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Purpose and Context:

The employer is introducing the private sector into the water and wastewater sector through afour year incentive management contract. If this is successful then the employer would look to

move to a more extensive contract. The operator collects revenues on behalf of the authority. The

operator is paid a fixed fee and an incentive fee, based on performance.

Whilst there is reference to new customers in the service standards, there is no specificmechanism or requirement for connecting neighborhoods.

Circumstances where this contract may be appropriate:

This form of contract is useful as an initial management contract, as part of a process for

introducing private sector involvement, where the government is willing to maintain the risk of

cost of operation of the assets and. It has some limited incentives for improvement of standardsand efficiency.

Main Features:

The operator is (i) to operate and maintain the water and wastewater facilities in order to

preserve and improve service standards, (ii) to invoice customers and collect revenues and takemeter readings, and (iii) preparation of the Annual Operating Investment Fund Plan and (iv) to

cooperate with the authorities in the implementation of the capital investment program (appendix

2, art. 2).

The contract is for 4 years, with the possibility of extending for a further 12 months.

The draft agreement does not state that the operator will have an exclusive right to provide the

services in the designated service area.

The operator is paid a base fee plus the Incentive Compensation (GC 6). It is paid in the currency

of the bid price.

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In the service standards and incentive compensation mechanism, the operator is to reach or

achieve certain standards, and there is no possibility in the contract for adjustment of standards inthe event that the asset condition or capacity is not capable of meeting these standards or if thedata on which these performance standards have been prepared is found to be inaccurate (this is

mitigated by the statement in the Service appendix, article 2 that except as stated elsewhere inthe contract the Operator is to perform the same level operations and maintenance of the

Facilities as were performed by the Employer in the Service Area in the Base Year. It is also notclear whether the Operator will be required to meet the performance standards in the event that

the employer fails to make the various operating and other investments.

The operator does not take on the risk of the cost of operation and maintenance or of financing

improvements. The risk for the operator is to be able to achieve and maintain the ServiceStandards. The operator is liable for performance of the services and for loss suffered by the

employer as a result of default by the operator. Aggregate liability is limited to the totalManagement Fixed Fee (other than in relation to criminal negligence or wilful misconduct), the

Operator is not liable for consequential and indirect loss (other than specified under [liquidateddamages]).

Specified staff of authority is to be seconded to the Operator under the Staffing Policy Index (GC

5.3(1)) and not transferred to the operator. However, under the Staffing Policy Index, their

salaries shall be determined by the employer and the operator shall not be responsible fordetermining rates of pay/ benefits/ hiring, firing or demotion. The operator can recommend merit

payments but this is subject to employer approval. It is therefore not clear that the operator willhave real authority over the staff. This will be a concern for the operator as under GC 3.5 the

operator is liable for acts of the Operations Staff under the supervisions of the operator.

Possible additional provisions that it might be appropriate to include:

It is not clear whether the employer is hoping to meet the needs of low income areas where this

is the desire, there should be clear provisions specifying provision to low income areas, how thisis to be achieved, whether through traditional service delivery or through standpipes etc, and

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create an incentive structure to encourage the operator to reach these poor areas in the life of thecontract.

Secondment rather than transfer of staff is often the most practical approach to short-termmanagement contracts and may sometimes be the only method available in law. However,difficulties may arise in ensuring that staff feels that they report to the operator, rather than their

employer. This may be mitigated by the operator being able to recommend merit payments butthe employer does not need to follow it. It would also be helpful if the operator could make

recommendations for disciplinary measures, even where these are not binding on the employer.

The employer has the right to suspend payments in the event of failed performance by theoperator (GC 2.7). This is a harsh and unusual provision as the employer is entitled to suspendperformance for any failure, not just a material failure to the Operator. If such a provision is to be

included there should be materiality included, the employer should furnish evidence of thefailure and the suspension should be only in relation to a portion of the payments. A better

mechanism might be to impose liquidated damages for certain breaches/ non-performance.

It might be helpful to include a clause allowing the Employer to suspend services in the event ofan emergency.

The employer is entitled to terminate for convenience (GC 2.8.1(f)). The operator will not be

compensated for loss of profits in such a circumstance and this will be resisted by a bidder asthey will be anxious to ensure that the employer does not terminate the contract for no good

cause.

The operator is taking on the risk of the asset condition and performance of the system. Whilst

performance is based initially on the performance of the employer in the year prior to contractcommencement, and in limited areas base year data is established in the first weeks of the

contract (appendix 2, art 2), there is no clear mechanism for the performance standards being

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amended or indeed for variation of the contract in the event that performance standards prove tobe unrealistic.

Force Majeure (GC 2.6) as the operator is operating a whole system, rather than an individualasset, the operator may be prevented from operating part of the following an event of Force

Majeure. The drafting could be adjusted to take this into account.

Fairness and good faith (GC 7) - it is not clear why this clause has been included in a civil law

jurisdiction there is likely to be a similar concept incorporate into law is this supposed to

supplement/ reflect/ supersede it? In a common law jurisdiction there is no such understood

concept other than doctrines preventing a party from benefiting from fraud/ negligentmisrepresentation a court in a common law jurisdiction/ arbitral panel may have difficulties ininterpreting such a provision.

Settlement of Disputes (GC 8) consideration should be given as to whether expert

determination should be sought before resorting to arbitration. Parties should also consider

whether it is appropriate to have one or three arbitrators.

