Infrastructure privatization is initiated through various modes by different countries and can generally include the construction of new privately owned facilities, privatization of existing facilities, concessions or lease and project financing.

By Asanga Gunawansa *


The most grandiose method from the point of view of the governments to attract foreign investment in to the public sector is direct and total privatization of state owned enterprises. A process which transfers the ownership of existing assets, or rights to those assets from the state to a foreign or domestic private entity, that will assume the duties and operation of the property.

Unlike initiating new private owned infrastructure facilities, complete and unilateral privatization of some existing state owned industries or enterprises requires great confidence and commitment to political liberalism as loss of control and displacement of labour can virtually assure local opposition. Thus many developing countries are reluctant to give up dominion over certain strategic industries such as power generation, telecommunication and port development to name a few, to private sector investors, whether of domestic or alien origin. Such industries are both viewed as being an important source of economic revenue as well as an integral part of the effective operation of the government.

The political complexities that can arise from total privatization of certain existing public sector enterprises have led some governments in developing countries to select alternative strategies such as allowing limited term operation or ownership to the private investors. Further, the increasing demand to develop the infrastructure and the lack of ability of the governments to finance the developmental requirements too have led to the development of various innovative financing techniques and instruments to finance infrastructure projects.

These include:

(a) asset – based financing.

(b) other forms of financing such as leasing, hire purchase and conditional sales, acceptance credit facilities and debt factoring (none of which involve conventional borrowing), and

(c) different project financing structures.1

While many of the said options may hold promise, project financing seems to be the popular mode among the developing countries. Project financing is regarded as an arrangement that creates a unique partnership between the host country government and private sector investors which allows consumers to gain from higher quality services

* LL.M (Warwick),State Counsel ‘ Smith, Martin Stewart, “Private Financing and Infrastructure Provision in Emerging Markets”, Law and Policy in International Business 1995, pg. 987 at 999.


“Project finance” is a broad term used to refer to a wide range of possible financing structures. “The term is generally used to refer to the arrangement of debt, equity, and credit enhancement for the construction or the refinancing of a particular facility in a capital-intensive industry, in which lenders base credit appraisals on the projected revenues from the operation of the facility rather than on the general assets or the corporate credit of the promoter of the facility, and in which they rely on the assets of the facility, including the revenue producing contracts and cash flow, as collateral for the debt”2.

In other words, project financing is lending based on the merits of a project rather than credit of the project sponsor. It is important however to note that “Project Finance” does not have a precise legal definition. Clifford Chance, an internationally renowned law firm with significant expertise in project finance transactions, describes the term as follows

Thus, although Project Finance is a wide term used to refer to a wide range of possible financing structures, they all have the common feature of the lender providing the debt for the project by placing substantial reliance on the viability of the project rather than on any external comfort provided through guarantees and other security.

A significant feature of project finance structure is that it allows a sponsor to avoid providing lenders with “recourse” to its general assets in the case of project failures, as the concentration for loan repayment is restricted mainly to project cash flows and project assets. This feature is generally referred to as the “non recourse” nature of project financing. Thus if project finance is non recourse in nature then a direct legal obligation is not imposed on the project sponsor to repay the debt or to make interest payment when the cash flow is too low to pay the debt.

However, the current trend particularly in the area of international project financing is towards limited recourse or credit supported financing. This is mainly because the present day infrastructure projects require immense sums of money


The use of project finance can be advantageous in many ways in the area of public sector infrastructure development to both host governments and private investors. It enables host governments to attract private capital investment without guaranteeing payment of project costs and

Hoffman, S.L., “A Practical Guide to Transactional Project Finance: Basic Concepts, Risk Identification, and Contractual Considerations”, The Business Lawyer. Vol.: 45, Nov. 1989. pg. 181. 3Clifford Chance, Project Finance, Clifford Chance Publications 1991, pg. 1.

without completely rearranging its economic markets through direct privatization. On the other hand lenders may be more willing to lend on such a project – specific basis in situations where a developing country would present an otherwise unfavorable credit risk due to political unrest or other similar non economic factors. Project financing can often provide a solution whereby a tailor-made financial package is developed together with a supporting security structure that will enable the sponsor to participate in a project which could otherwise be beyond his means. Further, project finance is expected to provide a lower overall tariff requirements for projects developed by the private sector. The cost will be higher than may have been the case with concessionary rates, when projects were financed by the public sector. But, project financing allows financing on a higher debt to lower equity ratio (e.g. 80% – 20%), and because debt is traditionally less expensive than equity, the overall project cost and the tariff necessary to repay the debt and provide an acceptable return on equity, can be less.

