What is a Build and Transfer Agreement?
Build and Transfer Agreements are particularly common in the context of construction of greenfield infrastructure projects to implement the concept of "transfer" of the built assets by the builder back to the owner. This involves an extension of time for completion of the Work under the Contract for the contractor to complete the building and transfer to the principal. On completion, a regulator typically certifies that construction has been completed according to the design and documentation.
The definition of "Build and Transfer" can vary , but the central theme is that a party other than the principal under a prime contract for construction of an asset will build such asset in accordance with the Contract and transfer to the principal upon completion. The purchaser of the asset pays the costs of construction and the delivery of the asset is used as a vehicle for investment. The Build and Transfer delivery model is very common in the case of greenfield assets such as water or wastewater treatment plants, rail systems or defence facilities.
Legal Structure of Build and Transfer Agreements
Build and Transfer Agreements are commercial contracts that grant the constructor the right to exclusively construct an asset until completion. In addition to grant of rights, typically grant is made of the right to manage the asset until it is operational. After this period, the asset passes to the employer and the constructor has no further remedies in relation to the works.
There are key legal elements that underpin any Build and Transfer Agreement. Parties entering are likely to be creating a joint venture, usually called an Asset Special Purpose Vehicle, although other structures can be used. In the first instance, therefore, they will need to address who their constituent members will be, how they will fund the overall project (through debt or equity) and how the cost of construction is to be apportioned.
From a contracting perspective, there will be the typical clauses that might be expected to make up a commercial contract of this nature, including those relating to payment (specific phrases may be used), dispute resolution (dispute boards are popular), termination and liabilities.
There is likely to be additional diligence in relation to intellectual property rights, in particular in respect of the parties’ rights to any plans, drawings, designs, specifications and other documents created in the course of the contract which may relate to the asset or the construction works, as well as the finished asset itself.
In addition, the parties will need to be careful to ensure that any adverse comments or clauses in project agreements do not inadvertently apply to the Build and Transfer Agreement (for example, those that would necessarily need to apply irrespective of whether the asset or institution was a movable or immovable good).
Advantages of Build and Transfer Agreements
Build and transfer agreements can be a practical alternative to traditional contracting methods for project development. The following are examples of the benefits often associated with using a build and transfer agreement. Reduction of costs. In many cases the process of planning, structuring, financing, designing and siting can in itself dramatically increase the cost of a project. If the developer, for example, can construct a cost-effective facility with a third-party contract, it avoids these additional costs. Under build and transfer agreements, there is also less need for capitalization and close financial scrutiny every time a minor change must be made. As a consequence, fewer disputes may arise, development is faster and costs are lower. More conservative risk assessment and classification. Although risk cannot be eliminated entirely, the construction company must assess risks at the outset and then monitor and manage the actual risks as they develop. In the end, if the construction company has successfully anticipated and accounted for risks, the developer will often receive the intended building at relatively minimal cost. Efficiency in design/construction. Often, because the builder both develops the project and constructs the project, the builder is able to build according to the pland rather than the project manager’s designs. Because the builder attempts to minimize costs, the builder is also likely to design the project according to minimum cost efficiency standards. In some cases this leads to efficiencies, increasing the value of the project. Retained loyalty. The developer’s commissioning of almost all project components – that is, the land, the design, the permit approvals, the construction, and the financing – fosters at atmosphere of trust and loyalty between the developer and the builder. In addition, the builder is not likely to sell project components to other companies directly competing with the developer. Reduced requirement for bonding by the developer. Because the builder is likely to take on a significant portion of the risk, its willingness to do so can reduce the risks typically required to be bonded by the developer. As a result, the developer is able to save substantially on bonding costs.
