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Fraport AG and the NAIA-3 Debacle: A Case Study

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First conceived in the early 1990’s, Terminal 3 at Manila’s Ninoy Aquino International Airport was supposed to be part of a master plan to give the Philippines a modern, ...

First conceived in the early 1990’s, Terminal 3 at Manila’s Ninoy Aquino International Airport was supposed to be part of a master plan to give the Philippines a modern, internationally-competitive air transport hub in Southeast Asia. Developed under one of the region’s first Build-Operate-and-Transfer laws, one that had proven remarkably effective in helping the country overcome a critical shortage of electrical power during the term of President Fidel V. Ramos, the centerpiece of the new airport should have been the Philippines’ ticket out of third-world status.

Things did not quite go as planned. NAIA-3’s major investor, the German airport operator Fraport AG, soon found itself in a messy tangle of political and professional rivalries, deceit, corruption, and mismanagement, and to this day – nearly 20 years after the airport project was first discussed, and more than a decade since Fraport became involved – the company has yet to see a single cent of the estimated $400 million it invested in the project. This case study traces the history of the NAIA-3 project and its regrettable aftermath, illustrating a few lessons every company considering investing in developing economies should take to heart.

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    Fraport AG and the NAIA-3 Debacle: A Case Study Fraport AG and the NAIA-3 Debacle: A Case Study Document Transcript

    • Fraport AG and the NAIA-3 Debacle: A Case Study by Ben Kritz
    • Fraport AG and the NAIA-3 Debacle: A Case Study is a GR Business Online publication © 2011, GR Business Online. All Rights Reserved.
    • Abstract First conceived in the early 1990’s, Terminal 3 at Manila’s Ninoy Aquino International Airport was supposed to be part of a master plan to give the Philippines a modern, internationally- competitive air transport hub in Southeast Asia. Developed under one of the region’s first Build-Operate-and-Transfer laws, one that had proven remarkably effective in helping the country overcome a critical shortage of electrical power during the term of President Fidel V. Ramos, the centerpiece of the new airport should have been the Philippines’ ticket out of third-world status. Things did not quite go as planned. NAIA-3’s major investor, the German airport operator Fraport AG, soon found itself in a messy tangle of political and professional rivalries, deceit, corruption, and mismanagement, and to this day – nearly 20 years after the airport project was first discussed, and more than a decade since Fraport became involved – the company has yet to see a single cent of the estimated $400 million it invested in the project. This case study traces the history of the NAIA-3 project and its regrettable aftermath, illustrating a few lessons every company considering investing in developing economies should take to heart.
    • 1 Introduction On November 16, 2011 the High Court of Singapore rejected an appeal by the Philippines International Air Terminal Corporation (PIATCO) against a ruling by the Singapore-based International Chamber of Commerce (ICC) Court of Arbitration, which had denied PIATCO’s claim to $564 million in compensation from the Philippine government for the latter’s nullification of PIATCO’s contract to build and operate a new terminal at Manila’s Ninoy Aquino International Airport (NAIA).1 While the current government of President Benigno S. Aquino III was predictably satisfied with the outcome, there was nevertheless a clear tone of uncertainty behind presidential spokesman Edwin Lacierda’s suggestion that PIATCO “should just give up” on pursuing further legal actions.2 Since its conception in the early 1990’s, the project to build and operate Terminal 3 at NAIA has been a thorn in the side of four Philippine administrations over a span of nearly two decades. Mr. Lacierda and the Administration he speaks for can certainly hope the way is now clear for NAIA-3 to be put to the purpose for which it was intended without further controversy. The number of lingering issues surrounding the project, however, suggests that optimism may be premature. One of those lingering issues is the claim of Fraport AG, the operator of Germany’s largest airport at Frankfurt-am-Main and a principal investor in the NAIA-3. As of November 2011, Fraport’s most recent claim for compensation from the Philippine government – an amount somewhere between $425 million and $800 million – for its losses in the ill-fated project is pending before the World Bank’s International Center for the Settlement of Investment Disputes (ICSID) in Washington, D.C. The experience of Fraport AG in the NAIA-3 project is not only a case study illustrating the toxic, deeply-dysfunctional business and political environment foreign investors face when doing business in the Philippines in particular, but is an object lesson for any business considering expansion into developing economies. By examining the chain of events, business investors and policymakers alike may take away lessons that can help them avoid costly pitfalls that ruin reputations and prevent productive development. 1 J.R. San Juan, “Singapore Court affirms ruling vs. Piatco,” Business Mirror, 16 November 2011. 2 M.M. Gonzalez, “Palace tells Piatco: Time to move on,” Business Mirror, 17 November 2011.