However, project financing is not without any shortcomings. The degree of risks involved with regard to all participants and the complex nature of the transactions involving many participants with diverse interests, which in turn requires lengthy technical


The funds for infrastructure projects through the mode of project financing are provided through the arrangement of debt and equity. Equity contribution for a project can take various forms including stock purchase and general and limited partnership capital contributions. The amount of equity contribution is sometimes indicative of the value placed on the project by the project sponsor. It decreases the burden placed on the project to service debt, thereby reducing the risk of repayment which gives the sponsor and the investor an incentive to make the project work by placing equity at risk.

In project financing debt too can take various forms. The two main categories being between senior and subordinate debt. Senior debt being the loans secured by a lien in the assets of the project and by other security agreements. However, occasionally even senior debt can be unsecured where the sponsors are held in high esteem as credit worthy by the lenders. Subordinate debt is often provided by the sponsors or the host government and used as an alternative for capital contribution.

Apart from the lenders and the sponsors who commit the equity there are several other participants in project financing who play an effective role in a project financing structure. The motivation for such participants to provide financing for the project can vary. The contractor

product or service will continue to be available4. The host government will participate to ensure that the public sector has a certain hold on the project and to satisfy the investors of the commitment to privatization policy.


Every investment action requires a financial decision making and activity. What is special about the phrase “project finance” is that a consortium of interested and inter-locking partners specific to a particular project, come together and pool their resources to see a particular project through and hopefully to profit from the venture. Thus in a project financing we have a sponsor, material and input suppliers, contractors, operators, consumers, providers of debt and equity capital, under-writers to the debt and equity offerings, credit enhancing and rating agencies, insurers and the host government as the several participants. The creation of a special purpose vehicle or a special purpose corporation and trustees to connect the different players together is also an essential requirement in project financing5.

Each of the aforesaid parties who might be engaged in regulation, financing or managing has a critical part to play, often at different stages of the projects life and faces various risks. Because, a project financing is non recourse or limited recourse to the project sponsor, financial responsibility for various risks in a project financing must be allocated to parties that will assume recourse liability and that possesses adequate credit to accept the risk allocated.


Although private financing is the preferred, if not the only alternative to fill infrastructure financing needs of developing countries, it is a myth that the private sector is waiting for such opportunities as infrastructure projects are associated with great risks at all stages of the project. Due to large scale project costs, long gestation periods, and due to the monopolistic nature of infrastructure projects, they present unusual risks to private investors and lenders. Some of these risks may not even be foreseeable during the initial stages of negotiation. Thus successful analysis, allocation and mitigation of the risks involved are a central feature of project financing.

Each of the parties involved in the regulation, financing and managing infrastructure projects face risks. The ability of all parties to agree on how risks will be shared is the key to successful conclusion of a project. These risks can be broadly categorized under two headings.

I. Commercial Risks

These include project specific risks, such as developing the project without cost overruns, operating and maintaining the plant and finding the market

II. Non Commercial or Political Risks

These include project specific risks such as expropriation, failure of the government utility to meet contractual obligations, change of Government etc. and non – project specific risks such as country risks, political risks, legal risks and force majeure risks.

For better understanding of the total risk structure in project financing see table 1.F.1. below.

See generally Nevitt, P. Project Financing, 4th edition 1983, pg. 9 – 20. Sellahewa, G.R. “Financial Techniques for Private Infrastructure Development”. Paper presented at the National Law and Economy Conference, Colombo, Sri Lanka, 1995.


