Laiban deal requires RP’s
performance undertaking

MORE THAN just a “take-or-pay” stricture, the P52-billion joint venture deal between the state-run Metropolitan Waterworks and Sewerage System (MWSS) and food-beverage giant San Miguel Corporation will require the Philippine government to issue a “performance undertaking,” a form of state commitment that the Arroyo administration has generally been wary of giving away.

A performance undertaking is a guarantee issued by the Republic that the state agency involved in a project will comply with all its obligations to the contractor, typically a private company.

In many past projects, such undertakings have compelled the government to either assume the multi-billion-peso debts or allot huge budget subsidies for obligations incurred by the agency.

Performance undertakings issued during the Ramos administration for at least two projects – the Metro Rail Transit system and the Casecnan multi-purpose dam have turned from contingent into actual liabilities that required direct budgetary appropriations.

The government is now in talks to buy back the MRT system from its creditors for $600 million to $1 billion, so it may avoid paying the annual subsidies. The private contractor MRT Corporation spent only $655 million to build the 17-kilometer elevated rail line.

Financial risk

Should things turn just as bad for the Laiban deal, the biggest dam project in the 131-year history of the MWSS, the required performance undertaking could expose the government to even bigger financial risks.

The Philippine Center for Investigative Journalism (PCIJ) has not seen a copy of the confidential joint venture agreement between the MWSS and San Miguel but references to some provisions are contained in a memorandum of the Office of the Government Corporate Counsel (OGCC) to the MWSS Board of Trustees.

Under the term sheet or Annex C of the Bulk Water Sales Agreement, the OGCC memorandum states that, “MWSS is obliged to submit the performance undertaking of the Republic of the Philippines to secure MWSS’ performance of its obligations (including but not limited to payment obligations and buy-out obligations under the Agreement).”

The required performance undertaking could attract extra scrutiny from economic policy-makers, particularly the Department of Finance, which issues performance undertaking instruments, for the joint venture deal.

By tradition, before issuing any performance undertaking, the DOF secures the recommendation of the inter-agency Investment Coordinating Committee (ICC) that is chaired by the Finance department with the National Economic and Development Authority (NEDA) as secretariat.

At bottom, however, performance undertaking matters are the call of the Finance secretary, official sources said.

NEDA nixes it

Already the Laiban dam project has turned contentious because of a “take or pay” provision that the NEDA, in a letter to the MWSS, says constitutes a direct government guarantee, which is prohibited for unsolicited proposals like San Miguel’s offer to build and operate Laiban dam.

The OGCC disagrees, and insists that a direct government guarantee refers only to “an agreement where the government guarantees to assume responsibility for the repayment of debt directly incurrent by the project proponent in implementing the project in case of a loan default.”

All government agencies are being assisted by the OGCC, particularly in relation to negotiation of project contracts.

Performance undertakings and take-or-pay schemes share one thing in common: a bad reputation.

During the Ramos administration, performance undertakings and “take or pay” schemes proliferated in the power sector, twin sweeteners invariably offered to independent power producers or IPPs that were tapped to ease the power supply shortfall.

Napocor bankrupt

Soon after the brownouts ended, what came to light was a dark result: the excessively high power rates drove the National Power Corporation (Napocor) to bankruptcy years later.

The state commitments, which call on the government to ensure that the state power company complied with its payments and other obligations, were blamed for unduly increasing the government’s contingent and actual liabilities.

The government later assumed P500 billion of Napocor’s debts and had to privatize the state power company’s generating plants and transmission assets to repay the assumed debt.

Lawyers say the law does not prohibit performance undertakings, pointing out that these are sometimes necessary to ensure that a government agency, corporation or unit complies with its obligations in public-private partnership contracts.

Performance undertakings are different from direct government guarantees, which require the government to assume the liabilities of a private proponent if it defaults on debts to creditors. The law does not allow direct government guarantees for unsolicited proposals, such as San Miguel’s offer to build and operate Laiban dam.

Aversion, attraction?

To be sure, the Arroyo administration has shown an aversion to issuing performance undertakings, and even more, to extending direct government guarantees.

