The closing of the Port of Miami Tunnel Project deal was just short of miraculous, given the tight financial markets and the political ups and downs of the project procurement. Novel risk allocations helped ensure the success of the deal. The current issue of Public Works Finance includes an excerpted discussion of the risks and the way the Florida Department of Transportation chose to address them. The full text of Port of Miami Tunnel: Digging Through Novel Risks is available on Infra Insight.
Port of Miami Tunnel: Digging Through Novel Risks
By Brandon Davis and Patrick Harder
On October 15th, the landmark Port of Miami Tunnel and Access Improvement Project reached financial close, eliciting a collective sigh of relief from those who participated in the 45-month procurement. Work could finally begin on the technically challenging $900 million project that will result in a tunnel under Biscayne Bay connecting the Port of Miami with I-395, thereby allowing truck and bus traffic to bypass Downtown Miami Streets.
Florida is home to many things, but not to complex tunneling projects. Compounding the issues created by this project’s novelty was the fact that it was the Florida Department of Transportation’s (FDOT) first procurement for a true public-private partnership. Instead of lowering its head like a University of Florida fullback intent on powering the ball to the goal line by brute force, FDOT kept its head up and reconsidered its standard risk allocations. In doing so, FDOT nimbly protected both the public’s interest and ensured the private sector remained interested.
To this end, FDOT kept an open mind, engaging the private sector early and often. From the industry forum in 2005, to sitting down with the selected proposer (the Miami Access Tunnel consortium) and discussing problems with its lead equity member and the slowing economy, FDOT considered many novel risk allocations. The following four stood out.
1. Changed Geotechnical Conditions
Because the geology under Biscayne Bay is porous and undisputedly unpredictable, the Port of Miami Tunnel project would be a challenging project for even for the most experienced tunneling contractors. Discovery of large voids or other unforeseen ground conditions during tunneling will undoubtedly lead to delays and increased costs. FDOT knew that it could not bear this risk all by itself. At the same time, if it shifted all of the risk of changed geotechnical conditions to the private sector, either no one would bid or the bids would skyrocket.
To address these countervailing concerns, FDOT came up with the following risk sharing solution:
a) The first $10 million of extra costs due to changed geotechnical conditions is the concessionaire’s responsibility;
b) The next $150 million is FDOT’s responsibility (paid out of a contingency reserve containing FDOT and Miami-Dade County funds); and
c) The next $20 million is covered by the concessionaire.
Over this threshold ($180 million), either party may choose to terminate the agreement. This allocation ensures that the private sector will have “skin in the game” without the threat of losing its shirt.
2. Named Windstorms (Hurricanes)
Florida’s hurricanes are as famous as its college football teams. So the shortlisted proposers were understandably concerned about the possibility of hurricanes wreaking havoc on the project. After considerable negotiations, FDOT decided to address the risk by agreeing to cover property damage costs resulting from a named windstorm (any storm severe enough for the government to name it), provided that the concessionaire:
a) Complies with the procedures in the Hurricane Readiness Plan prepared by the concessionaire and approved by FDOT;
b) Complies with storm-related directives issued by the Port of Miami or other governmental entities; and
c) Covers the first $1 million of damage caused by each storm (with a maximum liability of $3 million each year).
FDOT also agreed that if a named windstorm causes a project delay, it will extend the concessionaire’s construction completion deadlines.
Why did FDOT decide to shoulder this risk? If shifted to the private sector, FDOT would pay the cost for this risk through higher bids regardless of whether any hurricanes occur during project construction or not. In addition, the private sector may not have been able to obtain insurance to mitigate the risk of damage caused by a hurricane and the unavailability of insurance would have further increased bids. In contrast, by taking on this risk, FDOT got the benefit of lower pricing from the private sector and the ability to mitigate the risk itself through a combination of federal emergency funds and other similar sources if a hurricane were to cause extensive damage. Simply put, FDOT determined that it was more cost effective to keep this risk and hope that the only hurricanes near the project end up being students from the University of Miami.
3. Marine Transit of the Tunnel Boring Machine
Very few companies in the world manufacture tunnel boring machines (TBM) big enough to bore the twin 42-foot tunnels for the project. Since all of these manufacturers are outside the United States the concessionaire will need to transport the TBM over open water. The concessionaire was willing to assume the risk of losing or damaging the TBM in transit. The banks, however, were not. A few weeks prior to financial close the banks demanded time relief in the event the TBM joins the Titanic at the bottom of the Atlantic.
FDOT could have dug in its heels and rejected this request. Instead, FDOT kept an open mind. Ultimately, FDOT agreed to extend construction deadlines if the loss or damage results in at least 60 days of project delay, provided that the ship transporting the TBM was seaworthy. This compromise enables the concessionaire to avoid default if forced to replace its TBM (which takes a year or longer), though it does not extend the term of the concession or otherwise provide for monetary relief.
4. Bonding Requirements
Florida law required contractors on public works projects to provide surety bonds covering 100 percent of the contract price. Although such requirements are common, they can by themselves undermine PPP programs because the surety market does not provide bonds big enough to cover the contract price of many PPP projects. Nevertheless, legislatures are slow to pull back these requirements due to concerns that the state and local subcontractors will be unprotected if there is a default by the prime contractor.
To resolve this problem, FDOT spearheaded an effort to enact legislation in 2007 that permits FDOT to reduce bonding requirements for larger projects, as long as the private sector provides alternate security for the balance of the uncovered contract amount. With this revision in hand, FDOT was able to require payment and performance security that are obtainable in the market. This security, coupled with other project-appropriate tools, provides FDOT and local subcontractors with the protection they need in case of concessionaire default.
Although the Port of Miami Tunnel Project is novel in many ways, the construction industry generally, and the PPP market in particular, can learn from the deal. Specifically, as documented above, the industry can learn the value of early and active engagements between the sponsoring agencies and proposers regarding their concerns and re-assessing standard risk allocations when appropriate. At the end of the day, this approach played a key role in enabling FDOT to reach financial close on a project unlike any other in the state’s history, despite the worst recession in decades.
Nossaman LLP attorneys Patrick Harder and Brandon Davis served as lead outside legal counsel to the Florida DOT on both the Port of Miami Tunnel Project and the recently closed I-595 Corridor Roadway Improvements Project.