Toll Road Leasing Programs: Ready to Roll?

Part Two of a Two-Part Series

Part One of this series discussed precedent transactions and standard terms and conditions in the toll road leasing market. The conclusion continues the discussion of terms and conditions and addresses legislative developments.

Capital Improvements

Toll Road leases often contain provisions addressing development and financing of capital improvements to the relevant toll facility during the lease term. With respect to the Chicago Skyway and the Indiana Toll Road, for instance, the concessionaire is required to make certain capital improvements at its own cost, while other capital improvements are to be undertaken at the cost of the state. Most concessions provide that the state will continue to use its powers of condemnation as necessary to acquire any additional land required to implement such capital improvements. In addition, lessees often negotiate for the right to undertake lessee-initiated capital improvements that the lessee believes will improve the operational functionality ' and hence profitability ' of the roadway in question.

As mentioned above, lease concessions often contain provisions regarding mandatory capital improvements. For instance, the lease concession for the Indiana Toll Road requires both the concessionaire and the Indiana Finance Authority to make certain capital improvements set forth in schedules to the concession agreement. In addition, the lease concession for the Pocahontas Parkway requires Transurban to construct a 1.58-mile, four-lane extension connecting the Parkway to the Richmond International Airport, subject to Transurban's ability to secure $150 million in credit assistance under the Transportation Infrastructure Finance and Innovation Act. Transurban is required to conduct a competitive bid process for a design-build contract for the airport connector road. The VDOT may cancel the construction of the airport connector road if the projected development costs exceed $45,200,000. If it does not exercise its cancellation option, the VDOT is required to reimburse Transurban for all development costs exceeding that threshold.

Guarantees/Letters of Credit

Concessionaires may also be required to establish guarantees or letters of credit with respect to their obligations under the relevant lease concession. For instance, the lease concession for the Pocahontas Parkway requires Transurban to establish a cash reserve fund or letter of credit each year in an amount equal to the cost of any extraordinary maintenance and repair work projected to be performed for the following five-year period. Transurban is also required to deliver a letter of credit in an amount equal to 110% of any shortfall projected for the following year's budget for ordinary operating, maintenance, and repair costs (less projected toll and other revenues). Letters of credit may also be required in order to ensure that the concessionaire will continue to maintain for relevant toll facility during the final years of the lease concession. For instance, 10 years prior to the expiration of the lease concession for the Chicago Skyway, SCC is required to establish a letter of credit in favor of the concession grantor in an amount equal to the highest gross revenues received in the preceding 10 years. Similarly, six years prior to the expiration of the lease concession for the Indiana Toll Road, the ITR Concession Company is required to establish a letter of credit in favor of the Indiana Finance Authority in an amount sufficient to cover the costs of capital improvements required to be performed by the concessionaire during the remainder of the lease term.

Events of Default and Termination Rights

The concession agreements for each of the Chicago Skyway, the Indiana Toll Road, and the Pocahontas Parkway contain substantially similar events of default. Under each concession agreement, events of default are triggered upon a material breach of any representation or of any payment or other obligation under the relevant lease concession (subject to certain cure periods). Certain customary insolvency events will also trigger an event in default. In addition, each concessionaire will trigger an event of default under the relevant lease concession upon an unauthorized transfer of the concessionaire's leasehold rights in the relevant toll facility. Upon a default under any lease concession, the non-defaulting party may, among other remedies, terminate the concession agreement and seek to recover any losses arising from the default. Concession grantors also have the right to attempt to cure any concessionaire default.

Upon termination of any concession agreement, possession of the relevant toll facility and any related improvements will revert to the relevant concession grantor. In addition, each lease concession requires the lessor to pay out the fair market value of the lessee's interest in the concession lease if the lessee terminates the concession agreement upon a default by the lessor or if the lease is terminated other than pursuant to its terms. The lease concession for the Pocahontas Parkway also grants the Virginia Department of Transportation the unilateral right to terminate the lease concession for public convenience upon payment of the fair market value of Transurban's interest in the Parkway.

