July 19, 2018
A. What Are Public Private Partnerships?
A public private partnership is a business relationship between a private sector partner and a public agency partner for the purpose of completing a project to serve the public. Public private partnerships may be used to finance, build, operate, and maintain projects such as public transportation, roadways, parks, convention centers, but at the core a public private partnership is really a form of “outsourcing” or, the oft misused term, “privatization.” Financing a project through a public-private partnership can allow a project to be completed sooner or make it a possibility in the first place. Public private partnerships typically have a revenue source (tolls or user fees) that may be utilized to finance the project in part. Public private partnerships also typically use private sector investment to finance the project when public funding is not available or immediately available. For example, a county government may be heavily in debt, but a private partner may have an interest in funding the construction and initial operating costs of a public project, in exchange for revenue sharing once the project is complete.
Public private partnerships take on many forms and functions. A P3 may involve a simple build-finance arrangement where the private partner finances a portion of the upfront construction costs for the project. On completion, the public partner operates and maintains the project with payment to the private partner coming in the form of a percentage of user fees over time. A P3 may involve a long term arrangement where the private sector partner designs, builds and finances a project and enters into a long term lease for a public entity to operate and maintain the project over time, with a portion of the revenues going to the private partner and some going to the public sector partner. At the end of the lease term the project is turned back over to the public partner for continued operation and maintenance and collection of revenues.
The classic example of a public private partnership is a toll bridge. A private partner pays for the initial upfront construction costs and obtains a concession agreement to operate the bridge (and collect tolls) for a predetermined period of time. At the end of the concession agreement the private partner turns over the bridge to the public authority, which then takes over operation and maintenance duties, but also toll collection. While the toll bridge is a classic example, public private partnerships have been used for public transportation, ferries, water and sewer systems, healthcare and electricity.
B. Origins of Public Private Partnerships.
The origins of public private partnerships are not precise, but what we today call a public private partnership has been a project delivery method for centuries. In the early days of the United States, transportation was a critical component for a growing nation. Private parties’ involvement in highway projects goes back to the late 1700s, with the first turnpike charter. Also around that time, one of the first private charters for bridge construction was granted, and, consequently, one of the first American court cases involving a public private partnership project. The issues raised in The Proprietors of Charles River Bridge v. The Proprietors of Warren Bridge, et al. 36 U.S. 420 (1837) demonstrate the dynamics of public private partnerships which are still present, at least in some degree, in public private partnership arrangements today.
In 1640, the state of Massachusetts granted Harvard College the power to run a ferry on the Charles River between Boston and Charlestown. Harvard had the power to run the ferry, and proceeded to do so and collect its profits for over 100 years. However, in 1785, the Charles River Bridge Company requested the state legislature to grant it the right to build a bridge across the river. The bridge’s proponents argued that the two towns had grown, and that the ferry was inconvenient. The request was granted, and the Charles River Bridge Company was given the right to build a bridge and collect tolls for 40 years. In recognition that Harvard College would lose ridership, the company would have to pay 200 pounds (about $700) annually to Harvard Collect to make up for its lost profits from the ferry. Also, after collecting tolls for 40 years, the Charles River Bridge Company would turn ownership of the bridge back over to the state. In 1792 the legislature extended the charter to seventy years from the opening of the bridge.
The bridge was incredibly successful, convenient for the public and quite profitable for the private owners. In the first forty years of its charter, the Charles River Bridge had collected almost $1 million in tolls. The original investors had sold their shares in the company for tidy sums to new investors. The public began to complain about having to continue to pay tolls after the bridge’s profits had exceeded the original cost of the bridge. The new investors did not care, they had paid dearly for their shares and refused to either improve service or lower tolls. Plans to construct more bridges arose. In 1828, the Massachusetts legislature granted another company a charter to build another bridge, the Warren Bridge, across the same river, between Cambridge and Boston. Predictably, the Charles River Bridge Company owners complained, arguing that the new bridge would siphon off traffic and revenue from their bridge. The legislature responded by giving the Charles River Bridge an additional 30 years to collect tolls.
Massachusetts created a slightly different deal for the Warren Bridge. The Warren Bridge was to be turned over to the state once it had collected tolls sufficient to pay for the building of the bridge, or, after 6 years, after which it would be free. Obviously, a free bridge would take all of the competing traffic from the Charles River Bridge. Construction of the Warren Bridge would significantly devalue the shares of the shareholders of the Charles River Bridge Company.
The Charles River Bridge Company sued the state of Massachusetts in federal court, arguing that the Massachusetts legislature had broken its contract with the Charles River Bridge Company. The Charles River Bridge Company argued that the charter they brokered in 1786 implied exclusive rights to the Charles River Bridge Company, and that the building of a new bridge that would be free to the public was essentially a taking of their property rights. The case went to the United States Supreme Court and was heard several times. The Court addressed whether the rights of a primary contract holder could be divested by a subsequent state law.
