Papers
Payment mechanisms.
Under the structures being developed for PPP projects, the payment mechanism is an area, which in our opinion, requires added attention from both client and bidding consortiums.
The payment mechanism is the commercial component of the PPP agreement. lt establishes performance requirements, the risk the client is prepared to accept and how heavily the contractor can be penalised for under-performing.
In Australia, the current preferred payment mechanism model is based on the UK NHS model (hospitals). The main elements of this model are the unitary payment, volume adjustments, the key performance indicators and abatements triggers in the form of failure events and quality failures.
- The unitary payment is the periodic payment made by the client to the contractor. It represents a periodic apportionment of the total cost of capital, finance, services, overhead, profit and risk associated with providing the service / concession over the entire agreement as determined, during the bidding phase, by the contractor.
- Volume adjustments are positive adjustments made to the unitary payment for those services provided by the contractor at no risk. Under the agreement the client agrees to pay directly for consumption of specific services, where uncertainty in demand makes risk transfer unreasonable or uneconomic.
- The key performance indicators describe the contribution in terms of standards of performance, availability and /or usage that the client determines as a necessary deliverable from the contractor, in order to the support the client?s own service delivery objectives.
- Failure events tend to be allocated to areas. A failure event abatement arises if a particular area is out of commission or unable to perform as required.
- Quality failures generate abatements associated with aspects of the contractors overall performance, such as failure within a management system or to meet an obligation, as opposed to being specifically associated with a distinct space.
Through the payment mechanism the client has the ability to withhold portion of the unitary payment for non-performance on behalf of the contractor. The abatement calculated with reference to the failures generated within in a period, when non-performance is identified.
As the payment mechanism establishes the rules by which payments can be withheld the contractor?s risk is significantly determined by the extent of onerous conditions, performance requirements, or obligations incorporated into the payment mechanism structure.
Ideally an agreement or "partnership" needs to contain consideration of the need for both parties to satisfy their objectives. For the private sector this objective is commercial, for the public section the objective relates to service delivery. Having an agreement, which achieves the right balance, is very important. The payment mechanism is responsible for providing this element in a PPP arrangement.
Getting the right balance within a payment mechanism is not an easy task. Some challenges are:
- The agreement is drafted entirely by one of the parties i.e. the client. The ability of the contractor to achieve some of the requirements or performance criteria may not be adequately considered or understood;
- Inadequate calibration of the abatements during development of the mechanism resulting in unreasonably high abatements to be addressed through the contractor?s risk allocation.
- Interpretation of the payment mechanism by the Contractor in the bidding phase and subsequent exposure to errors in determination of risk allocation.