• In order for any project financing to be successful it is important that all participants should agree to bare project risks in an equitable manner. Allocation of risk is generally accomplished by the one party agreeing to compensate another party for financial injury resulting from the occurrence of the risks. The following general underlying dynamics relevant to allocation of risks in project finance can be identified.

(a) In the absence of reallocation parties face the panoply of risks with respect to their investments (emphasis added)

(b) Parties attempt to minimize the risks they will face

(c) Parties seek returns at least to commensurate with the risks they absorb

(d) Parties seek to allocate risks to the parties best able to manage them

(e) Parties attempt to reallocate risks to those parties capable of absorbing them or best able to evaluate them.

It should be understood that, risks cannot be eliminated. Thus what is possible and required is a proper risk management process. Such process can be identified as consisting of three stages.

Table l.F.l

Total Risk Commercial Non commercial/Political Project Specific Eeonomic Project Specific Non Project Environment specific Completion — Currency — Regulatory ___ Country Risk — Project Supplies __ Interest rate — Expropriation – Political — Market Risk Host — Inflation – Government _ Legal Obligations — Sponsor -Long term Force – Technical inputs Environmental _ Majeure

All the above risks can also be grouped according to the project cycle: development phase, construction phase and operation phase and the risks associated with the whole project cycle.

(I) The assessment of what each risk presents. (II) Identification of the party that is best suited to manage each risk

(III) Allocation and mitigation of each of the risks between the parties via contractual arrangements.


As it has already been noted project financing is an exercise that brings together resource from a number of parties where the participants collaborate towards the project success. Thus project finance as a contractual arrangement involves a set of agreements between the various participants of the project. These agreements provide the legal framework within which the whole financial structure of a project – functions.

A complete analysis of each category of project finance contracts is beyond the scope of this work. However, some of the possible legal and contractual relationships are shown in figure 1 .H, 1.

Figure l.H.l.

Supply Contracts for constrution and Supplier operation Land Owner / (Government/ ——————— Site Lease Contract ———- The Project Private Company’ Government ——– Industrial License, Commercial Registration, Concession and Exploration ‘ Agreements / Assurance Shareholder/ . . Project Sponsor/ ——– | Purchase Contracts / Purchasers/Guarantors Security Lenders Loan Agreements / Insurers v. Insurance Policies /


Earlier it was noted that project financing as a mode of infrastructure development can take many forms. Whatever the financial structure selected by the parties, all models of project financing will generally have the features dealt with above as an integral part. The specific structure selected in the case of infrastructure development in developing countries will depend on the extent of debt and equity required

The most commonly used concepts of project financing in recent years by the developing countries are the Build Own Operate (BOO) and Build Operate Transfer (BOT) models. These models involve a consortium submitting a proposal to finance, design, build, operate and sometimes transfer the project back to the host government after a certain period of time.

Although the popular use of BOO / BOT and other similar techniques of financing infrastructure commenced in the 1980’s, it really cannot be identified as a new development as often stated. In contrast it should be identified as a reawakening of an old concept. The earliest use of the concept can be traced back to 1782 in France where the Perrier brothers were granted a concessionary agreement similar to a BOT method, for water supply. Further, during the 19th century, these type of arrangements were adopted for water supply projects in Germany, Spain and France and for privately owned ‘turnpike’ roads, similar to the present day toll roads in the U.S. and Britain: However the modern use of the idea came about in the 1980’s with it’s introduction as a prominent method of financing infrastructure in Turkey as a part of the Government strategy to raise off – balance sheet financing6. This was followed by the success in Europe in using the concept to finance the Eurotunnel project7. Since then this type of project financing has become an instant attraction to both developed and developing countries.


The terms BOO / BOT are used to identify two of such financing methods. It is important to note that, sometimes the term ‘BOT’ itself is used generally to identify most infrastructure privatization projects where a consortium submits a proposal to finance, design, build and operate a project for a specific period of time as agreed between the consortium and host country8. Thus the variants of ‘BOT’ include, inter alia, BOO (Build Own Operate), BLT (Build Lease Transfer), BT (Build Transfer), BTO (Build Transfer Operate), RLO (Rehabilitation Lease Operate), and BOOST (Build Own Operate Subsidize Transfer)9. However, this paper will only concentrate on the most frequently used BOO and BOT methods.