    • 2 The Need for New Airport Facilities Expansion and upgrading of the Ninoy Aquino International Airport was a critical component of the 1993- 1998 Medium-Term Development Plan created by the government of President Fidel V. Ramos, who took office in mid-1992. The Philippines’ only international air gateway was in dire condition, altogether unsuitable for a country hoping to join its regional neighbors as another “Asian Tiger.” The airport at the time consisted of two terminals, the international terminal (now known as NAIA-1) opened in 1981, and a small domestic terminal that had been built in 1948; between them the terminals had a design capacity of 6.3 million passengers per year, but by 1992 passengers numbers had passed eight million passengers per year and were increasing at about 11% per year.3 The Medium-Term Development Plan envisioned the replacement of both of NAIA’s terminals as had been recommended by a French-government funded review of NAIA conducted by Aéroports de Paris (ADP) in 1989-1990, so it was here that the idea that would eventually develop into the ill-starred NAIA-3 project was first conceived. The immediate priority, however, was placed on developing a replacement for the old domestic terminal and carrying out some much-needed related infrastructure improvements around the airport such as apron and taxiway upgrades, a new waste-water treatment facility, and better road access to the airport. That project would be the new NAIA Terminal 2, colloquially known as NAIA-2 or the “Centennial” Terminal (it formally opened in 1998, the centennial of 3 JICA NAIA Terminal 2 Project Assessment Report, September 2002.
    • 3 the Philippines’ independence from Spain). ADP originally designed it as a domestic-only terminal – the future NAIA-3 would be dedicated to international flights – but modified the design to manage both domestic and international service. Design and construction costs were financed by a 30-million franc ($5.34 million) soft loan from the French government and an 18.12 billion yen ($165.93 million) Official Development Assistance (ODA) loan from Japan in August 1993. Because of the expanded design, construction took almost two years longer than planned, but was completed slightly under budget, and the terminal was formally turned over to the Manila International Airport Authority (MIAA) on December 28, 1998. Even before construction began on NAIA-2, President Ramos was aggressively lobbying the Philippines’ most important power brokers – the Filipino-Chinese taipans – to develop proposals for the construction of the second new terminal called for by the ADP master plan.4 It was, as one commentator has said, an appeal to patriotic duty as much or more than an offer of a potentially-profitable business opportunity,5 but it was fundamentally practical from Ramos’ perspective; having just committed the government to large debts – albeit ones with friendly terms – for the construction of part of the new airport, financing the second part of the master plan with further debt was politically risky. Instead, Ramos could employ a tool that had so far proven remarkably effective in helping the Philippines recover from a crippling shortage of electricity supply: the Build-Operate-Transfer (BOT) Law. Development of the BOT Law Republic Act 6957, the Build-Operate-Transfer (BOT) Law, was passed by the Philippine Legislature in 1990 as a solution to chronic budget constraints and lack of resources for development.6 The general arrangement of a BOT agreement under RA 6957 was one in which the contractor finances and builds an infrastructure facility, and then operates the facility for a fixed term of years (up to 50) to recover investment and operating costs, plus a reasonable rate of return. At the end of the agreed operation period, the facility would be turned over to the appropriate government agency or local government unit.7 Under RA 4 N. Lagustan, “Farolan mistaken; Ramos pushed airport dev’t.”, The Philippine Daily Inquirer, 9 May 2011. 5 R.J. Farolan, “Impossible Dream”, The Philippine Daily Inquirer, 17 April 2011. 6 Zambrano & Gruba Law Offices, “Public-Private Partnerships in the Philippines: A Practical Guide for Business”, Legal Update, 10 January 2011. 7 M.F. Villamejor-Mendoza, “Equity and Fairness in Public-Private Partnerships: The Case of Airport Infrastructure Development in the Philippines”, Philippine Society for Public Administration (PSPA), 17 August 2011.
    • 4 6957, two schemes were offered: Build-Operate-Transfer (BOT), and Build-and-Transfer (BT). Because some projects might not be suitable for either of these two programs, RA 6957 was amended in May 1994 by Republic Act 7718, which added several new options for private sector participation in infrastructure development8 :  Build-Own-and-Operate (BOO)  Build-Transfer-and-Operate (BTO)  Build-Lease-and-Transfer (BLT)  Contract-Add-and-Operate (CAO)  Rehabilitate-Own-and-Transfer (ROT)  Rehabilitate-Own-and-Operate (ROO)  Develop-Operate-and-Transfer (DOT) In addition, RA 7718 provides for other private-public partnership arrangements such as service or management contracts, leases, or concessions, as well as provisions for cost- sharing and other incentives, and a framework for market-based rate and fee setting (with the exception of natural monopolies and public services, whose rates are regulated externally) to ensure attractive rates of return on projects. The amended BOT law also permits the acceptance of unsolicited proposals, provided they meet the conditions that, “(1) such projects involve a new concept or technology and/or are not part of the list of priority projects, (2) no direct government guarantee, subsidy or equity is required, and (3) the government agency or local government unit has invited by publication, for three (3) consecutive weeks, in a newspaper of general circulation, comparative or competitive proposals and no other proposal is received for a period of sixty (60) working days.... In the event another proponent submits a lower price proposal, the original proponent shall have the right to match that price within thirty (30) working days.”9 This would be the framework under which the NAIA-3 project was developed and presented to the government, discussions about which were already well under way when RA 7718 was signed into law by President Ramos. 8 BOT Center, “The Philippine BOT Law R.A. 7718 and its Implementing Rules & Regulations”, Republic of the Philippines Department of Trade and Industry, January 2011. 9 RA 7718, Section 12.
