Toll Road Leasing Programs: Ready to Roll?

Part One of a Two-Part Series

States have recently, and with growing enthusiasm, embraced the use of public-private partnerships ('PPPs') as a highly effective method for addressing the significant capital needs associated with developing, expanding, and/or operating major roadway systems. Some of the largest roadway PPP deals to date have utilized leasing structures, and many states have enacted, or are in the process of enacting, legislation authorizing and encouraging leasing as a method to privatize toll roads. Leasing allows for an innovative teaming approach to the development and operation of various transportation-related assets, from design and construction through operation and toll collection. Leasing not only allows public sector officials to take advantage of private sector innovation and efficiencies, but it also provides a vehicle by which states can create large pools of money ' sometimes in the billions of dollars ' to address immediate and significant capital requirements without raising property or income taxes on their residents.

Under a typical roadway lease concession, a private operator assumes responsibility for operating and maintaining (and sometimes developing or expanding) a given roadway system for a specified term, oftentimes in exchange for an upfront concession fee paid to the state. The state may not only receive this very significant upfront concession payment, but may also continue to receive future payments through a long-term revenue sharing arrangement. In turn, the operator is authorized to retain for its own use all tolls and other user charges earned by operation of the roadway, and frequently retains the right, over the duration of the lease, to establish the level of tolls and user charges, subject to an agreed pricing formula.

To date, three major toll roads have been leased to private operators in the United States, including the $1.83 billion 99-year lease of the Chicago Skyway in 2004 and the $3.8 billion 75-year lease of the Indiana Toll Road in 2006, both of which were awarded to joint ventures owned by Spain's Cintra Concesiones de Infraestructuras de Transporte S.A. and Australia's Macquarie Infrastructure Group. In addition, Virginia's Pocahontas Parkway was recently leased to Transurban, LLC, an Australian toll road operator, for a term of 99 years under a long-term revenue sharing arrangement. A review of these transactions reveals some of the key issues that often arise in the course of negotiating toll road lease concessions. This article also examines recent legislative developments, which have seen more than
20 states enact or propose enabling statutes, as more and more toll roads are identified as viable candidates for leasing.

Precedent Transactions

Chicago Skyway

Originally operated and maintained by Chicago's Department of Streets and Sanitation, the Chicago Skyway is a 7.8-mile toll road connecting the Dan Ryan Expressway to the Indiana Toll Road. On Oct. 28, 2004, the city of Chicago awarded a 99-year lease concession for the Chicago Skyway to the Skyway Concession Company, LLC ('SCC'), a 55/45 joint venture owned by Cintra and Macquarie. The Chicago City Council authorized the concession by a unanimous ordinance under the city's broad home powers under the Illinois Constitution. The concession represented the first long-term lease of an existing toll road in the United States. SCC paid the city a one-time upfront concession fee of $1.83 billion, which was funded by equity contributions from each of Cintra and Macquarie in the amounts of $397 and $485 million, respectively, and by approximately $948 million in debt financing from a consortium of European banks. The city is not entitled to any further concession payments during the lease term. The city used the upfront concession fee to fund an $875 million reserve fund and a $100 million infrastructure fund as well as to pay off $855 million in Skyway debt and other city obligations. SCC assumed operation and maintenance responsibility for the Chicago Skyway on Jan. 26, 2006. SCC subsequently closed on a $1.55 billion refinancing in August 2006, the first capital markets financing for a European PPP style road concession in the United States.

