The government of the state where this blog is produced is in a pickle.
Prior to an election last November the then Opposition promised to cancel or defeat in court a contract for a big controversial road tunnel. The tunnel, worth perhaps $6 to $10 billion dollars, has not been built yet. Nothing beyond planning has commenced
Now the former Opposition are in power, they are finding that the old government left them a poison pill.
If the road is not built for any reason, the government must pay the company that would have built it $1.1 billion. This clause was added by the previous government. The companies might have done only $50 million of preparatory work – being generous here – but they get paid $1.1 billion simply for missing out on finishing the job.
Ignoring for a moment the morality of inserting such a clause into a contract (it’s vile, wasteful, ridiculous, and would in a better world result in a range of senior bureaucrats and politicians going to jail), we turn our minds to how the present government can deal with it.
There are three main options.
1. Avoid the payment and make the road. This would involve reneging on a major election promise, but you don’t waste the money.
2. Avoid the road and make the payment. This would gift a billion dollars from an indebted state government to a consortium of companies including Lend Lease Group, worth $9 billion, Acciona, worth €3.6 billion and Bouygues SA, worth €10 billion. It would probably be politically convenient too.
3. Avoid both the road and the payment. The government has one big advantage. It makes laws. It can write legislation that annuls the offending contract. But the big risk in such a course of action is that it establishes an extremely unwelcome precedent that promised payments can be cancelled at whim by the government, and valid questions being raised about sovereign risk.
I want to look more closely at option three. Is there a way a law could be drafted that gets a just result and avoids sovereign risk? I think there might be.
Any law to cancel the payment provisions in the east-west link should:
1. Make it clear that this is a once-off by raising the hurdle for ever cancelling this kind of contract again.
For example, the Government could include a clause requiring that in future passing legislation that annuls any contract above a multi-billion dollar value threshold requires a supermajority in parliament, e.g. two-thirds of votes. The requirement for a super-majority should not apply to contracts where the cancellation provisions are substantially greater than the cost of the work done.
Sovereign risk only applies if a company can genuinely fear its contract provisions may be changed by legislative fiat. If they fear risk, they will raise prices.
Reducing the risk of such legislative action should attenuate the real costs of sovereign risk (although it won’t prevent the political costs of big companies mouthing off about it.)
2. Legislate against any future government ever introducing “poison pill” contract clauses into infrastructure contracts. (Part of me wonders if this law could apply retrospectively?)
3. Legislate that any large contract signed during the “caretaker period” in the lead-up to an election should be agreed upon by the leader of the Opposition as well as the Government, in order to prevent sneaky surprises. Part of the problem with the east-west link project was that it was never an election pledge, was controversial for 3.5 years, and with weeks before the election it looked set to lose, the government signed a contract.
Now. Could the state government of Victoria pass such legislation? It has a lower house majority, so it could pass it there, no problem. In the Upper house it holds just 14 of 40 seats. But The Greens have five, and they are likely to support such a plan. Then the government needs just a couple more, drawn from The Democratic Labour Party, the Sex Party, Shooters and Fishers, and Vote 1 Local Jobs. It might require some side promises, but it may be possible.
I welcome your thoughts and comments on this idea. Please leave a comment below, or hit me up on Twitter.