Saving MRT 3

(Special to the BusinessMirror)

The contract to finance and implement the construction of a mass-transit line along Edsa, the Philippines’ busiest thoroughfare, was drawn up on August 8, 1997, between the Department of Transportation and Communications (DOTC) and the Metro Rail Transit Corp. (MRTC).

Under the Build-Lease-Transfer Agreement (BLT Agreement), the MRTC was obliged to construct MRT 3 in accordance with the specifications and drawings approved by the DOTC, maintain the system and procure all equipment to be used, including the rail vehicles.

The construction was financed through loans from various lenders, which were assumed by the Republic of the Philippines (RP) as direct obligor. The DOTC was required to pay the MRTC Equity Rental Payments (ERPs) based on an agreed 15-percent return on equity, the same to constitute direct, unconditional and general obligations of the government, and carry the full faith and credit of the RP.

The DOTC also assumed liability for the payment of value-added tax, withholding taxes, taxes on gross receipts and other business and real-estate taxes, documentary- stamps tax, and taxes on the importations of capital equipment to be used exclusively in the construction and operation of MRT 3.

In 2005 an Interagency Committee (IAC), composed of a representative from the the Department of Finance (DOF) as chairman, and representatives each of the Department of Budget and Management (DBM), National Economic and Development Authority (Neda), DOTC, BOT Center and the Office of the Chief Presidential Legal Counsel as members, conducted a review and evaluated the possibility of a government takeover of MRT 3. The objective was for the government to resolve and terminate its ERP obligations to the MRTC, and thereby realize savings.

The creation of the IAC was prompted by the government’s inability to pay its obligations provided under the BLT Agreement. In a December 2005 inquiry by the House Committee on Railways and Ro-Ro (Roll On-Roll Off) Systems, then-MRT general manager Roberto Lastimoso disclosed that there was a huge discrepancy between the income earnings of MRT 3 amounting to P130 million and its total monthly obligations amounting to $3.3 million. This was largely because when the BLT Agreement was executed in 1997, the peso-US dollar exchange rate was P27 to $1. This rate has more than doubled at the time of the project’s completion in 2000, accounting for the shortfall.

A 2000 DOTC proposal to increase the minimum fare was put on hold by the previous administration even when MRT 3 fares were less than comparable with bus-fare rates in consideration of the public benefit derived from this transit system by millions of Filipino commuters. MRT 3 is a social and economic catalyst spurring mobility among the commuting public and development in the vicinities of the transit stations. While the system itself had not been financially viable, the combined social and economic benefits of having such a system in place far outweighed the monetary equivalent of the government subsidies expended to support its operations, prompting the policy decision to keep fares low.

The IAC noted an onerous provision in the BLT Agreement in the form of the Neda-approved 15-percent internal rate of return (IRR) locked in for the entire 25-year duration of the BLT Agreement. There is no provision in the agreement allowing the government flexibility in negotiating a reduction. The DOF and the DOTC thus agreed that the best course was through a consensual unwind which would help the government save on the 15-percent IRR and result in full control and ownership of MRT 3 by the government in exchange for a lump-sum payment of its ERP obligations to MRTC.

However, the securitization of the ERP payments through the issuance of MRT Notes and the complex securitization structure prevented the implementation of the consensual unwind.

In December 2008 and January 2009, the MRTC sent two notices for arbitration (before the International Chamber of Commerce [ICC] in Singapore) to the DOTC, alleging that RP had breached its obligations under the BLT Agreement due to the DOTC’s failure: (a) to pay ERPs on due dates resulting in liability for late-payment interest in the amount of $26,628,185.35; (b) to maintain the letter of credit to cover the amount of the next ERPs; (c) to pay real-property taxes resulting in a judgment in favor of Mandaluyong City, which deprived the MRTC of ownership of the Mandaluyong portion of MRT 3.

In February 2009 Elliot (Netherlands) B.V., an investor in the MRTC, filed a request for arbitration with the International Center for the Settlement of Investment Disputes against RP, claiming over $230 million in damages resulting from the alleged breach by RP of its Bilateral Investment Treaty with the Netherlands in connection with the MRTC transaction.

In order to mitigate the cost of these arbitration proceedings and to realize substantial savings for the government, then-President Gloria Macapagal-Arroyo directed the Development Bank of the Philippines (DBP) and the Landbank of the Philippines (LBP) to purchase shares of stock, notes and securities representing the MRTC equity. The Bangko Sentral ng Pilipinas approved the acquisition, but required the government financial institutions (GFIs) to divest their equity interest within a certain time frame.

The public mind should be disabused of the notion that the acquisition by DBP and LBP of a controlling stake in the MRTC was detrimental to the interest of these banks. It should be reiterated that investors of the MRTC are guaranteed a 15-percent return throughout the 25-year duration of the BLT Agreement through the ERPs. The world was in a financial crisis at the time of the DBP and LBP acquisitions, and a financial instrument that guaranteed a 15-percent return, such as the MRT Notes, was certainly a golden opportunity. In fact, DBP and LBP are now receiving ERPs and profiting from their investment.

Moreover, the government itself benefits from the acquisition in the form of dividends that the two government financial institutions have to declare and remit to the government under Republic Act 7656, or the Dividends Law of 1994. Under this law, GOCCs and GFIs are required to remit 50 percent of their net earnings in each fiscal year to the national government.

The takeover of MRT 3 by the government through the DBP and the LBP, therefore, resulted in huge cost savings for the government, as the 25-year contract through 2025 would have cost the government $3 billion, as compared with the projected fare box revenues of $989 million. The entry of the DBP and the LBP into the picture also paved the way for the resolution of several technical issues raised by the government in relation to the obligations of Sumitomo Corp., the engineering, procurement and construction contractor.

As a result of negotiations during the first half of this year shepherded by then-Solicitor General Alberto C. Agra with the DBP/LBP-controlled MRTC Board, Sumitomo Corp. agreed to upgrade the pocket track at the Taft Avenue Station from a three-train pocket track to the required four-train pocket track; to reimburse the excessive maintenance fees paid by the DOTC for equipment that were not delivered or were defectively installed/constructed; and to shoulder the cost of wheel retro-filing, new sets of train wheels and incidental expenses. Despite these significant advances in the negotiations with the MRTC, several issues are still unresolved in the ICC arbitration proceedings, such as the MRTC’s claim that the DOTC’s failure to pay real-property taxes resulted in a judgment that deprived the MRTC of ownership of the Mandaluyong portion of MRT 3, and the DOTC’s allegations that the MRTC failed to deliver the DOTC headquarters and that the final project cost was excessive. These pending arbitration issues, with neither party wanting to admit default, complicate whatever strategy will be adopted by the government for the reprivatization of MRT 3.

Of paramount consideration are the onerous provisions of the BLT Agreement, such as the 15-percent IRR guaranteed by the government and the liability for taxes assumed by the DOTC. The contemplated buyout of the MRTC, either through the purchase of all its shares or the acquisition of the project assets of the MRTC, should extinguish the BLT Agreement and free the government from the onerous provisions therein. Furthermore, the buyout and transfer of the project to the DOTC should take into account the buyout mechanism provided in the BLT Agreement, the complex securitization structure and, ultimately, the take out of the equity interest of DBP and LBP. –Alberto C. Agra and Faye Josephine R. Miguel-Rañola / Forensic Solutions, Businessmirror