Indiana Toll Road

The Indiana Toll Road stretches 156 miles across the northern part of Indiana from the Ohio border to the Illinois state line, where it provides the primary connection to the Chicago Skyway. On April 12, 2006, the Indiana Finance Authority signed a 75-year lease concession for the toll road and certain related facilities with ITR Concession Company LLC, a 50/50 joint venture between Cintra and Macquarie. The lease concession was awarded upon completion of a 117-day bid process, the fastest in the history of such transactions, according to Indiana Governor Mitch Daniels. The lease concession was authorized pursuant to House Enrolled Act 1008 (also known as 'Major Moves'), a statutory provision that allows the Indiana Finance Authority to enter into PPP agreements for toll roads for up to 75 years. The concessionaire was required to pay $3.8 billion to the Indiana Finance Authority as a single upfront concession fee for the 75-year lease concession. The Indiana Finance Authority is not entitled to any further concession payments during the lease term. The concession fee was funded in a 60:40 debt to equity ratio, in the form of $385 million in equity contributions from each of Cintra and Macquarie and $3.030 billion in debt financing from a consortium of seven European banks. The Indiana Finance Authority used certain proceeds from the concession fee to pay off toll road bonds and other obligations secured by the toll road and related toll revenues. The concession fee was also used to finance the Major Moves program, Indiana's 10-year transportation spending initiative, which includes funding for more than 400 highway construction projects throughout the state. The Indiana Finance Authority was thereby able to close the state's $2.8 billion highway funding gap without raising state taxes.

Pocahontas Parkway

The Pocahontas Parkway (Route 895) is an 8.8-mile toll road seven miles south of Richmond, VA. Completed on Sept. 20, 2002, the Pocahontas Parkway was developed and built by a joint venture of Fluor Daniel and Morrison Knudsen and represents the first construction project implemented under Virginia's Public-Private Transportation Act of 1995. On June 29, 2006, Transurban acquired the lease rights to the Pocahontas Parkway for a term of 99 years after submitting an unsolicited proposal to the Virginia Department of Transportation ('VDOT'). The lease was authorized pursuant to Virginia's Public-Private Transportation Act of 1995, which had been modified during the 2005 legislative session to allow private entities such as Transurban to 'own, lease or acquire any other right to use or develop and/or operate' transportation facilities such as the Parkway. As consideration for the lease concession, Transurban agreed to pay off all outstanding debt of the existing operator, the Pocahontas Parkway Association ('PPA'). Transurban also agreed to reimburse certain maintenance and other expenses incurred by VDOT with respect to the parkway. These debt and reimbursement payments were financed in a 70:30 debt to equity ratio, in the form of a $191 million equity contribution from Transurban and $420 million in senior debt from a consortium of European banks. Unlike the Chicago Skyway and the Indiana Toll Road, however, the VDOT is entitled to ongoing revenue sharing payments from Transurban throughout the lease term, as discussed in greater detail below.

Terms and Conditions

Although the toll road leasing market is still developing, and further innovations are more than likely, a review of completed transactions already indicates there are some basic terms that are becoming market standard. Many of these concepts are derived from customary net lease terms frequently found in big-ticket equipment leasing deals.

Operation and Maintenance Responsibilities

Toll road leases often require the relevant concessionaire, at its own cost, to operate, manage, maintain, rehabilitate, and toll the relevant toll facility throughout the applicable lease term. The lessee concessionaire is also required to reimburse the relevant concession grantor for costs incurred with respect to health and safety services ' such as police and fire services ' the state continues to provide notwithstanding the leasing of the toll road. The concessionaire is required to operate and maintain the toll facility in accordance with detailed specifications set forth in a schedule to the concession agreement as well as any rules and regulations of the relevant state transportation authority. The concessionaire may delegate its performance obligations to a qualified operator upon approval of the relevant concession grantor.

Tolling Arrangements

Toll road lease concessions grant the relevant concessionaire the right to fix, charge, and collect tolls from the relevant toll facility throughout the applicable lease term. Before making any distributions of toll revenues to the lessee's equity holders, each concessionaire is generally required to first pay debt service on indebtedness secured by the concessionaire's interest in the relevant toll facility as well as any operation, maintenance, and other costs associated with the toll facility. Under the lease concessions for the Chicago Skyway and the Indiana Toll Road, the concessionaire has the right to retain all toll revenues and is not required to share any revenues with the relevant concession grantor. However, as noted above, the lease concession for the Pocahontas Parkway contemplates a revenue sharing arrangement with the Virginia Department of Transportation. After obtaining a 6.5% internal rate of return on its total investment, Transurban is required to pay the VDOT a 'permit fee' equal to 40% of the gross revenues collected from the parkway. That fee is increased to 80% of gross revenues after Transurban obtains an 8% rate of return.