Issues and Risks with Build and Transfer Projects
While the terms of a standard build and transfer agreement typically provide for definite and clear parameters, significant risk accompanies such agreements. The defining feature of a build and transfer agreement is that the developer must obtain a land use and/or construction permit to build the project with all its infrastructure on the land being transferred. The developer is also expected to have obtained the required land use and construction permits with the various authorities. This places the burden on the developer to assume the risk and costs of approvals, which if unsuccessful, may be rejected. In such an event, disputes may arise about the status of the land and development expenses incurred up to that point in time. A build and transfer agreement may also be rendered defective if the developer is unable to obtain the required development rights/land use permits; in particular, in the case where land is transferred in pursuance of all requisite approvals being granted but, post-transfer, the construction permit is rejected. Another scenario that may arise is that the additional costs of approvals, such as environmental clearance, are spent post-transfer or during the construction phase/infrastructure provision phase. Such amounts may not be recoverable from the transferee upon the rejection of the construction permit and could place a significant burden on the developer (as transferor). There are no carved-out exceptions for obtaining requisite approvals since the developer voluntarily assumed the risk of obtaining and fulfilling all approvals.
Examples of Successful Build and Transfer Projects
The following sections provide case studies of successful build and transfer projects to provide examples of how this type of agreement has been effectively implemented. These case studies will focus on a range of key factors that contributed to the success of the projects, with particular regard to how the delivery of skilled physicians and specialists has underpinned their success.
In Japan, a large general hospital in Yokohama was seeking an effective specialty service that would satisfy a growing demand in the community. The hospital began by surveying the market to ascertain what demand their specialty services would have within the community. Once they had established that demand for the specialty services was growing steadily, the hospital determined that it would be best served outsourcing the demand through a highly specialized service that would be delivered by an external physician group. The specialist group that they chose was based in Korea. They had established a reputation for providing high-quality, patient-focused specialty services and were unanimous in their willingness to be involved in the venture. After a period of discussion, a build and transfer agreement was drawn up to focus on providing a high-end orthopedic service within the existing general hospital. The arrangement was refined over the course of six months to ensure that both parties were happy with the terms and a five-year plan was agreed upon to develop the service. This plan focused on recruitment of specialist staff from Korea, investment in equipment and facilities, and the establishment of a training service within the hospital to teach existing Japanese physicians the effective delivery of specialist orthopedic care. The service was hugely successful, generating more than the projected revenue and establishing a reputation as the pre-eminent orthopedic clinic in the area, and this case study includes a later section that discusses some of the lessons learned from this agreement that further enhanced its success. A second example took place in Malaysia, where a general hospital was enlisted to deliver a palliative care service for a newly built hospital . When the public hospital was taken over by a private company, it retained its status as the region’s only referral center and began to work with the new facility to offer a specialized palliative care service for the new hospital. Because the project was long-term in scale, the two groups were able to make the arrangements that were necessary to successfully implement the project in the long run after just a year of planning. After communicating this to the private hospital, the process of developing a plan of action began. Again, there were a number of factors that had become apparent during the planning phase that informed the final plan. One such factor was the lack of existing palliative care services in the area. Although the majority of physicians that end up going into palliative care practice will have some exposure to the field as part of their residency program, the fact remains that not all physicians specialize in palliative care and many instead prefer to spend as little time as possible in this specialized field. The practice must be brought in to meet demand for this specialization and, over a period of time, the pace of paediatric death in the area decreased. Yet another case study is that of a large general hospital in Tainan, Taiwan that had operated as a single proprietary hospital for many decades prior to an acquisition by the state. The only independent hospital within the area, upon acquiring the hospital every effort was made to ensure that they maintained the level of care that had been established by the offering of quality services within the region’s only pediatric department. The delivery of these services required a revision of the hospital’s management strategies to allow for the new style of service to reach fruition, but the hospital worked with industry experts to develop a comprehensive plan with an operational focus. The department was allowed to operate autonomously but within the context of the larger hospital and upon the development of the pediatric service, the hospital was ranked among the highest in the country in terms of quality of services delivered and standard of care. The hospital then went on to replicate the arrangement with a number of other specialized services.
Making a Build and Transfer Agreement
Beyond the basics, there are a handful of elements essential to any build and transfer agreement. The agreement needs to provide specifications and a schedule for developing the product, a way to evaluate expertise and assign responsibility for selecting the vendor, and a method for resolving disputes between the parties. In some cases, especially with less-experienced stakeholders, a build and transfer agreement may be used more as a negotiating tool than an actual agreement.
