Over the last decade, major developments in the applicable legal framework have led to the fast-tracking of development projects based on privatization and public private partnership models.
Project companies are the leading private actors in PPP projects, as the entire structure stems from project agreements executed between project companies and Turkish administrative bodies. These project companies are expected to complete projects on time and provide uninterrupted services during the operational phase, in compliance with the conditions set forth by the relevant ministry under the project agreements. To accomplish these goals, project companies must often rely heavily on the work of subcontractors. Due to the extensive variety of operational service assignments to subcontractors, assignments to sub-subcontractors become inevitable, especially in PPPs based on the BLT model.
Although the contractual relationship established between project companies and administrative bodies is crucial to ensure the sustainability of PPP projects, the vertical relationship between project companies and subcontractors plays an increasingly important role in implementing fundamental aspects of projects, particularly with respect to the fulfilment of operation and maintenance (“O&M”) services undertaken by the project companies.
Now that the construction phase of some BLT projects is approaching completion and the operational phase is about to begin, the focus has shifted to new players in the PPP game, specifically sub-subcontractors who specialize in O&M services. Each particular type of service within a PPP project is being assigned to sub-subcontractors depending on their area of expertise. These O&M services may be of a general nature, such as security, cleaning, and catering, or they may be specific to the relevant project type, such as providing medical support services (e.g., sterilization, imaging, and laboratory) or information technology systems in a hospital. Overall, the services of sub-subcontractors comprise a much needed part of PPP projects, especially when maintaining a flawless operation phase.
However, the Turkish legal system lacks a specific legal regime governing the sub-subcontracting relationship in PPP projects. Therefore, agreements executed between a subcontractor and a sub-subcontractor (“Sub-Contracting Agreement”) are of the utmost importance in terms of regulating the legal framework applicable to the vertical relationship between sub-subcontractors, subcontractors, and project companies.
In the absence of such specific legal regime, principles set forth under the Turkish Code of Obligations No. 6098 (“TCO”) will be applicable to the sub-contracting relationship. Depending on the specific elements of a sub-subcontracting relationship, provisions applicable to different contract types (e.g., freelance contract, service contract, proxy relation) may come into play. Under the TCO, a Sub-Contracting Agreement executed for establishment of an information technology system would typically be considered as an agreement under which the contractor undertakes to create a work, and the employer undertakes to pay an amount in return for the work created, but it may still include sui generis elements from different contract types under the TCO. Due to the complexity of legal structure, it will be highly crucial to determine pillars of the actual legal relationship to identify the applicable provisions of the TCO.
Failure to adequately reflect the rights and remedies available under the project agreement into the Sub-Contracting Agreement to the widest extent possible or to address issues specific to the sub-subcontractor’s position vis-à-vis the project company, may lead to disputes between the interested parties. To that end, below is a preliminary guideline in terms of material issues that may arise during the negotiation of a Sub-Contracting Agreement, particularly from the stand point of a sub-subcontractor:
Bilateral Agreement but Multiple Parties Involved
In practice, the Sub-Contracting Agreement may introduce an imbalance to the disadvantage of sub-subcontractors, whereby they are held liable, not only vis-à-vis the subcontractors (as their contractual counter party), but also vis-à-vis the project company along with the relevant ministry for certain obligations. In addition, such agreements may tend to vest rights in the project companies and the ministries to give instructions to the sub-subcontractors, regardless of the fact that the latter are not immediate contractual parties. Theoretically, the right of project companies or administrative bodies to interfere with or instruct sub-subcontractors may seem reasonable, but such a mechanism may result in an effectively unclear chain of command and practical chaos with different parties issuing different instructions and the likely problem of implementation resulting from contradictory instructions provided by different parties. In order to avoid such practical uncertainty, sub-subcontractors should be contractually bound to perform only the instructions of subcontractors (e.g., O&M contractors), but not those of the project companies or the administration, except under extreme circumstances where urgent action by the administration is required (such as natural disasters etc.).
Gaps in Information Flow
Given the absence of a direct link between sub-subcontractors and project companies or ministries, necessary measures should be implemented to ensure a well-structured information flow between the sub-subcontractor and subcontractor, so that the sub-subcontractor will receive timely information on the latest developments in the project (e.g., settlements or waivers). Delays in such information are likely to result in the sub-subcontractor not being able to exercise its rights under the Sub-Contracting Agreement in an efficient manner.
Sub-Contracting Agreements should be designed to allocate liability to the sub-subcontractor solely for its own acts or the acts of its own subcontractors, but not the acts or omissions of other parties involved in the project over which sub-subcontractor does not have any control, such as other sub-subcontractors, the ministry, and the project companies.
Given the nature of the vertical relationship between the project participants, payment to subcontractors may be dependent on the receipt of payments from the relevant ministry by the project companies, and then from the project companies to the subcontractors (O&M contractors). As the revenues of subcontractors depend on the cash flow at higher levels, they may be reluctant to make payments to the sub-subcontractors, because of late payments from their counter parties. To the extent uncertainty arising from such a waterfall structure is unacceptable to the sub-subcontractor from a commercial stance, parties may agree on a definite term for payments, taking into account all payment terms in the applicable vertical line up until the final chain above, including the relevant ministry, to minimize late-payment risk.
Return on Investment
The implementation of services undertaken by sub-subcontractors may require a significant amount of investment, such as the purchase and installation of heavy equipment, to be made prior to commencement of its services. Following the expiry or termination of the Sub-Contracting Agreement, subcontractors will most likely request to use the existing infrastructure developed and/or installed by the sub-subcontractor. While the investments by the sub-subcontractors are made with long term expectations, Sub-Contracting Agreements are usually executed in rather short contract periods (e.g., five years).
Such investments may leave the sub-subcontractors with the risk of not getting a return on their investment, if the agreement is terminated prior to the expiry of the Sub-Contracting Agreement. In order to overcome such risk, it may be useful to negotiate the inclusion of a termination fee payable to the sub-subcontractor in case of early termination triggered due to any reason other than a reason attributable to the sub-subcontractor. However, in BLTs after the relevant contract term expires, the O&M services will be subject to market testing, where the sub-subcontractors will be entitled to match the prices of other contestants and thus benefit from the value of their own initial investments.
While the foregoing items only provide a snapshot relating to the material issues that might be faced with respect to the sub-subcontracting relationship in PPPs, one may expect that the appetite for PPP projects in Turkey will introduce a greater portfolio of issues on Sub-Contracting Agreements, and experience will inevitably lead to solutions to accommodate the needs of sub-subcontractors in the PPP business who are farther down on the food chain.