Toll rates are set in accordance with detailed provisions outlined in each concession agreement. For the Chicago Skyway, toll rates can, on average, be increased a maximum of 12.50% per year through Jan. 1, 2017 (for a total of a 150% increase in the initial 12-year term of the concession). For the Indiana Toll Road, tolls will be fixed at their current rate through 2010 (though it should be noted that Indiana Governor Mitch Daniels instituted an upfront toll increase just months before the lease became effective). For the Pocahontas Parkway, maximum toll levels are subject to periodic increases through Dec. 31, 2016. Upon expiration of the applicable rate increase schedule, toll rates are guaranteed to increase each year by 2% (in the case of the Chicago Skyway and the Indiana Toll Road) and 2.8% (in the case of the Pocahontas Parkway). In addition, each lease concession allows toll rates to be increased each year by a maximum of the annual CPI increase or, if greater, the annual growth in per capita GDP, after expiration of the applicable rate increase schedule.

Critics have argued that indexed rate increases will allow concessionaires to charge exorbitant toll rates. However, toll rates should remain constrained by the elasticity of consumer demand for transportation facilities, as consumers seek out lower-cost transportation alternatives in response to aggressive toll increases, thereby leading to a decrease in overall toll revenues. In this respect, it should be noted that the lease concession for the Chicago Skyway does not prohibit the city of Chicago from developing any new or existing highways or other transportation facilities that may compete with the Chicago Skyway. However, the Indiana Finance Authority is required to compensate the ITR Concession Company for any net income loss attributable to any state highway constructed during the lease term within 10 miles of the Indiana Toll Road.

The conclusion of this series will continue the discussion of terms and conditions, as well as discuss legislative developments.

Sven C. Hodges practices in the Global Projects Group of Paul, Hastings, Janofsky & Walker, LLP, in New York. Most recently, he advised clients on the development of a concessioned toll road in Peru.

Part One of a Two-Part Series

States have recently, and with growing enthusiasm, embraced the use of public-private partnerships ('PPPs') as a highly effective method for addressing the significant capital needs associated with developing, expanding, and/or operating major roadway systems. Some of the largest roadway PPP deals to date have utilized leasing structures, and many states have enacted, or are in the process of enacting, legislation authorizing and encouraging leasing as a method to privatize toll roads. Leasing allows for an innovative teaming approach to the development and operation of various transportation-related assets, from design and construction through operation and toll collection. Leasing not only allows public sector officials to take advantage of private sector innovation and efficiencies, but it also provides a vehicle by which states can create large pools of money ' sometimes in the billions of dollars ' to address immediate and significant capital requirements without raising property or income taxes on their residents.

Under a typical roadway lease concession, a private operator assumes responsibility for operating and maintaining (and sometimes developing or expanding) a given roadway system for a specified term, oftentimes in exchange for an upfront concession fee paid to the state. The state may not only receive this very significant upfront concession payment, but may also continue to receive future payments through a long-term revenue sharing arrangement. In turn, the operator is authorized to retain for its own use all tolls and other user charges earned by operation of the roadway, and frequently retains the right, over the duration of the lease, to establish the level of tolls and user charges, subject to an agreed pricing formula.

To date, three major toll roads have been leased to private operators in the United States, including the $1.83 billion 99-year lease of the Chicago Skyway in 2004 and the $3.8 billion 75-year lease of the Indiana Toll Road in 2006, both of which were awarded to joint ventures owned by Spain's Cintra Concesiones de Infraestructuras de Transporte S.A. and Australia's Macquarie Infrastructure Group. In addition, Virginia's Pocahontas Parkway was recently leased to Transurban, LLC, an Australian toll road operator, for a term of 99 years under a long-term revenue sharing arrangement. A review of these transactions reveals some of the key issues that often arise in the course of negotiating toll road lease concessions. This article also examines recent legislative developments, which have seen more than
20 states enact or propose enabling statutes, as more and more toll roads are identified as viable candidates for leasing.