    • 5 The “Emerging Dragons” In September 1993, a group of six of the Philippines’ most powerful businessmen accompanied President Fidel Ramos on a state visit to China, and it was there that the proposal for the construction of NAIA-3 was first discussed with Ramos and his key advisors.10 This luminary group of taipans included Lucio Tan, chairman of the Lucio Tan Group of Companies with interests in liquor, tobacco, banking, real estate, and, significantly, owner of Philippine Airlines (PAL); Henry Sy, head of SM, the country’s largest retailer, and majority owner of Banco de Oro and China Banking Corporation;11 Alfonso Yuchengco, a former ambassador to China and head of the Yuchengco Group of Companies that included, among other businesses, Rizal Commercial Banking Corporation, the country’s largest commercial bank; George K. Ty, founder of the Philippines’ second-largest bank, Metropolitan Bank and Trust Company; Andrew Gotianun, head of the major real estate developer Filinvest Development Corporation and East- West Bank; and John Gokongwei, Jr., chairman of JG Summit Holdings, with varied business interests that would, from 1996 onwards, include Cebu Pacific Airlines, which has since surpassed Tan’s PAL as the country’s largest airline. Encouraged by Ramos, the taipans formed Asia’s Emerging Dragon Corporation (AEDC) with Yuchengco as its chairman for the express purpose of developing a project proposal for a new, large-capacity terminal to replace the outdated NAIA-1 and complete the master plan for the airport. On October 5, 1994, AEDC submitted an unsolicited proposal for a 10 million passengers-per-year Terminal 3 to the Department of Transportation and Communications (DOTC). In March 1995, the DOTC endorsed the AEDC proposal to the Investment Coordinating Council (ICC) for further study.12 In November 1995, AEDC sought a meeting with President Fidel Ramos, and secured his approval for the terminal project. Strictly speaking, Ramos’ approval was just the signal for the appropriate government agencies to begin the bidding and contract process for NAIA-3, and not necessarily a specific endorsement of AEDC. AEDC, however, had several good reasons to believe the project would be awarded to their group. Ramos – at least according to his spokesman in a reply to a critical editorial in 201113 – had been the one to first raise the 10 J.P.E. Andaquig, “Corruption Still Haunts Arroyo Presidency”, Bulatlat, March 23-28, 2003. 11 The China Banking Corporation takes its name from the fact that it was originally founded to serve Chinese and Chinese-Filipino customers and businesses in Manila in 1920. 12 Villamejor-Mendoza, 2011. 13 Lagustan, 2011.
    • 6 subject of the NAIA-3 project with the taipans, and his formal approval in November 1995 carried some weight by the President’s being the ex officio head of the National Economic Development Authority (NEDA) Board. Having been the first to present a project proposal gave AEDC original proponent status, giving the group an advantage in the Swiss challenge bidding process to which the project would be subjected. And the AEDC group had a formidable array of resources, financially and politically, that they could apply to winning the project. The “Other Guys” On February 13, 1996, the NEDA Board granted first pass approval of the project as conceived by AEDC. On September 20, 1996, a challenge bid was received from a consortium comprising People’s Air Cargo (Paircargo) owned by Vic Cheng Yong; Warehousing Co., Inc.; Philippine Air Ground Services; and Security Bank and Trust Co. Cheng Yong was the owner of the largest customs bonded warehouse business at the airport and a former college classmate of Lucio Tan.14 On October 16, less than a month after receipt of the Paircargo group’s bid, the Prequalification, Bids and Awards Committee (PBAC) of the DOTC/Manila International Airport Authority (MIAA) opened the financial proposals to the government from AEDC and Paircargo and Associates. The bids for the construction of the terminal were the same at $350 million, but Paircargo and Associates were offering the government concession payments of Php 17.75 billion over a 27-year period, while AEDC’s proposal was for a mere Php 135 million for the same amount of time.15 Being ambushed by a bunch of relative upstarts came as a nasty surprise for AEDC, but matching Paircargo’s extraordinary bid was apparently out of the question; in a breakfast meeting between AEDC’s Tan and Cheng Yong just days after the opening of the bids, Tan reportedly told Cheng Yong that Paircargo “was very silly to have submitted such a high financial offer of annual guaranteed payments to the government. He [Tan] considered such 14 R. Landingin, “The Battle for Manila’s Gateway”, Newsbreak, 14 September 2007. 15 P. Wallace, “NAIA-3 to Open in December?” The Wallace Report, September 2002; Andaquig, 2003.