Shortly after coming to power in 2001, it adopted a policy of generally avoiding performance undertakings to prevent a further build-up in the government’s contingent liabilities or future possible obligations.

In a statement issued on April 2, 2003 on contingent liabilities, Arroyo’s Department of Finance said: “It has been the policy of the Arroyo administration to refrain from issuing performance undertakings and similar commitments except in extra meritorious cases subject to very tight scrutiny.”

The department added that contingent liabilities generally consisted of direct guarantees to the borrowings of government corporations and “indirect guarantees primarily from
performance undertakings and other similar commitments of support that have been issued in relation to BOTs, its variants, and other private sector participation (PSP) projects such as joint-ventures.”

In those days, it was very difficult for agencies to get performance undertakings from the Finance department and Malacanang, recalls as former Trade and Industry department official tasked with attracting private investments in infrastructure projects.

“Then-Finance Secretary (Jose Isidro) Lito Camacho and Presidential Chief Legal Counsel Avelino Cruz were very careful about these things,” the official adds.

By its conduct, the Department of Finance then pursued a policy of avoidance of performance undertakings.  It tried to generally veer away from commercial or market risks, which are at the heart of “take or pay” schemes, and to just take risks that government can manage such as regulatory issues.

OGCC plays safe
Similar circumspect drives the guidelines of the NEDA and the Investment Coordinating Committee that also discourage the issuance of performance undertaking and schemes that require state agencies and corporations to provide subsidy and market guarantees, especially for unsolicited proposals.

As matter stand, the OGCC seems to want to play it safe. It has posed no objections to the joint venture agreement but wants MWSS and San Miguel to elaborate on the matter of the performance undertaking that the agreement requires.
In its memorandum, the OGCC urged the MWSS and San Miguel to “define and clarify” the performance undertaking provided for in the term sheet “in order that said provision will not be construed or taken to mean as a direct government guarantee barred under the 2008 NEDA Joint Venture Guidelines.”

It looks unlikely if MWSS and San Miguel have complied with the OGCC instruction and elaborated on the performance undertaking to avoid turning it into a direct government guarantee, however. The MWSS Board of Trustees passed the resolution calling for challenges to the deal on June 17, or just a day after the OGCC issued the memorandum, leaving the water agency no time to revise the agreement.

By all indications, the MWSS felt no rush or saw no reason to clarify the term even as it launched the challenge process on July 2, 2009. The OGCC itself said the two parties can define and clarify “within the period stated in the joint venture agreement,” which could refer to the one-year “financial investment decision” period. During the FID period, the two parties should firm up the take or pay agreement and bring the two private concessionaires on board, the OGCC advised.

OK with OGCC

There is hint of consent in the OGCC memorandum as well. It noted, for instance, that the joint venture agreement “does not per se provide for a direct government guarantee … in the event of default.”

Instead, the agreement outlines a mutual buy-out scheme where the defaulter is obliged to sell its interest in the project to the other party at only 80 percent of the appraised value. Alternately, the defaulter must buy the other party’s stake at 120 percent of the appraised value.

The OGCC thus concluded: “Nowhere does MWSS’ possible default … result in the National Government’s assumptions of responsibility for repayment. In other words, it appears that the draft JV agreement, as the parties intended and worded, does not result in a direct government guarantee in favor of MWSS.”

More than a mere disagreement over the correct definition of a government guarantee, the dispute between the OGCC and MWSS, on one hand, and the NEDA, on the other, is at heart a debate on whether the government should agree, once more, to take on commercial risks.

The trade-off is assured water supply for Metro Manila. With Laiban in place, the capital region will have a second and more secure source of water that can supply an additional 1,900 million liters per day (MLD). The entire volume, however, may or may not be needed by the time the dam is completed in 2015. The concessionaires are projecting they will need at most  4,450 MLD of water only by 2015,  instead of the 5,600 MLD that is being projected by the MWSS.

It’s not easy weighing the trade-offs. It’s just too bad that Filipino taxpayers – who may be saddled with multibillion-peso obligations on account of Laiban dam – are just starting to get into the discussion even as the MWSS is moving closer, faster to awarding the deal to San Miguel.  – PCIJ, 2009