In addition to defining the scope of the system to be built, it is of utmost importance that the method for transferring knowledge from the vendor to the company is clearly defined. Inappropriate or incomplete knowledge transfer can result in considerable time and resources being wasted trying to determine why a finished product is not working as intended. When negotiating the final terms of the agreement, this is one of the most important points to convey to other stakeholders who may not see it as a priority because they do not have first-hand experience with such systems and transfers. The idea in the agreement is to specify the steps that will be taken to ensure a successful transfer and to define the deliverables of that transfer. This typically includes the documentation of all steps of the build process. The goal is to provide sufficient instruction that the company’s personnel are able to maintain a working system without needing the vendor on speed dial.
In addition to knowledge transfer, including clauses that provide for maintenance and support after the transfer can help ensure the system’s long-term usability. This can include maintenance to the system by the vendor, providing the company with a line of communication with the builder, and periodic updates. Depending on the project, it may be worth securing a service level agreement regarding response time for issues that arise once the system is live. As part of negotiating, it may be worthwhile to become involved as early as possible, which may help identify areas of contention at the negotiating table.
The Future Direction of Build and Transfer Agreements
As we move into an increasingly complex and interconnected world, emerging trends in technology and legal frameworks are expected to have a significant impact on build and transfer agreements. Some of the future trends we expect to see in the upcoming years include increasing usage of sophisticated methods of documentation, the use of smart contracts, and the incorporation of software as an integral part of the outputs of the contract.
The growing trend towards electronic record-keeping will make the order of quality assurance standards (e.g. ISO, CMM etc.) an important aspect to cover in the contract, since it is often overlooked and can give rise to liabilities if the quality assurance standards are not incorporated in the contract. As standards change over time, it is likely that the industry’s ability to quickly adapt and implement changes in existing projects will be a key factor in determining profitability. The use of electronic submission, review and approval of design documents, as typified by the Dutch planview / documentary review system, will provide an expected degree of flexibility in meeting such rising standards. This will further incentivize greater use of electronic record-keeping, storage, and distribution systems.
The use of "smart contracts" – self-executing contracts with the terms of the agreement between buyer and seller being directly written into code – is thought by some to be on the verge of widespread adoption. Although there currently are no widely adopted and universally sacred standards for a smart contract, this concept has the potential to simplify bargain and contract enforcement processes. It seems certain that the widespread use of smart contracts will be an important development for "consensus" based agreements (i.e. contracts ratified by all parties). Its use in the case of a build and transfer agreement, requires trust that the electronic means through which the final product is delivered will not be hacked or compromised . This is especially important because a build and transfer agreement usually involves products or services that may affect a third-party and benevolent action of one of the parties can have repercussions for a third-party. In addition, the possibility of creating a smart contract that automatically enforces compliance after permitting a lapse in force (by, for instance, a deficiency of insurance or of a bank guarantee) seems unlikely. The current understanding of build and transfer contracts considers liquidated damages as a penalty that cannot be enforced if not carefully drafted. However, it remains to be seen if a build and transfer contract could someday be ‘automatically’ complied with, consequently imposing a bond penalty without being expressly ratified by a court as an acceptable punishment.
With the development of computer based applications that allow for users to review project quality and defects, establishing clear protocols for deciding which defects are of what level and what steps must be taken to rectify them is an area that will need to be addressed in the contract. Because the distinction between slight and significant defects may have to be based on a scale that has no universally used standard, establishing the applicable protocol will be important in maintaining clarity in the contract.
Finally, as the global economy becomes more interconnected, it is important to consider the role of technology in regulatory compliance. The structure of a build and transfer contract, and the regulations that apply, must consider the possibility that an intervening political event at the future time of delivery could alter the terms of the contract, or its performance. Such an event could be the result of a cyber-attack on a nation’s information technology infrastructure or a change in government policy allowing a broad interpretation of an existing law.