    • 7 substantial payments a waste of money and urged that Paircargo & Associates simply withdraw its bid”, even offering to reimburse Paircargo its Php 150 million bid bond if it did so.16 Paircargo and Associates’ financial capacity to undertake the project, however, was rather misrepresented. The financial requirement for the NAIA-3 project was 30% of the bid amount, or Php 2.73 billion; because of a legal restriction on the amount of equity a bank (Security Bank in this case) could invest in a single project, the Paircargo group reportedly only had between Php 558 million and Php 925 million in hand, not enough to actually be a qualified bidder for the project.17 This point would lead to serious legal problems for PIATCO in years to come. Those problems, however, were still in the future. In October 1996, no matter how much the Ramos government may have wished or assumed that AEDC would be building the new terminal, it had no choice but to award the contract to Paircargo and Associates. PIATCO Enters the Picture On February 27, 1997 the Securities & Exchange Commission (SEC) issued a Certificate of Registration for Philippine Air Terminals Co. Inc. (PIATCO). The Cheng Yong-led Filipino group comprising Paircargo, Security Bank and Trust Company, Equitable Banking Corp., Chuah Huh Holdings Company, and Philippine Airport Ground Services (PAGS) initially held 80% of the shares of PIATCO, while 10% were owned by another Filipino company, SB Airport. Fraport AG of Germany would take an initial 25% ownership stake in PIATCO from the Paircargo group in 1999 (which had been raised to 30% by 2001), while the Japanese zaibatsu Nissho Iwai owned the final 10% of the company.18 The ownership of PIATCO thus reflected – on paper at least – the constitutionally-required 40% limit on foreign equity in Philippine businesses. In an attempt to forestall their loss of the NAIA-3 project, AEDC filed a lawsuit on April 18, 1997 in the Pasig City Regional Trial Court against the members of the DOTC/MIAA PBAC and the head of the PBAC Technical Committee, Pantaleon Alvarez, who would later briefly – and controversially – be DOTC Secretary under President Gloria Macapagal-Arroyo, charging 16 Landingin, 2007. 17 Landingin, 2007; Villamejor-Mendoza, 2011. RA 7718 (Section 5.4c) does not fix an amount of financial capacity, but leaves this to the discretion of the LGU or concerned government agency on a case-by-case basis. 18 Wallace, 2002; Landingin, 2007. The deal struck between PIATCO and Fraport was complex; some of Fraport’s stake in PIATCO was indirect, obtained through taking 40% of both PAGS Terminal, Inc. (PTI), and PAGS Terminal Holdings, Inc. (PTH).
    • 8 them with collusion and gross malfeasance in awarding the NAIA-3 bid to the Paircargo- PIATCO group of Vic Cheng Yong. The case is still pending at the RTC by July 12, when the concessionaire contract was signed between the DOTC/MIAA, represented by DOTC Secretary Arturo Enrile, and PIATCO represented by Henry Go. 1998-2002: Controversy and Conspiracies The involvement of Ramos’ successor, President Joseph Estrada, in modifications made to the NAIA-3 project contract has never been fully explained, but it was during his brief term in office that amendments which would eventually lead to the contract’s scuttling by President Gloria Macapagal-Arroyo were made. The first of these amendments was made in November 1998, a second just a week after the NEDA Board granted second pass approval on the contract in August 1999, and a third in September 2000, after Takenaka Corporation of Japan had been granted the construction contract for the Skidmore, Owings & Merrill- designed terminal building. Movie actor-turned-politician Estrada was hounded by corruption allegations and a serious downturn in the Philippine economy and forced from office in 2001, replaced by Arroyo, his Vice-President. In addition to having Estrada quickly arrested and jailed on plunder charges,19 the Arroyo Administration conducted a review of many of the contracts and projects undertaken during Estrada’s truncated term in office; as a result of that review, a final amendment to the NAIA-3 contract was added on June 22, 2001, which essentially confirmed the various changes made since 1997 and the “operate” part of the BOT agreement, whereby PIATCO would have a 25-year concession to operate NAIA-3 and recover its investment before turning it over to the government of the Philippines. Sometime in early 2002, the Arroyo Administration raised the idea of buying out Fraport’s stake in PIATCO immediately for $400 million, a suggestion to which Fraport, which had invested about $375 million in the project to that point, was agreeable, particularly since 19 After a lengthy legal battle, Estrada was eventually convicted by the Sandiganbayan, the Philippines’ special court for graft and corruption cases, and sentenced to life imprisonment in September 2007. In a controversial move, Arroyo pardoned Estrada the following month. Thus politically rehabilitated, Estrada ran for President again in 2010, finishing a surprising second to election winner Benigno S. Aquino III.