Under each lease concession, an independent third-party appraiser determines the fair market value of any payout. However, lease concessions such as that for the Indiana Toll Road may also require any such payout to be at least equal to the sum of outstanding indebtedness secured by the concession's leasehold interest in the relevant toll facility. The Indiana Finance Authority is also required to use its best efforts to lease or borrow against the Indiana Toll Road or its other assets in order to finance any such payout, with any deficiency to be appropriated from the state budget. Termination payouts may also include a guaranteed rate of return. For instance, any payout of the Pocahontas Parkway, whether upon an event of default or unilateral termination by the VDOT, is required to be at least equal to the sum of outstanding indebtedness secured by Transurban's interest in the Parkway, plus a guaranteed 10.5% rate of return for Transurban.

Adverse Legislative and Other State Action

Lease concessions may contain provisions protecting concessionaires against adverse legislative or other action taken by state legislatures or governmental authorities during the relevant lease term. For instance, with respect to the Chicago Skyway and the Indiana Toll Road, if any such action has a material adverse effect on the fair market value of the relevant concessionaire's interest in the toll road facility, the concession grantor may be required to compensate the concessionaire for any losses as they occur (including increased operating, capital, and maintenance costs as well as any lost toll road revenues). Alternatively, the concessionaire may terminate the lease concession and require the concession grantor to make a termination payout. The lease concession for the Pocahontas Parkway affords the concessionaire similar protections against adverse state action. Thus, the Virginia Department of Transportation is required to compensate Transurban for the adverse economic impact of discriminatory legislation and other state or local action (including any imposition or property taxes or license fee) or if the state expands the class of toll-exempt vehicles.

Third-Party Financing

Concession agreements may also contain provisions regarding the concessionaire's right to securitize any toll revenues or grant institutional lenders a security interest in its leasehold interest in the toll road. For instance, under the lease concession for the Indiana Toll Road, institutional lenders and beneficiaries of any securitization vehicle have a 30-day period to cure any default by the ITR Concession Company under the terms of the concession agreement. The concession agreement also grants such financing parties the right to foreclose on their interest in the toll road and to take possession of and manage the toll road upon a default under the terms of the relevant financing documentation. Upon foreclosure, the financing parties (or an approved transferee) will take the concessionaire's interest in the toll road subject to the concessionaire's obligations under the concession agreement. However, prior to the commencement of foreclosure proceedings, the Indiana Finance Authority has the right to purchase the interest of such financing parties in the toll road and any related revenues for the full amount secured by the toll road and related revenues. The Indiana Finance Authority will be able to secure funding for the purchase price through the appropriation process, by borrowing against the toll road or by re-leasing the toll road to a new concessionaire.

Toll Road Lease Concessions: Legislative Developments

Following the successful leasing of the Chicago Skyway, more than a dozen states enacted statutes authorizing public-private partnerships, including long-term leases of toll facilities. In addition to Indiana and Virginia, states that have enacted PPP legislation enabling the long-term lease of transportation facilities include Alabama, Alaska, Arizona, California, Colorado, Delaware, Georgia, Louisiana, Maryland, Minnesota, Missouri, Nevada, North Carolina, Oregon, Utah, and Washington. Similar legislation proposed in a number of other states, including New Jersey, remains subject to ongoing negotiation.

The U.S. Department of Transportation has prepared model legislation that identifies many of the key issues addressed in such enabling statutes, whether enacted or proposed. The model legislation sets forth provisions for the solicitation, evaluation, and selection of private sector PPP proposals, including lease proposals, as well as the evaluation and selection of unsolicited PPP proposals. After a solicited or unsolicited lease proposal has been selected, the winning contractor is required to enter into a public-private agreement with the state authority owning the relevant transportation facility. This agreement is required to contain certain mandatory provisions set forth in the model legislation, including provisions relating to the term of the lease, the nature of the contractor's operational or other responsibilities, actions the authority may take to ensure proper maintenance, toll fee determination and collection, and contract termination and amendment. Upon an event of default under the agreement, the model legislation permits the state authority to replace the operator or terminate the agreement. Additionally, the model legislation exempts any leased transportation facility from state property taxes and permits the authority to exercise state eminent domain powers to acquire the necessary property rights for the transportation facility.