Precedent Transactions

Chicago Skyway

Originally operated and maintained by Chicago's Department of Streets and Sanitation, the Chicago Skyway is a 7.8-mile toll road connecting the Dan Ryan Expressway to the Indiana Toll Road. On Oct. 28, 2004, the city of Chicago awarded a 99-year lease concession for the Chicago Skyway to the Skyway Concession Company, LLC ('SCC'), a 55/45 joint venture owned by Cintra and Macquarie. The Chicago City Council authorized the concession by a unanimous ordinance under the city's broad home powers under the Illinois Constitution. The concession represented the first long-term lease of an existing toll road in the United States. SCC paid the city a one-time upfront concession fee of $1.83 billion, which was funded by equity contributions from each of Cintra and Macquarie in the amounts of $397 and $485 million, respectively, and by approximately $948 million in debt financing from a consortium of European banks. The city is not entitled to any further concession payments during the lease term. The city used the upfront concession fee to fund an $875 million reserve fund and a $100 million infrastructure fund as well as to pay off $855 million in Skyway debt and other city obligations. SCC assumed operation and maintenance responsibility for the Chicago Skyway on Jan. 26, 2006. SCC subsequently closed on a $1.55 billion refinancing in August 2006, the first capital markets financing for a European PPP style road concession in the United States.

Indiana Toll Road

The Indiana Toll Road stretches 156 miles across the northern part of Indiana from the Ohio border to the Illinois state line, where it provides the primary connection to the Chicago Skyway. On April 12, 2006, the Indiana Finance Authority signed a 75-year lease concession for the toll road and certain related facilities with ITR Concession Company LLC, a 50/50 joint venture between Cintra and Macquarie. The lease concession was awarded upon completion of a 117-day bid process, the fastest in the history of such transactions, according to Indiana Governor Mitch Daniels. The lease concession was authorized pursuant to House Enrolled Act 1008 (also known as 'Major Moves'), a statutory provision that allows the Indiana Finance Authority to enter into PPP agreements for toll roads for up to 75 years. The concessionaire was required to pay $3.8 billion to the Indiana Finance Authority as a single upfront concession fee for the 75-year lease concession. The Indiana Finance Authority is not entitled to any further concession payments during the lease term. The concession fee was funded in a 60:40 debt to equity ratio, in the form of $385 million in equity contributions from each of Cintra and Macquarie and $3.030 billion in debt financing from a consortium of seven European banks. The Indiana Finance Authority used certain proceeds from the concession fee to pay off toll road bonds and other obligations secured by the toll road and related toll revenues. The concession fee was also used to finance the Major Moves program, Indiana's 10-year transportation spending initiative, which includes funding for more than 400 highway construction projects throughout the state. The Indiana Finance Authority was thereby able to close the state's $2.8 billion highway funding gap without raising state taxes.

Pocahontas Parkway

The Pocahontas Parkway (Route 895) is an 8.8-mile toll road seven miles south of Richmond, VA. Completed on Sept. 20, 2002, the Pocahontas Parkway was developed and built by a joint venture of Fluor Daniel and Morrison Knudsen and represents the first construction project implemented under Virginia's Public-Private Transportation Act of 1995. On June 29, 2006, Transurban acquired the lease rights to the Pocahontas Parkway for a term of 99 years after submitting an unsolicited proposal to the Virginia Department of Transportation ('VDOT'). The lease was authorized pursuant to Virginia's Public-Private Transportation Act of 1995, which had been modified during the 2005 legislative session to allow private entities such as Transurban to 'own, lease or acquire any other right to use or develop and/or operate' transportation facilities such as the Parkway. As consideration for the lease concession, Transurban agreed to pay off all outstanding debt of the existing operator, the Pocahontas Parkway Association ('PPA'). Transurban also agreed to reimburse certain maintenance and other expenses incurred by VDOT with respect to the parkway. These debt and reimbursement payments were financed in a 70:30 debt to equity ratio, in the form of a $191 million equity contribution from Transurban and $420 million in senior debt from a consortium of European banks. Unlike the Chicago Skyway and the Indiana Toll Road, however, the VDOT is entitled to ongoing revenue sharing payments from Transurban throughout the lease term, as discussed in greater detail below.

