In the realm of infrastructure project finance, termination price clauses in concession agreements play a significant, albeit often underappreciated, role in structuring effective risk management. These clauses, which address compensation in the event of project termination, serve as an essential financial tool to mitigate potential losses when a project faces unforeseeable challenges. While a well-designed project is expected to run smoothly over the years, certain situations may compel lead parties to consider termination options carefully. Not all project defaults automatically lead to termination, and termination itself may be triggered under a range of circumstances, from prolonged force majeure events to regulatory changes or other unexpected operational hurdles. In some cases, even a default by one party may not result in termination if the situation can be remedied through step-in rights, renegotiations, or other provisions that allow the project to continue. However, when termination becomes the final course of action, particularly in long-term hydropower projects spanning decades, carefully structured compensation provisions offer a layer of financial stability, which is invaluable to both public authorities and private stakeholders.
Why Termination Price Matters: Securing Stability in Uncertain Terrain
Termination price clauses offer a vital safeguard, ensuring that parties have a path to compensation if the project is halted. These provisions mitigate potential losses by ensuring that, when necessary, both parties have a basis for recovering certain sunk costs and liabilities. For instance, the Upper Trishuli Hydropower Project has set a notable precedent by incorporating a termination price - a provision that stabilises financial exposure. However, with termination clauses absent in other Nepali projects, parties, especially lenders, face increased risks and may adopt more conservative terms to offset potential liabilities.
Balancing Financial Protections and Public Sector Obligations
In the event of a project termination, two major interests come to the forefront: private investors, such as lenders, and the public authority (often referred to as the off-taker). When termination is triggered, lenders may lose the primary cash flow source that would typically repay their debt. Especially if the project is in the construction phase, lender exposure can be at its peak, heightening the need for structured compensation.
On the other hand, the public authority may question the necessity of compensating a project that has underperformed or failed. From their perspective, taking control of incomplete or challenging assets requires substantial costs, potentially including construction completion, repairs, or re-tendering. Public authorities must navigate the balance between avoiding unjust enrichment by acquiring project assets without paying due compensation and ensuring public funds are not used inefficiently. The structure of termination compensation must balance these perspectives by ensuring fairness in asset transfers while maintaining financial security for all parties.
Global Practices in Termination Compensation
Countries with established infrastructure frameworks have long recognised the value of tailored termination price clauses. The UK’s Private Finance Initiative (PFI) and Private Finance 2 (PF2) model, for example, include defined compensation guidelines which guarantee certain recoveries while limiting returns in specific scenarios. In the UK’s DBFO road projects, for instance, compensation is excluded in cases of project company default, underscoring a model where competition and efficient risk allocation are prioritised. In contrast, in sectors like healthcare or education, public-private partnerships in the UK employ re-tendering mechanisms to align compensation with current market valuations, balancing the financial exposure of both parties.
Japan and South Korea, in contrast, emphasise guaranteed termination price clauses within their PPP frameworks, offering debt recovery and partial equity compensation, ensuring lender security and facilitating steady financing. Meanwhile, in African markets, where investment risk is often higher, approaches vary. In sectors such as ports, initial projects may offer quasi-sovereign guarantees to enable foreign investment by covering debt in termination scenarios. As these markets evolve, they adopt more refined approaches, such as paying percentages of asset book value based on debt-to-equity ratios, ensuring that both parties share a more balanced risk and reward distribution.
These examples show that, globally, termination provisions are calibrated to the local context, managing the interests of both public and private stakeholders.
Structuring a Solution
For infrastructure financing in Nepal and similar markets, adopting a risk-adjusted approach to termination pricing offers a balanced solution. Capital and time intensive industries, such as energy or transport, may justify clauses covering debt recovery and certain equity returns, similar to frameworks in the UK and Japan. Where full termination prices are deemed impractical, partial risk guarantees or multilateral insurer participation can serve as viable alternatives, distributing the financial exposure. Additionally, involving third-party valuations ensures that compensation reflects fair market conditions, adding another layer of security and clarity for stakeholders.
These provisions may also include carefully designed “step-in” rights, allowing parties to take over the project if default risk escalates. By embedding step-in rights alongside termination pricing, agreements can achieve a dynamic structure where parties have the flexibility to salvage the project without immediately resorting to termination. However, the success of such provisions relies on clarity on how these rights are executed, and on both parties’ assurance that any compensation obligations will be honoured should termination be the final course of action.
Conclusion: Aligning Global Practices with Local Policy
Termination price clauses are essential tools for structuring fair and sustainable infrastructure projects. Inconsistent application of these provisions can lead to financing challenges, deterring investment and increasing capital costs. By adopting a well-structured, transparent approach to termination prices Nepal can enhance its infrastructure financing landscape. A reliable framework for termination compensation, built on fair valuations, defined timelines and clear third-party assessments, will help bridge the gap between public fiscal responsibility and private investment security.
(Khanal holds an LLM from the University of Geneva and serves as both a lawyer and an arbitrator.)
(This opinion article was originally published in December 2024 issue of New Business Age Magazine.)