Provisions that may not be advisable to replicate/ may need further thought:

The employer has the right to suspend payments in the event of failed performance by the

operator (GC 2.7). This is a harsh and unusual provision as the employer is entitled to suspendperformance for any failure, not just a material failure to the Operator. If such a provision is to be

included there should be materiality included, the employer should furnish evidence of thefailure and the suspension should be only in relation to a portion of the payments. A better

mechanism might be to impose liquidated damages for certain breaches/ non-performance.

The employer is entitled to terminate for convenience (GC 2.8.1(f)). The operator will not be

compensated for loss of profits in such a circumstance and this will be resisted by a bidder as

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they will be anxious to ensure that the employer does not terminate the contract for no goodcause.

The operator is taking on the risk of the asset condition and performance of the system. Whilstperformance is based initially on the performance of the employer in the year prior to contract

commencement, and in limited areas base year data is established in the first weeks of thecontract (appendix 2, art 2), there is no clear mechanism for the performance standards being

amended or indeed for variation of the contract in the event that performance standards prove tobe unrealistic.

Provisions of wider general use:

The draft agreement contains provisions relating to exemption from tax of operator (GC 1.9),conflict of interest (GC 3.3), the possibility of a transition period following the end of the

contract (GC 2.4), appointment of a Project Management Unit on the part of the Employer to bethe day to day representative of the Employer (GC 5.5), provides for handover of assets and staff

on termination (GC 2.8.7). The Service Appendix and Incentive Compensation Appendix couldserve as precedents.

Experience Since Coming Into Force (including any amendments)/ if draft form, whether ithas been applied:

This contract proved to be successful, with reduction of leakages, illegal connections and more

accurate metering.

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Type of Agreement:

Management contract

Region (if known):

South America

Year of Agreement/ Draft:

2002

Annotation by:

Victoria Delmon, LEGPS, World Bank LEG VPU

Purpose and Context:

The host government is seeking (i) to improve and expand the existing system for drinking waterto achieve 24 hour supply, improve drinking water quality, expand customer base, ensure

effective treatment and disposal of sewage, improve water supplies to poor and hinterlandcommunities and achieve financial self-sufficiency.

Circumstances where this contract may be appropriate:

This form of contract is useful as an initial management contract, as part of a process for

introducing private sector involvement, where a water systems performance is uncertain and thegovernment is willing to maintain the risk of cost of operation of the assets and. It has some clearincentives for improvement of standards and efficiency.

Main Features:

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y The contract is for 5 years.

y This is a true performance-based management contract with little operational risk beingtransferred to the Operator but with performance incentives built into the contract.

y The Operator is to manage and maintain the water and sewage network for the country.The Operator is to provide the project manager who is to act as managing director of the

Employer and be a member of the board of directors of the Employer the services are tobe provided to the employer (clause 3.1.2) and the Operator will not have a direct

relationship with the customers. [this is unusual arrangement as the project manager mayfind itself with conflicts of interest]

y The Operator is to provide personnel for management and also work with the Employersown staff [exactly how this is achieved is unclear]. The contract is however much more

than a technical assistance arrangement for improving systems as the Operator hasextensive duties to manage and maintain the systems and is subject to detailed

performance obligations (set out in Schedule H), which is supported with incentivepayments.

yThe Operator submits each year a plan setting out external resources that will be requiredfor the following year.

y There is no reference to exclusivity of the Operator however this is implied as theOperator provides the managing director of the Employer.

y The operator is paid a base fee (adjusted in line with official index for salaries) plus theIncentive Compensation (cl 6). The fixed costs are to cover personnel etc so theOperator does not bear the risk of the cost of operations such as power

y Liability of the Operator is unclear as the Operator has a performance obligation of bestendeavours to provide the services. There is also a limitation of liability provision

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excluding liability for things which were not in the operators control this provision israther unusual and unclear.

yThe operator does not take on the risk of the cost of operation and maintenance or offinancing improvements. The risk for the operator is to be able to achieve and maintainthe Service Standards.

Possible additional provisions that it might be appropriate to include:

A stated objective of the contract is to extend services to low income ands rural areas there isno detail of how this is to be achieved, whether through traditional service delivery or through

standpipes etc, although part of the performance standards is increased service delivery to thehinterlands. It might be useful to include a more detailed plan of service delivery to poor areas,

service standards to be applied, billing arrangements in those areas etc.

It is unclear how the operator will assert its authority on the utility employees and how discipline

will be dealt with. This is a critical area as the operator will be dependent partly on performanceof the staff to achieve the performance standards. The clearest solution is to transfer employees

to the operator, however there are often legal/ union/ political restrictions on this and it is rare, inmanagement contracts at least, that this will be practical. Secondment of staff to the operator is

often the most practical approach to short-term management contracts and may sometimes be the

only method available in law. However, difficulties may still arise in ensuring that staff feel thatthey report to the operator, rather than their employer. This may be mitigated by the operatordeciding salary levels and requiring the employer to act in disciplinary matters. However, it is

not clear how the parties would resolve a dispute in the event that the operator recommended amember of staff for discipline and the authority refused to take action.

Clause 8 introduces concepts of the parties acting in fairness and good faith. The benefit of such

a provision is questionable because if the contract is located in a civil law system then there islikely to be a similar concept enshrined in law anyway and therefore reference here to it will notadd anything (and may cause confusion as to whether the parties were trying to include an

obligation different from that in law); in common law, there is no general principle allowing acontract to be avoided by reason of a party not acting in good faith (unless they are fraudulent or

have made a misrepresentation prior to contract signature) and so the courts might find it hard tointerpret the provision.

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