For a long time, we have heard in different social media, for various reasons, some more positive than others, information related to Turnkey Contracts and the State indebtedness resulting from the Partial Payment Accounts (in Spanish, “Cuentas de Pago Parcial”) and Certificates of No Objection (in Spanish, “Certificados de No Objeción”). Do you know what these legal concepts that have been used to finance the largest State projects in the last two government administrations are? Let's get today into a few lines, because in the words of Rudyard Kipling "You learn more by what people talk to each other or by what it is understood, than by asking questions."
- What is a Turnkey Contract?
Turnkey Contracts are regulated by Law 22 of 2006, as amended from time to time, concerning public procurement. This same law defines this type of contracts as: “the one in which the contractor undertakes before the State to perform different services, that must include as a general rule, studies, designs, supplies and execution of a project for a determined global price by the bidder entity, in accordance with the provisions of the contract and of the tender documents”. These contracts may also include the equipment, operation of the project or any other provision within the contractor's obligations. In addition, the contractor must have its own financing for the project.
Consequently, the contractor accepts responsibility of the project delivery (taking over construction risk) but in addition to the operation, in the sense that the mandate must include as the term says, "turnkey", the project delivery ready to be put into operation by the State (for the purposes of this article I will refer to the State in general terms, without specifying or differentiating between Central Government, decentralized entities and public companies), which has carried out the correspondent bid.
The greatest responsibility assumed by the State in this type of contracts is the supervision of the construction of the respective project and payment to the contractor.
- What is a Partial Payment Account or a Certificate of No Objection?
First, is that both terms refer to the same type of legal instrument and have only been interchangeably used depending on the entity that issued them. For reference, the Ministry of Public Works, the Social Security Fund, Empresa de Transmisión Eléctrica, S.A. and the National Institute of Culture have named it as "Partial Payment Accounts"; nevertheless; the Ministry of Health and the Metro de Panamá have named it as "Certificate of No Objection." Therefore, from now on, we will call them the “Payment Documents”. Having clarified the above, the Payment Documents have been regulated through regulations and/or procedures adopted and promulgated by the respective entities as well as in the Turnkey Contracts. There is no law that regulates them.
In general terms, the main characteristics of the Payment Documents are:
- Once each Payment Document has been issued, it constitutes an autonomous, independent, unconditional and irrevocable obligation of the contracting entity for the amount expressed therein and is payable on the date indicated in the document without the possibility that once issued, the entity can make tax reductions, fines, penalties, compensations, deductions, claims or other withholdings.
- The contracting entity may only deduct or compensate amounts from the Payment Documents to be issued.
- Once the Payment Document is issued by the entity and endorsed by the General Comptroller of the Republic, contains the net amount to pay.
- Having issued and endorsed the Payment Document, the contracting entity will only have the resource to initiate corresponding legal proceedings against the respective contractor or the guarantor for taxes, fines, penalties, compensations, deductions, claims or other withholdings; and
- Payment Documents must be paid on the date indicated on them, even in the case of early termination, suspension or administrative resolution of the Turnkey Contract, regardless of the cause or claims between the contracting entity, the contractor and/or the bonding company, with respect to any matter related or not to the project and regardless of whether the project has been completed.
In accordance with the information published by the Ministry of Economy and Finance and on the website datosabiertos.gob.pa as of October 31st, 2019, there were Payment Documents that sum up the amount of US$834,770,000 (payable between October 2019 and until the year 2022) as detailed by contracting entity and by the respective project, on the website of the Ministry of Economy and Finance (www.mef.gob.pa) and www.datosabiertos.gob.pa.
- Why are Payment Documents attractive in financing?
Two important facts mentioned in previous answers: in Turnkey Contracts the contractor must have its own financing for the project and the inherent characteristics of the Payment Documents. Based on these two factors, the Payment Documents, as mean of payment for the contracting entities, turn the Turnkey Contracts into a way of securing and conserving the interest of financial entities in relevant State projects.
Financial institutions acquire the Payment Documents at a discount and the contractors assign these Payment Documents to the financial entities. The financial institutions are certain of the payment from the State on the date set forth in the Payment Document regardless of what happened with the respective work or project.
In case of non-payment by a contracting entity, provided that it is part of the Central Government of a Payment Document, there is always the possibility of suing the State, municipality or any other decentralized, autonomous or semi-autonomous entity, under the procedure established in the articles 1047 and 1048 of the Judicial Code.
- What does the issuance of Payment Documents represent for the State?
The Payment Documents do not represent a financial indebtedness to the State, that is, they are not shown in their finances as in the case of bonds issuance. The Payment Documents are accounts payable as a result of investment expenses, which are also of long duration and therefore, must be covered by subsequent general State budgets (the general budget of the State is approved annually).
Based on the foregoing, and since everything must be shown in the annual general state budget, the Ministry of Economy and Finance, for example, per each Turnkey Contract, must: (i) give its no objection to the conditions related to the dates and payment amounts of the work, as well as its duration and the total amount, prior to the call for bid; and (ii) once the bid has been awarded to a contractor, funding proposal must be delivered which will be subject to its review, negotiation and subsequent approval.
- How does the Social Tax Responsibility Law affect?
Law 34 of June 5, 2008 on Social Tax Responsibility, as amended from time to time, aims to establish rules, principles and methodologies to consolidate tax discipline in the financial management of the Public Sector. Said law and the General State Budget Law, refer to the term “Non-Financial Public Sector”, as the group of all the entities of the General Government (composed by the National Assembly, the General Comptroller of the Republic, the different ministries, the Judicial Authority, the Public Ministry and the Electoral Court) and Non-Financial Public Companies (industrial or commercial units owned by the Government that sell public goods and services on a large scale, and that are constituted as stock capital companies or of other type of legal status such as: the Colon Free Zone, the Panama Maritime Authority or the National Charity Lottery). The “Non-Financial Public Sector” differs from the total Public Sector which includes public financial institutions, deposit collectors, Empresa de Transmisión Eléctrica, S.A., Empresa Nacional de Autopistas, S.A., Aeropuerto Internacional Tocumen, S.A. and the Panama Canal Authority.
Article 10 of the Social Tax Responsibility Law provides that the annual laws of the General State Budget and the budget execution shall be subject to the guidelines of this law. In addition, it is set forth that the Gross Domestic Product of the reference shall be calculated by the National Statistics Institute of the General Comptroller of the Republic. The maximum limit of the Tax Balance deficit of the Non-Financial Public Sector will be of 3.50% of the Gross Domestic Product for fiscal year 2019, of 2.75% for fiscal year 2020, of 2.50% for fiscal year 2021 and 2.0% as of fiscal year 2023.
In addition, Article 13 of Executive Decree No. 52 dated June 3rd, 2019, which regulates the Social Tax Responsibility Law, establishes that the investment expenses to be made under the modalities of turnkey projects and of deferred payment projects in a tax term may not exceed 20% of the total investment expenses of the Non-Financial Public Sector in the respective fiscal period.
The use of this type of legal instruments as a form of payment allows contracting public entities to obtain greater efficiency in the financing of projects and to manage their annual budgets based on an agreed payment schedule. To the extent that the limits of the Social Tax Responsibility Law are met and complied, without requesting continuous waivers to these limits, they are still an efficient way to handle accounts payable debt due to the investment expenses necessary to keep public services at appropriate levels of services to the requirements of the population.
Kharla Aizpurua Olmos
Partner, Morgan & Morgan