    • 9 Arroyo’s office reportedly raised the possibility that Fraport could return and operate the terminal under a new sub-contract.20 Arroyo ordered the formation of a committee to study the buyout proposal, and it was at this point that the entire project began to go sideways. The story the Philippine public heard was that in the course of reviewing the NAIA-3 project and contract, the Presidential committee discovered dozens of anomalous provisions. This led to a “Blue Ribbon Committee” investigation in the Senate, where the anomalies were laid out; among other things, now-acting DOTC Secretary Pantaleon Alvarez was accused of having used his knowledge of the project in his former role as head of the PBAC Technical Committee to form a new company called Wintrack in October 1999, which was awarded a major sub-contract for site development and excavation work.21 To make matters worse, many of the board members of PIATCO, including a couple of officials from Fraport, were also board members of Wintrack. Hounded by controversy and facing graft charges before the Ombudsman, Alvarez was denied confirmation as DOTC Secretary by the Commission on Appointments, and left public service (the graft case was later dropped for lack of evidence22 ). President Arroyo was then left with no choice but to declare the contract void, and order the government to take over the nearly-completed terminal. The whole story, however, was not quite so simple. After the withdrawal of AEDC’s case against Pantaleon Alvarez and the PABC in April 1999, Lucio Tan began looking elsewhere for airport-related business and in 2000 the Tan Group’s MacroAsia opened Lufthansa Technik Philippines. But getting control of NAIA-3 was obviously not a lost cause from Tan’s point of view; it would give Tan a huge stake in the entire airport – Philippine Airlines was the sole tenant of NAIA-2, MacroAsia controlled the largest part of the airport’s ground service and catering 20 Wallace, 2002; N. Cacho-Olivares, “Nixing Pancho’s $20-M demand led to GMA, SC Piatco voiding”, The Daily Tribune, 9 June 2003. The NAIA-3 project had by this time grossly overrun its original contract cost, from $350 million to about $675 million. The offer to contract Fraport later to operate NAIA-3 in a separate deal was widely reported, but the Administration later denied having made such a suggestion. 21 PCIJ, “Special Report – Open for Business”, Philippine Center for Investigative Journalism iReport, IX(3), July- September 2003. 22 G.U. Quemado, “Graft charges against Phil minister dropped”, Cargo News Asia, 8 April 2002.
    • 10 business, and aircraft service through LTP was quickly proving to be another healthy income stream. Not to mention that it would redress the largely-valid grievance Tan held against Cheng Yong and Alvarez for what he saw as their having cheated the AEDC group out of the project in the first place.23 That the “anomalies” quickly came to the attention of the Palace and the Senate was no coincidence; to pressure the Arroyo Administration, the Senate, and eventually the Supreme Court to scrap the PIATCO-Fraport contract, MacroAsia teamed up with Miascor (NAIA’s other large ground service operation) and engaged the services of PR firm Creative Point International, a successful operation that the latter firm highlights on its website to this day.24 Fraport now found itself caught in the crossfire, and as a minority investor – albeit now the largest one, and one that had shelled out several hundred million dollars – had little cover. Complicating Fraport’s position was the size of their indirect equity stake in the project, which could be interpreted as violating the constitutional prohibition against greater than 40% foreign ownership. PIATCO had created a new business, Philippines Air Ground Services Terminal Inc. (PTI), to serve as the eventual operator of NAIA-3. Cheng Yong’s group, which had very little of their own capital invested in the NAIA-3 project, had prevailed on the German company to take a 40% equity stake in PAGS (which had a direct equity stake of 11% in PIATCO), and through PAGS, increase PTI’s equity in PIATCO to 35%.25 Thus, even though each of Fraport AG’s investments – in both of PAGS shareholding companies, PTI and PTH26 , and in PIATCO directly – met the constitutional limit of no more than 40% foreign ownership of a Philippines company, the corporate interlocking gave Fraport an effective stake of over 60% in PIATCO.27 The manner of their investments in the various component companies behind the project suggests that Fraport’s leadership were aware that their stake in PIATCO could be interpreted as a violation of the Philippines’ Anti-Dummy Law that protected the 40% constitutional limitation on foreign ownership, and that they were treading carefully to try to avoid clearly crossing the line. Given the greatly uneven balance of investment in the NAIA-3 project – Cheng Yong’s group, despite their machinations, had only invested about $16.5 million to Fraport’s $375 million – Fraport had good reason to find ways to guard their 23 Lucio Tan had by the end of 1999 bought out his AEDC partners, and so was effectively acting on his own at this point. 24 Creative Point International, Inc., “An Illegal Airport Contract Nullified”, 2011. 25 Landingin, 2007. 26 See Note 18. 27 Landingin, 2007.
    • 11 stake. And the Anti-Dummy Law (Commonwealth Act 108, amended several times), does not clearly address the sort of circumstances Fraport was in with respect to PIATCO.28 Lucio Tan, who was pressuring the government to ‘do something’ about the NAIA-3 contract, had plausible reasons to keep Fraport on board or at least have them depart on friendly terms; as the operator of Germany’s biggest airport, Fraport had a cozy relationship with Lufthansa29 , and given MacroAsia’s Lufthansa connection a breach with Fraport might present potential complications. But it would seem some officials of the Arroyo Administration had their own ideas about how to “keep Fraport on board.” From taped conversations among Fraport officials and attorneys obtained in 2003 by The Daily Tribune, it appears that the Administration attempted to extort Fraport in order to keep them from getting caught up in PIATCO’s impending doom. Arroyo’s personal attorney at that time, F. Arthur “Pancho” Villaraza, reportedly asked Fraport for $20 million to be paid to an ‘offshore entity’ (presumably a Hong Kong account) to cover “in the background” legal and government services.30 Although the methodology and real motives of Arroyo’s officials are indeed highly questionable, the understandable wish to keep the highly-experienced airport operator Fraport in the NAIA-3 formula faced one insurmountable obstacle: legally, there was no way to separate Fraport AG from PIATCO, the project contractor of which Fraport was a component, and still keep the contract intact. Buying out Fraport AG’s stake in PIATCO was actually an excellent solution – the issue of ‘effective control’ exceeding the constitutional ownership limitation would have become moot, and the Arroyo Administration would have been in a position to dictate to Cheng Yong and PIATCO certain desired arrangements – such as contracting Fraport AG separately as the airport 28 CA 108, Sec. 2A provides that a violation of the law occurs when: “Any person, corporation, or association which, having in its name or under its control, a right franchise, privilege, property or business, the exercise or enjoyment of which is expressly reserved by the Constitution or the laws to citizens of the Philippines or of any other specific country, or to corporations or associations at least sixty per centum of the capital of which is owned by such citizens, permits or allows the use, exploitation or enjoyment thereof by a person, corporation or association not possessing the requisites prescribed by the Constitution or the laws of the Philippines...” leaving it to the courts to decide what constitutes permitting or allowing “the use, exploitation or enjoyment” of the enterprise in question. 29 Lufthansa bought 4.95% of Fraport AG in 2005, a stake which has since increased to 9%. 30 Cacho-Olivares, 9 June 2003.