BOO (Build Own Operate) is a scheme which combines private finance, design and construction with private operation after completion of a project. Operation and ownership of the project is usually continued with no transfer back to the government. However the government is usually entitled to a certain amount of shared revenue within a specified period10. Thus in a BOO scheme the project remains in the private sector without the requirement of transfer to the host government, and thus is very close to the free market ideal. Under this method the private entity is allowed to recover its total

6See Generally Barret, M. “Project Finance Develops New Risks”, Euromoney, Oct 1986. pg. 75-76. 7See Tiog, R.L.K., “Project Financing as a Competitive Strategy in Winning Overseas Jobs”, International Journal of Project Management. May 1993. pg. 75-86. Harder op cit. pg. 36. 9United Nations Industrial Development Organization, UNIDO BOT Guidelines, Vienna 1996, pg. 3. 10 Harder, op cit. pg. 36.

investment, operating, and maintenance costs, plus a reasonable return by collecting fees and other charges from facility users.

BOT (Build Own Operate) scheme also involves a private sector design, consortium, operation and finance of infrastructure projects. However, unlike in BOO, ownership of the project does not vest in the private sector. The private sector entity is given the operational rights of the project for an agreed period of time, during which the private entity is expected to recover the project investment, operating and maintenance costs, and a reasonable profit from the project revenues. The project has to be transferred back to the host government at the expiry of the agreed period of time.

BOT (Build Own Operate) scheme also involves a private sector design, consortium, operation and finance of infrastructure projects. However, unlike in BOO, ownership of the project does not vest in the private sector. The private sector entity is given the operational rights of the project for an agreed period of time, during which the private entity is expected to recover the project investment, operating and maintenance costs, and a reasonable profit from the project revenues. The project has to be transferred back to the host government at the expiry of the agreed period of time.

For both BOO and BOT projects and the other ‘BOT’ variants, project finance is the cornerstone. That means

Where BOT projects are concerned, the governments not only gets to transfer the responsibility of financing and providing infrastructure services to the private sector, but also have the benefit of inheriting a fully operational project which the governments are incapable of financing and operating with own finances and technology.

The BOO / BOT projects also enable the partnership between public and private sector, thus exposing the public sector, to market – based policy making and modernized operations, which are essential in the case of developing countries. Where especially BOT projects are concerned, they also enable wary governments to privatize in the short term while retaining future control. Another important fact is that, where developing countries are concerned, apart from the private capital, BOO / BOT projects give access to private sector technology.

‘ Sometimes, due to the very nature of the long term infrastructure projects and the various risks involved, private investors are not interested in investing unless the host government also participates in the project by giving assurance to the private investor of the government’s commitment to the liberal economic policies. Thus in addition to providing assurances and incentives to encourage private investment through the licensing procedures, tariff exemptions contractual concessions and guarantees

Although the developing countries find BOO/BOT projects attractive untested risk allocation structure among the project participants is worth considering. As these methods are relatively new, no definite analysis of the successful or the unsuccessful nature of the risk sharing is possible. The various risks that exist throughout the projects life should be carefully identified, defined, allocated and provided for within the contract that define the project. This process requires highly effective lawyering.and financial and technological know-how on behalf of all the project participants as clear evaluation of each party’s capacity to bear the risks and the extent of such risks etc. is necessary. Thus this process quite obviously can be time consuming and costly.

Conflicts of interests that may arise between the parties, especially in the public-private partnership between the interests of consumer friendly pricing and efficient services verses profit making is another disadvantage, where a balance need to be struck. Potential disagreement with regard to technology transfer is also a matter worth careful consideration.

From the investor point of view the non recourse or limited recourse nature of the projects too can be a disadvantage as it restricts the investors capacity in claims beyond the project assets. Thus the negotiators of the project from both public and private sector should give careful consideration to the above aspects before finalizing the project structure.


