Potential Pitfalls in PPP Projects: Entering into a Subcontract Agreement on Back-to-Back Basis

Public private partnerships (PPP) are considered attractive liberal project financing models for governments. Turkey has been experimenting with PPP contracts since the early 1980s when the country was seeking to liberalize its economy. Since then, Turkey has extensively used PPP models in infrastructure, transportation, energy, and health care sectors. Despite heavily relying on the PPP model, Turkish legislation lacks sufficient protection towards sub-contractors with respect to back-to-back contracting and distribution of risk. The lack of proper legal regime pertaining to the rights of private sector parties is an obstacle both for the success and sustainability of PPP projects.

Specifically, the PPP structure is based on a series of tender contracts, often concluded between a special purpose vehicle (SPV) established by the successful tenderer and the administration whereby the SPV becomes the leading private party in that PPP project. The main obligations of SPVs arising from a successful tender usually include timely construction of the project and continuous performance of the public services specified therein. As PPP projects are comprised of complex specifications, they usually require various technical capabilities and input of specialized expertise. Hence, the SPV often chooses to sub-contract the works either fully or partially to achieve the results. Therefore, the allocation of risks and liabilities are passed down from the SPV to those sub-contractors through back-to-back contracts. 

In this interconnected set of agreements, the sub-contractor plays a crucial role as they agree to physically perform either all or a part of the works (or services) that the SPV has undertaken legally in the contract agreement. Thus, legal compatibility in this vertical back-to-back contractual basis is crucial to create and maintain a sustainable PPP project. 

As a further complication to the picture, in cases where a single sub-contractor is not specialized enough for the entire works and services, various subcontractors (and sub-subcontractors) specialized in different services such as security, technology, cleaning or laboratory services may be required. Hence, coherence of these sub-contracts become more important within the construction and operation of the projects as the burden and the risks shift down to sub-subcontractors. 

Despite the highly crucial role of the subcontracts, Turkish law lacks an effective mechanism to protect the rights of sub-contractors (and sub-subcontractors) in potential disputes. As the general reference point of contractual rights, the Turkish Code of Obligations (TCO) is the applicable legislation to the PPP agreements and sub-contracts resulting thereof. However, the TCO is not always sufficient for complex and large-scale disputes between contractors, sub-contractors, sub-subcontractors, SPVs and the administration. Since each contract in the back-to-back basis is separate, it is generally not possible to make a claim directly to the administration or the main contractor. This system is also preferable for the administration as they are only faced with claims from one party i.e. the successful tenderer. This is particularly disadvantageous for sub-subcontractors who can contractually make claims against only the party to that sub-subcontract.  

In practice, some sub-contracts contain relief clauses in the agreements enabling sub-contractors to claim parallel rights up the chain. However, in case the main contractors are organized as SPVs, they may possess little to no capital and assets. Hence, by the time, the sub-contractor manages to exercise parallel rights up the chain, they may be left empty handed, facing a shell company. 

This detriment of the subcontractors become particularly prominent in cases of pay when paid clauses which are often included in these types of models. Therefore, deductions made higher up the contract chain will affect the downstream flow of payments disturbing the income and commercial expectations of the subcontractor significantly. 

In summary, encountering problems in the PPP practice arising from insufficient downstream protection is highly common. Hence, potential solutions can be sought while drafting subcontracts (and sub-subcontracts) as specified below: 

• The risks contained in pay when paid clauses should be balanced out with rights of subcontractors to pursue parallel rights up the contract chain, potentially reaching the highest contracting party i.e. the administration.
• While doing so, the subcontract should contain a dispute resolution mechanism that allows pursuing such parallel rights. These mechanisms should either enable subcontractors to force their contracting party to take action higher up the contract chain or better yet, allow the subcontractor to directly bring claims higher up the contract chain themselves. Having such a dispute resolution mechanism with the option to co-fund claims higher up the contract chain may also be beneficial for parties to a subcontract. For example, if the administration defaults on their obligations, a co-fund mechanism would allow all of the subcontractors and successful tenderer to share the risks and costs of a potentially complex, expensive arbitration or litigation. 
• In case a subcontract is based on local currency, foreign exchange rate adjustment clauses will also protect these subcontractors from fluctuating income. 
• If possible, subcontractors that have significant negotiation leverage may also request a third-party guarantee from the administration which is only usually available to a successful tenderer depending on the type of PPP model.