California provides a representative example of PPP legislation authorizing toll road lease transactions. Under California Streets and Highway Section 143, the California Department of Transportation and certain regional transportation agencies have the sole right to 'solicit proposals, accept unsolicited proposals, negotiate and enter into comprehensive development lease agreements' for toll facilities. The statute sets forth certain procurement approaches that may be utilized in selecting private entities for leasing arrangements. After a period for public comment, a negotiated lease agreement must be submitted to the California state legislature, where the agreement will be deemed approved unless rejected by both houses within 60 days of submission. The statute also contains provisions regarding the terms of the lease concessions themselves that reflect many of the key issues identified above with respect to the concession agreements for the Chicago Skyway, Indiana Toll Road, and Pocahontas Parkway. Lease agreements are required to establish performance standards as well as specified toll or user fee rates, with any increase to be approved by the relevant state agency. Lessees are required to apply toll road revenues and user fees to capital and operation costs, expenses for state services, and a reasonable return on investment. Lease agreements may require any excess revenue to be applied to debt reduction or capital improvements or paid into the State Highway Account. The toll facility will revert to the relevant public agency upon any failure to comply with the lease agreement.

Conclusion

Although some commentators have called for a single national plan for leasing toll roads, states remain the primary incubators for toll road leasing programs. One advantage of this approach is to allow states to tailor their leasing programs to the highly specific physical, political, and economic factors applicable to each state roadway system. Lease terms that may make sense for an urban environment like Los Angles or Chicago may be inappropriate for more rural areas such as Texas. Single concession payment transactions such as those adopted in Illinois and Indiana may not be as attractive to some states as programs that provide for ongoing toll revenue sharing. Regardless of whether a truly uniform market in this area develops, or more of a state-by-state approach remains the norm, it seems likely that toll road leasing programs are gaining both traction and speed.

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 Two of a Two-Part Series

Part One of this series discussed precedent transactions and standard terms and conditions in the toll road leasing market. The conclusion continues the discussion of terms and conditions and addresses legislative developments.

Capital Improvements

Toll Road leases often contain provisions addressing development and financing of capital improvements to the relevant toll facility during the lease term. With respect to the Chicago Skyway and the Indiana Toll Road, for instance, the concessionaire is required to make certain capital improvements at its own cost, while other capital improvements are to be undertaken at the cost of the state. Most concessions provide that the state will continue to use its powers of condemnation as necessary to acquire any additional land required to implement such capital improvements. In addition, lessees often negotiate for the right to undertake lessee-initiated capital improvements that the lessee believes will improve the operational functionality ' and hence profitability ' of the roadway in question.

As mentioned above, lease concessions often contain provisions regarding mandatory capital improvements. For instance, the lease concession for the Indiana Toll Road requires both the concessionaire and the Indiana Finance Authority to make certain capital improvements set forth in schedules to the concession agreement. In addition, the lease concession for the Pocahontas Parkway requires Transurban to construct a 1.58-mile, four-lane extension connecting the Parkway to the Richmond International Airport, subject to Transurban's ability to secure $150 million in credit assistance under the Transportation Infrastructure Finance and Innovation Act. Transurban is required to conduct a competitive bid process for a design-build contract for the airport connector road. The VDOT may cancel the construction of the airport connector road if the projected development costs exceed $45,200,000. If it does not exercise its cancellation option, the VDOT is required to reimburse Transurban for all development costs exceeding that threshold.