    • 12 operator. The only obvious explanation for this not happening is the personal greed of Villaraza and others in Arroyo’s inner circle. The ‘payoff’ scheme was spearheaded by Arroyo’s Presidential Adviser for Strategic Projects Gloria Tan-Climaco, who would eventually produce the damning report accepted in its entirety by the Presidential and Senate committees in recommending the contract be nullified. The President herself was not directly implicated in the plot, but the Fraport officials had discussions not only with Villaraza and Tan-Climaco, but also Executive Secretary Alberto Romulo and Presidential Legal Counsel Avelino Cruz, suggesting that Arroyo was most likely aware of what was going on. The deal was this: Fraport would pay the $20 million and help ensure “the right partners” (i.e., most likely the MacroAsia/Miascor group) were brought in to replace Vic Cheng Yong and his son Jefferson. When Fraport refused, Tan-Climaco threatened them with finding them in violation of the Philippines’ Anti-Dummy Law.31 Though nonplussed, Fraport officials held their ground, and in her Bonifacio Day speech on November 30, 2002, President Arroyo declared the NAIA-3 contract null and void and announced that the government would expropriate the new terminal. A Carnival for Lawyers PIATCO immediately filed a case before the Philippines Supreme Court in 2003 to overturn the nullification, but was denied on four basic grounds: 1. Absence of the required financial capacity of at least 10% of the bid amount by the Paircargo group at the time of the original bidding in 1996, in violation of the BOT Law. This was true enough, although it was a slightly inaccurate interpretation of the BOT Law, which reserved specification of the required capital to the concerned agency or government unit. Fraport AG, without whom Paircargo/PIATCO realistically would not have had sufficient capital, did not formally enter the picture until 1999. 31 N. Cacho-Olivares, “GMA ‘aide’ asked Fraport to invent evidence”, The Daily Tribune, 10 June 2003.
    • 13 As head of the PBAC Technical Committee, Pantaleon Alvarez had presumably been made aware by Paircargo and Associates as early as 1996 that Fraport would potentially be a part of the project, and had based his recommendation partly on that knowledge. If Alvarez had strictly adhered to the rules, however, he should have rejected Paircargo’s bid as ineligible; what is not known for certain and is only a matter of speculation is whether he was offered some ‘incentive’ by Cheng Yong or the Paircargo group to bend the rules. Alvarez’ justification for finding the Paircargo bid sufficient was that the group did in fact have adequate capital; he and PIATCO argued – unsuccessfully, as it turned out – that the investment limitation rule that applied to Security Bank’s assets was being purposely misinterpreted by people like Tan-Climaco to justify the “inadequate assets” charge. 2. Amendments to the 1997 Concession Agreement made under the Estrada Administration were contrary to public policy, since they changed the contract substantially from the original proposal for which the bid had been awarded. This was also true. Some of the changes made included:  A provision requiring the government to pay Php 180 million to PIATCO in the event the construction contract was nullified by the Pasig RTC (presumably in connection with the case filed by AEDC, although this was not exactly spelled out in the amendment).  A provision designating PIATCO the sole collector of fees for aircraft parking, tacking, check-in, passenger fees, and other services in the airport.  A significant change in the project design by allowing for a surface access road between Terminals 3 and 2 instead of a tunnel under the airfield as originally proposed. The contract amount was not adjusted accordingly – roads are obviously much cheaper than tunnels – so PIATCO would have been able to pocket the considerable difference.  The project contract did not provide a ceiling cost from which rate-of-returns could be calculated, as required by the BOT Law, but only a floor cost ($350 million), which had ballooned to $675 million by 2002.32 3. Amendments in the 1997 Concession Agreement provided for a direct government guarantee of PIATCO’s debts, which is expressly prohibited by the BOT Law and its Implementing Rules and Regulations. 32 Wallace, 2002.