Ultimately, the Court concluded that a state law could be retroactive in character and not violate the U.S. Constitution unless the original obligation was rooted in contract. As a result, the Court found that the Charles River Bridge Company’s right to use the water was not exclusive, and was not impeded by defendant’s competing bridge.
The use of public private partnerships, particularly for highways dwindled in the early
1900s, particularly with the advent of the federal Highway Aid Acts which required each individual state to hire engineers to manage, design, and build highways using federal funds. A requirement that individual states hire as state employees the very professionals to whom work could be outsourced is clearly contrary to a public private partnership environment. Traditional procurement methods were utilized, with the public sector outsourcing only portions of its work, using traditional project delivery methods.
However, over the past 20 years, public private partnerships in the United States have increased substantially. The first public private partnership state legislation in the United States was in 1989 in California, followed by Virginia in 1995. In 2011, 18 states considered public private partnership legislation, and at least 22 states considered such legislation in the 2012 legislative sessions. Transportation remains the focus of state public private partnership activity, because state government has primary responsibility for owning, developing financing for, and operating transportation assets. As of January 2013, 33 states (and Puerto Rico) enacted laws authorizing P3 for highway and bridge projects.
States have taken different approaches to public private partnership legislation. These different approaches have reflected the different philosophies of the states. For example, some states, like Indiana and Virginia, have taken an aggressive approach to public private partnerships, others have taken a positive but cautious approach, such as Arkansas and Minnesota, while others have taken a more wait and see approach, such as Missouri and Tennessee. Some states have adopted legislation that allows for “pilot” or “demonstration” projects only, such as Illinois and North Carolina. Others, such as California and Florida have demonstrated an ongoing commitment to larger public private partnership programs, which include standardized procedures and streamlined processes for public and private sector. Some states require legislative approval for specific projects, as of October 2010, Delaware, Florida, Indiana, Maine, Michigan, North Carolina, Tennessee, Washington and West Virginia require some form of legislative approval for certain public private partnerships.
While the United States still lags behind other industrialized countries in utilizing this method, many states and the federal government have enacted laws to encourage public private partnerships and have undertaken such projects. Between 1990 and 2006, approximately $10 billion in such projects have been undertaken in the United States. While this still is just a fraction of the use of public private partnerships elsewhere (the United Kingdom financed $50 billion in transportation public private partnerships in that same 16 year period), the use of public private partnerships in the United States for infrastructure has increased fivefold from the 10 year period between 1998-2007 to the period between 2008 and 2010, just after the U.S. recession.
C. Reasons for Recent Movement Towards P3
A fiscal crisis in the public sector has led to the increased use of public private partnerships in the United States and elsewhere. Infrastructure needs have outpaced the public sector’s ability to borrow and obtain needed improvements and even maintenance of existing public assets. It has been said that the United States is at the dawn of a “replacement era” for its public infrastructure, because much of the public infrastructure is nearing the end of its useful life. For example, drinking water, a staple of public infrastructure, is provided to Americans by thousands of miles of underground pipes. Based on some estimates, most of this 100 year old underground infrastructure will have to be replaced within the next 30 years, at a cost of $250 billion.1 This figure does not include wastewater infrastructure, or the cost of new drinking water standards. Likewise, as recent spectacular bridge failures have made the news, it has been estimated that one in nine of the nation’s bridges are rates as “structurally deficient,” and Federal Highway Administration (FHWA) estimates for the cost of eliminating the deficient bridge backlog is in excess of $20.5 billion annually for the next 14 years.2 A public private partnership provides a method for funding infrastructure and other public services by allowing the public sector body to make a capital investment without incurring any borrowing on its own account.
In a typical public private partnership, the borrowing is incurred by the private sector entity implementing the project. From the public agency’s perspective, a public private partnership can be viewed as an “off the balance sheet” financing method to deliver new public assets, or improvements to existing ones.
Another reason for the increased use of public private partnerships is the increase in the private sector’s ability to provide services, and the market efficiencies that the private sector brings to the table. Public private partnerships enable the public entity to utilize the expertise and efficiencies of the private sector to deliver services and facilities that traditionally have been delivered by the public sector, either through public sector employees or by traditional procurement methods. While outsourcing has been a component of the provision of government services for a great while, the ability of the private sector to accomplish these tasks independently and with less oversight has continued to increase. In addition, the private sector is in many respects better suited to support the increased complexity of historically governmental tasks with an efficiency that is market driven.
1 Am. Water Works Ass'n, Dawn of the Replacement Era: Reinvesting in Drinking Water Infrastructure 10 (2001) (available at http://www.win water.org/reports/infrastructure.pdf).
2 Am. Society of Civil Engineers, Report Card for America’s Infrastructure: Bridges (2013) (available at http://www.infrastructurereportcard.org/bridges/).