Guarantees/Letters of Credit

Concessionaires may also be required to establish guarantees or letters of credit with respect to their obligations under the relevant lease concession. For instance, the lease concession for the Pocahontas Parkway requires Transurban to establish a cash reserve fund or letter of credit each year in an amount equal to the cost of any extraordinary maintenance and repair work projected to be performed for the following five-year period. Transurban is also required to deliver a letter of credit in an amount equal to 110% of any shortfall projected for the following year's budget for ordinary operating, maintenance, and repair costs (less projected toll and other revenues). Letters of credit may also be required in order to ensure that the concessionaire will continue to maintain for relevant toll facility during the final years of the lease concession. For instance, 10 years prior to the expiration of the lease concession for the Chicago Skyway, SCC is required to establish a letter of credit in favor of the concession grantor in an amount equal to the highest gross revenues received in the preceding 10 years. Similarly, six years prior to the expiration of the lease concession for the Indiana Toll Road, the ITR Concession Company is required to establish a letter of credit in favor of the Indiana Finance Authority in an amount sufficient to cover the costs of capital improvements required to be performed by the concessionaire during the remainder of the lease term.

Events of Default and Termination Rights

The concession agreements for each of the Chicago Skyway, the Indiana Toll Road, and the Pocahontas Parkway contain substantially similar events of default. Under each concession agreement, events of default are triggered upon a material breach of any representation or of any payment or other obligation under the relevant lease concession (subject to certain cure periods). Certain customary insolvency events will also trigger an event in default. In addition, each concessionaire will trigger an event of default under the relevant lease concession upon an unauthorized transfer of the concessionaire's leasehold rights in the relevant toll facility. Upon a default under any lease concession, the non-defaulting party may, among other remedies, terminate the concession agreement and seek to recover any losses arising from the default. Concession grantors also have the right to attempt to cure any concessionaire default.

Upon termination of any concession agreement, possession of the relevant toll facility and any related improvements will revert to the relevant concession grantor. In addition, each lease concession requires the lessor to pay out the fair market value of the lessee's interest in the concession lease if the lessee terminates the concession agreement upon a default by the lessor or if the lease is terminated other than pursuant to its terms. The lease concession for the Pocahontas Parkway also grants the Virginia Department of Transportation the unilateral right to terminate the lease concession for public convenience upon payment of the fair market value of Transurban's interest in the Parkway.

Under each lease concession, an independent third-party appraiser determines the fair market value of any payout. However, lease concessions such as that for the Indiana Toll Road may also require any such payout to be at least equal to the sum of outstanding indebtedness secured by the concession's leasehold interest in the relevant toll facility. The Indiana Finance Authority is also required to use its best efforts to lease or borrow against the Indiana Toll Road or its other assets in order to finance any such payout, with any deficiency to be appropriated from the state budget. Termination payouts may also include a guaranteed rate of return. For instance, any payout of the Pocahontas Parkway, whether upon an event of default or unilateral termination by the VDOT, is required to be at least equal to the sum of outstanding indebtedness secured by Transurban's interest in the Parkway, plus a guaranteed 10.5% rate of return for Transurban.

Adverse Legislative and Other State Action

Lease concessions may contain provisions protecting concessionaires against adverse legislative or other action taken by state legislatures or governmental authorities during the relevant lease term. For instance, with respect to the Chicago Skyway and the Indiana Toll Road, if any such action has a material adverse effect on the fair market value of the relevant concessionaire's interest in the toll road facility, the concession grantor may be required to compensate the concessionaire for any losses as they occur (including increased operating, capital, and maintenance costs as well as any lost toll road revenues). Alternatively, the concessionaire may terminate the lease concession and require the concession grantor to make a termination payout. The lease concession for the Pocahontas Parkway affords the concessionaire similar protections against adverse state action. Thus, the Virginia Department of Transportation is required to compensate Transurban for the adverse economic impact of discriminatory legislation and other state or local action (including any imposition or property taxes or license fee) or if the state expands the class of toll-exempt vehicles.