    • 14 Because the project was unsolicited, it was not eligible for government guarantees. PIATCO took the imaginative position that Ramos’ encouragement of the formation of AEDC for the purpose of presenting a proposal made it a de facto solicited project. Until Ramos endorsed the project in his capacity as head of the NEDA Board, however, his involvement was off-the- record; the project, as the proposal and bidding developed, simply did not meet the rather clear definition of ‘solicited’ set out in the BOT Law. 4. Violation of the Anti-Dummy Law and the Constitutional requirement for Filipino majority ownership in corporations dealing with natural monopolies and public services. This allegation was directed against Fraport, and as already noted, the Anti-Dummy Law was sufficiently ambiguous to allow for judicial interpretation in almost any direction.33 That the “Anti-Dummy” issue wasn’t raised until Gloria Tan-Climaco realized that Fraport would refuse the $20 million payoff through Atty. Villaraza is an indication that it was not the strongest of arguments against the NAIA-3 contract. Violation of the Anti-Dummy Law was mainly of matter of impression; PIATCO had been caught in a couple other clear legal violations, and the extraordinary difference between the levels of Fraport’s and the “natives’” investment in the project simply looked bad. Finding no relief in the Philippine courts, and with negotiations on compensation from the government going nowhere, in 2004 Fraport AG cut loose from PIATCO to file a claim against the government for $425 million at the World Bank’s International Center for the Settlement of Investment Disputes (ICSID) in Washington, D.C., in accordance with an established German-Philippine agreement that investment disputes should be handled by the ICSID. PIATCO, meanwhile, filed its own $564 million claim at the Singapore-based International Chamber of Commerce (ICC) Court of Arbitration. By December 2004, the Office of the Solicitor General finally got around to filing a petition for expropriation of NAIA-3 in the Pasay RTC. The RTC issued a Writ of Possession to the government, but ordered an initial payment of $66 million to PIATCO in accordance with the principle – spelled out in the Supreme Court’s 2003 ruling – that PIATCO, as the builder of the terminal, was entitled to just compensation for the facilities. Compensation to Fraport, however, was not addressed by the ruling. The government delayed payment of the initial $66 million compensation ordered by the Pasay RTC to PIATCO until September 2006, which finally allowed the MIAA to take possession of NAIA-3 and complete work for its opening, although PIATCO continued to contest ownership. 33 See Note 28.
    • 15 In August 2005 an apparent opportunity for Fraport to cut its losses in the NAIA-3 imbroglio was presented when the Manila Hotel Corporation, owned by Manila Bulletin publisher Emilio Yap, offered to buy Fraport’s stake in PIATCO for $200 million, half of what Fraport had been hoping to collect from the failed government buyout. Five months of negotiations failed to overcome what Fraport officials described as “substantial roadblocks” to completing the sale, however, and in February 2006 the deal was off.34 In August 2007, the ICSID dismissed Fraport AG’s claim, ruling that it had no jurisdiction because Fraport’s investments were made illegally, in contravention of the Philippines’ Anti- Dummy and other laws, and that illegal investments are not entitled to treaty protection. The supporting documents presented by the Philippines, however, consisted of the report filed by Tan-Climaco, the decision of the Presidential Committee (based solely on that report), the decision of the Senate committee (also based solely on that report), and the Supreme Court decision (which was a ruling against PIATCO as a respondent, and not specifically against Fraport AG). Since the report made by Tan-Climaco was apparently prejudiced by the failed bid to extort Fraport AG, the ruling against Fraport was based on evidence that was suspect at best. The ICSID, however, could not act on that knowledge even if they had it, but only on what was a matter of the official records of proceedings in the Philippines. The virtually deserted Departures Area of NAIA-3, circa 2007. 10 years after its completion, less than half of the terminal has been put into regular operation. 34 “Manila Hotel Corp acquires Piatco stake from Fraport – report”, Forbes.com, 29 August 2005; “Collapse of Fraport-Manila Hotel deal won’t affect government cases — OSG”, The Philippine Star, 3 February 2006.
