Protection from regulatory risks

MANILA, Philippines—President Benigno Aquino anchored his election promise of liberating our people from the yoke of poverty on public-private partnerships (PPPs). Realizing that the government does not have the funds to build or to upgrade infrastructures like highways and airports to propel the economy, he invited private investors to provide the needed capital and expertise. He assured them of reasonable returns and of protection from “regulatory risks.”

Honoring agreements. The President explained, “if private investors are impeded from collecting contractually agreed fees—by the regulators, courts or the legislators—then our government will use its own resources to insure that they are kept whole.” He added that investors “cannot deal with a government where the right hand is offering a handshake and the left hand is trying to pick (their) pocket.”

Obviously, the President was responding to complaints that PPPs entered into by past administrations have not been honored by the courts, or that agreed toll fees for the rehabilitation of expressways have not been collected at the agreed time due to regulatory delays.

Immediately, the opposition led by House Minority Leader Edcel C. Lagman harrumphed the presidential policy as “heretical,” saying that government contracts are not “immune from judicial review by the Supreme Court and police power legislation by Congress.”

I do not doubt the President’s sincerity to honor contracts and to protect investors from duplicities. Supporting him is the constitutional provision barring the enactment of laws that “impair the obligations of contracts.” This provision however assumes that the contracts were entered into in accordance with existing laws. There is no protection for agreements that violate the Constitution or the laws.

The specific question is: May investors be protected from “regulatory risks?” The Supreme Court’s recent decision in Francisco vs Toll Regulatory Board (Oct. 19, 2010) answered in the negative. To start with, the Court unanimously upheld the legality of toll way PPPs. It ruled that the Toll Regulatory Board (TRB) is authorized to enter into PPP contracts (called Toll Operation Agreements or TOA) with a “qualified entity” to construct and operate toll ways for a maximum of 50 years. Moreover, the TRB is also authorized “to promulgate toll fees,” thereby becoming both a contracting party and a regulator at the same time.

Disadvantageous and unconstitutional. In regard to regulatory risks, the Court held that a contractual provision in which the TRB “warrants and so undertakes to compensate, on a monthly basis, the resulting loss of revenue due to the difference between the authorized toll rate actually collected and the authorized toll rate which (the private investor) would have been able to collect had the… adjustments (or increases in rates) been implemented” is “not only manifestly disadvantageous to the government but a manifest violation of the Constitution.”

The Court explained that this contractual clause contravenes a law, which states, “(n)o guarantee… shall be issued by any government agency… on any financing program of the toll operator…” Moreover, the clause also crosses the constitutional mandate that “(n)o money shall be paid out of the Treasury except in pursuance of an appropriation made by law.”

Thus, the Court concluded that this PPP clause, “under which the TRB warrants and undertakes to compensate (the investor’s) loss of revenue resulting from the non-implementation of the periodic and interim toll fee adjustment, is illegal, unconstitutional and hence void.”

Further, the Court said that “(e)ven with the existence of an automatic toll rate adjustment formula,” the TRB and the investors “should still comply with the twin legal requirements of publication and public hearing, the absence of which will nullify the imposition and collection of the new toll fees.” Finally, it added that investors are nonetheless entitled to a “reasonable rate of return on their investment” which “in no case shall exceed 12 percent.”

No motion for reconsideration. Considering the importance given by P-Noy to the protection of investors from regulatory risks, I wonder why the Office of the Solicitor General (OSG), as counsel for the government, did not ask for a reconsideration of this portion of the ruling.

The OSG could have argued that the protection clause is neither a prohibited guarantee nor a manifestly disadvantageous stipulation. Rather, it is merely a contractual obligation subject to appropriation by Congress; that it is simply an agreed compensation or liquidated damage for the breach of an obligation by a contracting party; and that liquidated damage is a normal stipulation in contracts.

An easy-to-understand example of liquidated damage is a clause in a construction contract in which the contractor agrees to pay the building owner a fixed amount of say P10,000 for every day of delay in the completion and delivery of the contracted edifice worth, say, P200 million.

P-Noy’s consolation is that the private respondents who stood to benefit by the clause in question did not also appeal the point. Apparently, the investors were happy with the main ruling upholding the legality of toll way PPPs entered into by the TRB. They did not mind the regulatory risk and would probably just take other steps to minimize it.

To guide investors in avoiding legal pitfalls, I will discuss next week why the Supreme Court struck down a number of past PPPs.

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