The need for Regulation does not arise when infrastructure is provided on a monopoly basis by the Government or a Government Owned Institution. The provider of infrastructure in such cases either provides it according to its own rules or applies it accordingly to rules imposed by legislation as part of the system of Government. (Sri Lanka Electricity Board and Sri Lanka Ports Authority can be cited as examples).

The situation differs when infrastructure is to be provided in whole or in part by the Private Sector. In such cases as the role of the Government moves from that of service provider to that of supervisor of those providing the services, some form of a regulatory frame work will be required. The instrument forming the new regulatory frame work may constitute an authorization or contract between the Government and the service providers. This may typically take the form of license or concession contract.

Apart from these instruments of regulations, the institutional arrangements that form part of the new regulatory frame work also need to be designed to give the Private Sector comfort that the Government is seriously committed to sustained private participation. Therefore, either a governmental regulatory agency or an autonomous regulatory commission may be established as an institution to administer these instruments in a manner that demonstrates commitment and credibility to reform. The Regulator appointed to the Telecom sector in Sri Lanka is a good example.

The Concession Contract under which the private participant is specifically authorized to construct and operate the project under stated terms and conditions, is the typical contractual form of regulation. On the other hand, a license which similarly stipulates operational terms and conditions, may or may not be of a contractual nature depending on the legal tradition of the country. If the instrument is characterized as an authorization, it is essentially an administrative act of the government governed by Administrative Law and can be unilaterally revoked or amended by the government (the grantor) at will. However, where the instrument is characterized as a contract, the government as grantor is acting in commercial capacity such that general Commercial and Contract Law could apply, as a consequence of which revocation or amendment normally cannot be effective without consent of both parties.

While the goal is to achieve a balance between flexibility and certainty in implementing regulatory policy, primary enabling legislation that establishes the principles and parameters within which regulatory institutions may exercise delineated discretionary powers is usually necessary. Granting significant discretionary powers to an independent agency is, however, uncommon in developing countries like Sri Lanka. The governments are often reluctant to allow an outside agency to have wide discussion in approving prices or service standards for public services. In the premises, the practice is to create an enclave body of rules in the license or concession, the result being a lengthy and

sophisticated contract between the government and the private promoter / operator. Further, such mechanism will not satisfy the concerns of investors as they tend to doubt the stability of the contractual regime, the capability and independence of the judiciary, to arbitrate disputes between the government and the other project participants. This may result in the investors and the lenders demanding that the contract be subjected to foreign jurisdictions.

The practice in Sri Lanka and most other developing countries have been the designing of the regulatory environment to suit each specific project as and when necessary. The disadvantages in this approach are that, the lack of a uniform law/regulation to which all parties to a project can look up to and the time consumption in project specific reforms. In the premises what could be recommended is placing a governing law for infrastructure development projects which will supersede all other statutory and regulatory problems that may have to be faced when developing a particular project. Already countries like Vietnam and Philippines have taken a step in the right direction by enacting a BOT law to facilitate the infrastructure development policies and movements of their respective governments.


Infrastructure projects are extremely complex in nature from both a financial and a legal point of view. Thus they require a sound knowledge, strategy, and dedication by all involved or interested parties for project success. Despite the complex nature, the development of infrastructure is extremely important to developing countries if they are to move ahead in the modern world, as improved performance of infrastructure services would enable rapid development and provide better access to essential services for the people.

The BOO/BOT modes of project financing which are increasingly getting popular among developing countries are likely to become the established modes for infrastructure development in most countries due to precarious finances and the lack of technological expertise within the countries. In the case of Sri Lanka, the BOO/BOT type of project financing has progressed rather slowly for a variety of reasons, ranging from lack of policy dedication to scarce use of expert facilitators such as financial, technical and legal experts in the privatization process. If the country is to make the maximum use of these new financing techniques, in addition to fine tuning the present administrative and regulatory net work, it is also essential to ensure that sound procurement policies, transparency, and free market access are part and parcel of the goals of good government. The present government of Sri Lanka has already taken some positive steps in the right direction with the pronouncement of the government policy on transparency and the renewed undertaking to maintain free market economy.