Legal risks with land transfer revenues in PPPs

By Jiang Fengtao and Liu Bing, Hengdu Law Firm
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In recent years, the public-private partnership (PPP) model has been widely used in the fields of infrastructure and public services. The state has also been vigorously promoting a deepening connection between PPPs and capital markets. Project operators can raise funds from capital markets through a variety of means, such as the issuance of bonds and capital securitization, to ensure the funding needs throughout the ecological chain of PPP projects, from launch, construction and operation, to exit.

Jiang Fengtao, Hengu Partner
Jiang Fengtao
Managing and founding partner
Hengu Partner

To promote the development of local PPP projects, local governments either introduce preferential policies or promise funding support. A prominent example is channeling land transfer revenues back to PPP projects, which mainly takes on three forms: first, using future land transfer revenues to support government investments in PPP project companies; second, using land transfer revenues as a source of repayment of debts owed to financing platform companies; and third, carrying out the “sharing of premiums” received from land transfers.

In the fourth quarter of 2016, the Ministry of Finance successively issued the Notice on Jointly Announcing the Third Batch of Public-Private Partnership Demonstration Projects and Accelerating the Construction of Demonstration Projects (No. 91), the Notice on Issuing (No. 92) and the Interim Measures for the Implementation of Monitoring of Local Government Debt by Financial Ombudsman Offices of the Ministry of Finance Throughout the Country. These clarified the budget management system for PPP projects and required competent authorities to incorporate government accountability for expenditures beyond the current year as agreed in PPP project contracts into medium-term fiscal plans, subject to approval by people’s governments at corresponding levels, and according to the budgeting procedures and requirements, incorporate revenues and expenditures for the next year specified in contracts that meet the requirements for budget management. Notice No. 91, meanwhile, stipulates that sources of funding for, and future profits from, PPPs and debt service obligations may not be linked to land transfer revenues.

The use of anticipated land transfer revenues as a source of funding for investment in the construction of PPPs may lead to project funding uncertainties, thus posing legal risks to project implementation.

Legal analysis

Is it a foregone conclusion that land transfer revenues cannot be used as a source of funding for government support for PPPs?

Liu Bing, Hengu Law Firm
Liu Bing
Corporate partner
Hengdu Law Firm

The answer is no. First, according to the Notice of the General Office of the State Council on Standardizing the Administration of the Collection and Expenditure of State-Owned Land Use Right Transfer Fees, the Notice of the Ministry of Finance and the Ministry of Land and Resources on Further Strengthening the Administration of the Collection and Expenditure of Land Transfer Fees, and other relevant regulations, the collection and expenditure of land transfer fees must be fully incorporated into the management of local fund budgets, with all revenues being paid into the local treasury and all expenditures being financed by land transfer revenues through local fund budgets, thoroughly separating revenues from expenditures. Special accounts dedicated to the collection and expenditure of land transfer fees must be set up in the local treasury.

Second, the Notice of the Ministry of Finance on Further Promoting Public-Private Partnerships in the Public Service Sector points out that government fund budgets may be arranged under a unified plan, and used to support PPPs, provided that doing so is in line with the policy direction and relevant regulations.

Finally, notice No. 92 explicitly stipulates: For PPP projects whose inclusion in medium-term fiscal plans has been agreed to by local governments, competent authorities must incorporate revenues and expenditures for the next year specified in contracts that meet the requirements for budget management according to the budgeting procedures and requirements, and after approval of revenue budgets for the next year by finance departments incorporate such revenues and expenditures into draft budgets, which, after being approved by governments at corresponding levels, must be submitted to people’s congresses at corresponding levels for consideration. Government expenditures on PPPs include expenditures incurred in connection with equity investments, operating subsidies, matching investments and risk acceptance, which, according to law or contracts, need to be met by government funds, as well as expenditures on special rewards and subsidies for PPPs granted by lower-level finance departments at the request of higher-level finance departments.

In summary, land transfer revenues should be fully incorporated into the management of government fund budgets and then arranged under a unified plan and used to support PPP projects. Local governments can give funding support to projects through a variety of means such as equity investments and operating subsidies. What notice No. 91 and the interim measures prohibit are irregularities such as directly using land transfer revenues to support government investments in PPP companies, or as a source of repayment of debts of PPP companies, or even carrying out the “sharing of premiums” without incorporating land transfer revenues into the management of government fund budgets.

In practice, governments and social capital should be vigilant against the legal risks of channeling land transfer revenues back to PPP projects and take timely remedial and preventive measures against existing or potential legal risks. The authors suggest that local governments should standardize the reward mechanism for channeling land transfer revenues back to PPPs within the framework of national laws, regulations and policies. To counter the legal risks of projects that have been implemented, governments and social capital may actively work together to develop new risk-sharing, profit distribution and compensation mechanisms and give funding support to PPPs according to laws and regulations.

Jiang Fengtao is the founding partner and Liu Bing is a partner at Hengdu Law Firm. Zhai Yiyang, an associate of the firm, co-authored the article

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