Terms and Conditions

Although the toll road leasing market is still developing, and further innovations are more than likely, a review of completed transactions already indicates there are some basic terms that are becoming market standard. Many of these concepts are derived from customary net lease terms frequently found in big-ticket equipment leasing deals.

Operation and Maintenance Responsibilities

Toll road leases often require the relevant concessionaire, at its own cost, to operate, manage, maintain, rehabilitate, and toll the relevant toll facility throughout the applicable lease term. The lessee concessionaire is also required to reimburse the relevant concession grantor for costs incurred with respect to health and safety services ' such as police and fire services ' the state continues to provide notwithstanding the leasing of the toll road. The concessionaire is required to operate and maintain the toll facility in accordance with detailed specifications set forth in a schedule to the concession agreement as well as any rules and regulations of the relevant state transportation authority. The concessionaire may delegate its performance obligations to a qualified operator upon approval of the relevant concession grantor.

Tolling Arrangements

Toll road lease concessions grant the relevant concessionaire the right to fix, charge, and collect tolls from the relevant toll facility throughout the applicable lease term. Before making any distributions of toll revenues to the lessee's equity holders, each concessionaire is generally required to first pay debt service on indebtedness secured by the concessionaire's interest in the relevant toll facility as well as any operation, maintenance, and other costs associated with the toll facility. Under the lease concessions for the Chicago Skyway and the Indiana Toll Road, the concessionaire has the right to retain all toll revenues and is not required to share any revenues with the relevant concession grantor. However, as noted above, the lease concession for the Pocahontas Parkway contemplates a revenue sharing arrangement with the Virginia Department of Transportation. After obtaining a 6.5% internal rate of return on its total investment, Transurban is required to pay the VDOT a 'permit fee' equal to 40% of the gross revenues collected from the parkway. That fee is increased to 80% of gross revenues after Transurban obtains an 8% rate of return.

Toll rates are set in accordance with detailed provisions outlined in each concession agreement. For the Chicago Skyway, toll rates can, on average, be increased a maximum of 12.50% per year through Jan. 1, 2017 (for a total of a 150% increase in the initial 12-year term of the concession). For the Indiana Toll Road, tolls will be fixed at their current rate through 2010 (though it should be noted that Indiana Governor Mitch Daniels instituted an upfront toll increase just months before the lease became effective). For the Pocahontas Parkway, maximum toll levels are subject to periodic increases through Dec. 31, 2016. Upon expiration of the applicable rate increase schedule, toll rates are guaranteed to increase each year by 2% (in the case of the Chicago Skyway and the Indiana Toll Road) and 2.8% (in the case of the Pocahontas Parkway). In addition, each lease concession allows toll rates to be increased each year by a maximum of the annual CPI increase or, if greater, the annual growth in per capita GDP, after expiration of the applicable rate increase schedule.

Critics have argued that indexed rate increases will allow concessionaires to charge exorbitant toll rates. However, toll rates should remain constrained by the elasticity of consumer demand for transportation facilities, as consumers seek out lower-cost transportation alternatives in response to aggressive toll increases, thereby leading to a decrease in overall toll revenues. In this respect, it should be noted that the lease concession for the Chicago Skyway does not prohibit the city of Chicago from developing any new or existing highways or other transportation facilities that may compete with the Chicago Skyway. However, the Indiana Finance Authority is required to compensate the ITR Concession Company for any net income loss attributable to any state highway constructed during the lease term within 10 miles of the Indiana Toll Road.

The conclusion of this series will continue the discussion of terms and conditions, as well as discuss legislative developments.

Sven C. Hodges practices in the Global Projects Group of Paul, Hastings, Janofsky & Walker, LLP, in New York. Most recently, he advised clients on the development of a concessioned toll road in Peru.