Third-Party Financing

Concession agreements may also contain provisions regarding the concessionaire's right to securitize any toll revenues or grant institutional lenders a security interest in its leasehold interest in the toll road. For instance, under the lease concession for the Indiana Toll Road, institutional lenders and beneficiaries of any securitization vehicle have a 30-day period to cure any default by the ITR Concession Company under the terms of the concession agreement. The concession agreement also grants such financing parties the right to foreclose on their interest in the toll road and to take possession of and manage the toll road upon a default under the terms of the relevant financing documentation. Upon foreclosure, the financing parties (or an approved transferee) will take the concessionaire's interest in the toll road subject to the concessionaire's obligations under the concession agreement. However, prior to the commencement of foreclosure proceedings, the Indiana Finance Authority has the right to purchase the interest of such financing parties in the toll road and any related revenues for the full amount secured by the toll road and related revenues. The Indiana Finance Authority will be able to secure funding for the purchase price through the appropriation process, by borrowing against the toll road or by re-leasing the toll road to a new concessionaire.

Toll Road Lease Concessions: Legislative Developments

Following the successful leasing of the Chicago Skyway, more than a dozen states enacted statutes authorizing public-private partnerships, including long-term leases of toll facilities. In addition to Indiana and Virginia, states that have enacted PPP legislation enabling the long-term lease of transportation facilities include Alabama, Alaska, Arizona, California, Colorado, Delaware, Georgia, Louisiana, Maryland, Minnesota, Missouri, Nevada, North Carolina, Oregon, Utah, and Washington. Similar legislation proposed in a number of other states, including New Jersey, remains subject to ongoing negotiation.

The U.S. Department of Transportation has prepared model legislation that identifies many of the key issues addressed in such enabling statutes, whether enacted or proposed. The model legislation sets forth provisions for the solicitation, evaluation, and selection of private sector PPP proposals, including lease proposals, as well as the evaluation and selection of unsolicited PPP proposals. After a solicited or unsolicited lease proposal has been selected, the winning contractor is required to enter into a public-private agreement with the state authority owning the relevant transportation facility. This agreement is required to contain certain mandatory provisions set forth in the model legislation, including provisions relating to the term of the lease, the nature of the contractor's operational or other responsibilities, actions the authority may take to ensure proper maintenance, toll fee determination and collection, and contract termination and amendment. Upon an event of default under the agreement, the model legislation permits the state authority to replace the operator or terminate the agreement. Additionally, the model legislation exempts any leased transportation facility from state property taxes and permits the authority to exercise state eminent domain powers to acquire the necessary property rights for the transportation facility.

California provides a representative example of PPP legislation authorizing toll road lease transactions. Under California Streets and Highway Section 143, the California Department of Transportation and certain regional transportation agencies have the sole right to 'solicit proposals, accept unsolicited proposals, negotiate and enter into comprehensive development lease agreements' for toll facilities. The statute sets forth certain procurement approaches that may be utilized in selecting private entities for leasing arrangements. After a period for public comment, a negotiated lease agreement must be submitted to the California state legislature, where the agreement will be deemed approved unless rejected by both houses within 60 days of submission. The statute also contains provisions regarding the terms of the lease concessions themselves that reflect many of the key issues identified above with respect to the concession agreements for the Chicago Skyway, Indiana Toll Road, and Pocahontas Parkway. Lease agreements are required to establish performance standards as well as specified toll or user fee rates, with any increase to be approved by the relevant state agency. Lessees are required to apply toll road revenues and user fees to capital and operation costs, expenses for state services, and a reasonable return on investment. Lease agreements may require any excess revenue to be applied to debt reduction or capital improvements or paid into the State Highway Account. The toll facility will revert to the relevant public agency upon any failure to comply with the lease agreement.

Conclusion

Although some commentators have called for a single national plan for leasing toll roads, states remain the primary incubators for toll road leasing programs. One advantage of this approach is to allow states to tailor their leasing programs to the highly specific physical, political, and economic factors applicable to each state roadway system. Lease terms that may make sense for an urban environment like Los Angles or Chicago may be inappropriate for more rural areas such as Texas. Single concession payment transactions such as those adopted in Illinois and Indiana may not be as attractive to some states as programs that provide for ongoing toll revenue sharing. Regardless of whether a truly uniform market in this area develops, or more of a state-by-state approach remains the norm, it seems likely that toll road leasing programs are gaining both traction and speed.

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.