Conflicts between PPPs and the existing legal system

Although the Ministry of Finance, the National Development and Reform Commission (NDRC) and other departments have been issuing new policies on public-private partnerships (PPPs), our past experiences tell us that several existing conflicts between the PPP and the current Chinese legal system have not yet been effectively addressed, and investors may find themselves in an awkward predicament during their operation.

Conflicts with land system

Under current land policies, land use rights can be acquired by free allocation or compensatory granting, among other methods. Specifically, the methods of compensatory granting include invitation of bids, auction, listing and agreement. The law stipulates that land of a business nature – such as for industry, commerce, tourism, amusement and commercially developed residential premises – shall be granted by invitation of bid, auction and listing.

For commercial PPP projects, under the existing land system it’s highly likely that on one hand the government would choose the investors of PPP projects by invitation to bid, competitive negotiations, granting and other ways, while on the other hand, it has to grant the commercial land of PPP projects through public methods of invitation of bid, auction and listing, which may result in the failure of the investors to acquire the land use rights, although they have won the bid for PPP projects. This conflict is particularly sharp in PPP projects involving the integrated development of rail transportation with the land alongside.

Conflict with tax system

The promises of certain tax break policies made by local governments in PPP projects’ bidding documents, or the investment agreements signed with public investors, are in practice not always accepted by tax authorities due to the vertical leadership structure of tax authorities. In a PPP project of a stadium, on which we provided advice, the local tax authority rejected the local government’s promise of land value-added tax exemption and demanded tax from the public investors.

This conflict rendered the promise of tax break policies empty talk, which not only dampened the investors’ confidence in the local investment climate, but also jeopardised the integrity of the government.

Conflict with price system

Because the operating income of build-operate-transfer (BOT) projects is the key revenue for investors, the pricing and adjustment approaches directly affect the returns on investment for investors. However, for BOT projects that directly concern the public interest – such as railways and other infrastructure projects – the pricing and adjustment must be approved by local governments and commodity price bureaus, and investors have quite limited discretion on the charge rate, and they are also disadvantaged in their ability to adjust the rate in a timely manner based on operating cost or market demand. It takes a long time to adjust the charge rate, and once the price is set, it cannot be changed within a fixed period, which to some extent influences the operating income of investors.

Line 4 of the Beijing subway is a typical case. Pursuant to the project contracts, ticket price operations applied the management of state-prescribed prices and were charged by the meter. In the concession period, in accordance with relevant laws and the principle of equal price within one network, Beijing’s government enacted and issued the pricing policy of Line 4 and adjusted the price according to social and economic development. However, in practice, after operating for five years, the ticket price of Line 4 has just changed from a flat fare to tiered prices, ending the era of “RMB2 for anywhere”.

Conflict with state-owned equity

Asset buyback and equity buyback are two buyback approaches under build-transfer (BT) investment and financing mode. In BT projects entirely invested by the investors, the assets buyback (or buyback of 100% equity) is usually adopted. However, in other BT projects partly invested by the investors, the only way to repurchase is equity buyback, and this should not change the substantial character of BT investment and financing mode.

According to the Provisional Measures on Administration of Transfer of State-owned Property Rights in Enterprises, both state-owned assets and state-owned equity are of the same state-owned nature. Both are required to be transferred by being listed in property rights exchanges. If it is well accepted by the regulatory authorities and the professionals that the assets buyback in BT projects could proceed without being listed in property rights exchanges as required by the existing rules, it should also be accepted that equity buyback could proceed without being listed in property rights exchanges.

As a matter of fact, in a transfer agreed by both parties, the squandering of state-owned assets and the rigging of the transfer of state-owned property rights do not exist. Being listed in property rights exchanges cannot truthfully reflect the returns on equity investment of the investors, because most of the returns on equity investment in BT projects are achieved by construction profits.

Therefore, there are huge differences between equity buybacks in BT projects and the normally mentioned equity buybacks. Taking the payment of equity transfer price as an example, the payment in BT projects is usually paid out within three to five years after the delivery and acceptance of projects. In some projects, the interest is even paid within the construction period before the equity buyback.

All these circumstances are quite different from the requirement that all payment of equity transfer price shall be paid within one year as stipulated in the Provisional Measures on Administration of Transfer of State-owned Property Rights in Enterprises. If the requirements of being listed in property rights exchanges are applied mechanically, it would certainly compromise the projects requiring that each construction contract have two versions: the formal one and the real one – which would violate existing regulations and cause great inconvenience to the implementation of projects.

Apart from the above-mentioned conflicts, there are also conflicts in systems of project approvals, budgeting, government procurement, bid and tender, guarantee and others.

We expect that relevant legislative authorities will enact regulations with greater legal effects on PPPs, and could take the characteristics of PPPs into consideration to effectively link them up with the existing legal system and avoid the awkward situation that all parties become lost when facing these conflicts during the implementation of the projects.