university officials who participate in planning and first implementing them. After the departure of those officials, lost institutional knowledge could lead to critical misunderstandings between the university and its P3 partners or failures by the university to abide by the terms of the P3. The complexity and distinct terms of each P3 project exacerbate this risk. Transferring the knowledge and understanding of retiring officials to their successors is a daunting but critical challenge. Universities should detailed develop succession plans to assure that future university officials will understand the terms and provisions of, and the university’s rights and obligations with respect to, each P3 partnership and project.
P3s in the university setting became common within the last 10-15 years. Many projects are only a few years old. As time passes, the university community will continue to learn about the potential pitfalls of P3s and actions that universities can take to avoid them. Nevertheless, the importance of careful planning before and after implementation have been demonstrated and documented. P3s are long-term commitments that can significantly impact a university’s control over facilities, as well as a university’s finances and operations. Universities should work with counsel to understand the university’s long-term goals and negotiate and document the P3 to best achieve those goals and protect the university’s interests. Additionally, universities should engage in detailed succession planning to assure that future university officials will be prepared to protect the university’s interests and comply with its obligations over the entire term of the P3.
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