    • 16 Ninoy Aquino International Airport. In terms of size and passenger capacity, Terminal 3 is approximately equal to Terminals 1 and 2 combined. 2010-onward: A Never-Ending Story? On July 22, 2010 the ICC dismissed with finality PIATCO’s claim for compensation, ruling that the NAIA-3 contract had been illegally obtained. This was claimed as a victory by the then less than month-old Aquino Administration, perhaps out of relief at having at least one nagging situation inherited from Aquino’s despised predecessor Gloria Macapagal-Arroyo apparently solve itself. There was a clear sign that optimism might have been misplaced,
    • 17 however, when on December 23, the ICSID Ad Hoc Committee on Annulment voided the August 2007 decision in favor of the Philippines government, allowing both parties to present their cases again for arbitration. The intention of the Committee’s action was to encourage the two parties to negotiate their own amicable settlement; signals from the Aquino government, however, indicated a certain hostility towards contracts, valid or not, entered into with foreign companies, and so on April 1, 2011, Fraport AG announced it was re-filing its case against the Philippines at the ICSID.35 On May 23, the Pasay RTC issued a decision setting the compensation due PIATCO at $175.79 million, less the $66 million already paid in September 2006. PIATCO filed an immediate appeal against the ruling, claiming they had not been furnished a copy of the final report of the Supreme Court’s Board of Commissioners which had recommended the final compensation amount (said to be $376 million). On July 22, PIATCO filed a petition before the SC asking that Pasay RTC Judge Eugenio Dela Cruz be suspended and removed from office for “gross ignorance and disregarded the rules of court by promulgating a decision without giving the complainant (PIATCO) the opportunity to file its comments or objections to an alleged ‘final report’ of the Supreme Court-appointed Board of Commissioners.”36 That move, which, if the Philippine judicial system remains true to its character, is probably futile, may have been PIATCO’s last gasp now that the High Court in Singapore has weighed in on the case.37 At least in the case of PIATCO, however, there is clear evidence of its malfeasance; Fraport AG, on the other hand, may be asking itself why and how it wandered into the bad neighborhood that is the Philippines’ business environment. One speculation raised by critics of Fraport is that the airport operator probably knew, or at least should have known, that Paircargo’s original bid was legally invalid, and that by getting involved with the plan in the first place was tantamount to engaging in corrupt practices, demonstrated by 35 “Fraport takes on Philippines in NAIA-3 row again”, ABS-CBN News, 1 April 2011; B. Kritz, “Aquino Officially Reneges on Pledge to Build Philippine Infrastructure”, GR Business Online, 22 June 2011. 36 I. Cabayan, “PIATCO slams judge”, Journal Online, 22 July 2011. 37 On July 31, 2013, the Philippines Court of Appeals did rule favorably on PIATCO’s appeal, declaring that there was “no obvious massive structural defect” in the NAIA-3 facility to justify reducing the compensation amount due to PIATCO for the expropriation, contrary to the government’s claims. Accordingly, the CA set the amount payable to PIATCO at $300,206,639 less the $59,438,604 (exclusive of interest) paid in 2006, plus 6% interest, for a total as of July 31 of $371,426,688 (Php 16.172 billion); furthermore, the CA directed that upon finality of the judgment, the interest rate will be raised to 12% p.a. until the payment is completed. (J.R. San Juan, “CA orders government to pay Piatco $240 million plus”, BusinessMirror, 8 August 2013)
    • 18 Fraport’s having taken advantage of loopholes to circumvent the Anti-Dummy Law. That argument, however, tends to evaporate in light of Fraport’s refusal – at a time when their position had become desperate – to pay a bribe amounting to only about 5% of what they had put into the NAIA-3 project to make the PIATCO mess “go away” back in 2002. Lessons Learned The NAIA-3 project came to the attention of Fraport AG at a time when the company was aggressively seeking opportunities for expansion, and to some extent ambition may be to blame for the some of the mistakes Fraport made in the ensuing mess. Fraport seems to have been naïve, or at least insufficiently informed, about the particular relationships of key players in the project, such as the rivalry between Lucio Tan and Vic Cheng Yong, or the role of Pantaleon Alvarez. Fraport also clearly had not considered an exit strategy or contingency plans for when things started to go wrong; cost overruns and encouragement from its partners in PIATCO to increase its level of equity investment should have been clear warning signs, and in hindsight, Fraport should have realized they were throwing good money after bad. Even so, Fraport’s experience in the Philippines is like that of the wayward visitor who wanders into the wrong part of town and gets robbed; he might be blamed for a lack of wisdom or foresight in putting himself in the wrong place at the wrong time, but he is nonetheless a victim of a crime. The NAIA-3 saga is fundamentally a damning indictment of the Philippine system and the people in it. The BOT Law is actually a potentially productive framework for investment and development, but is handicapped to the point of being unworkable by the 40% constitutional limitation on foreign equity and a political system that concentrates too much power in the Office of the President, almost guaranteeing that long- term contracts will be changed mid-stream to suit political expediency. Add to that an almost pathological greed that, sadly, appears all-too-often in well-placed individuals and a glacially-slow legal system almost powerless to discourage such behavior, and the risks of doing business in the Philippines become almost too great to consider. But while these kinds of circumstances may find spectacular expression in the Philippines, they are by no means unique to this country, and the story of NAIA-3 and the failed venture of Fraport AG offer valuable reminders of basic steps that should be taken to protect investments in the developing world. Taking on an experienced in-country consultant – one who is not connected to the project in question or the people involved – can reveal problematic political, business, and personal relationships. Any investment should have a “stop-loss” or a “decision point” programmed into it as well; for example, Fraport’s basic 30% PIATCO stake should have suggested a limit of $105 million (plus perhaps a reasonable
    • 19 amount to allow for cost overruns) based on the awarded contract amount – once the required investment soared past that ceiling, Fraport should have taken it for the warning sign it actually was, and made a hard reassessment of its participation. References Andaquig, J.P.E. (2003) “Corruption Still Haunts Arroyo Presidency”. Bulatlat, 3(8), March 23- 28, 2003. http://bulatlat.com/news/3-8/3-8-corruption1.html. BOT Center. (2011) “The Philippine BOT Law R.A. 7718 and its Implementing Rules & Regulations”. Build-Operate-And-Transfer Center, Republic of the Philippines Department of Trade and Industry, January 2011. http://ppp.gov.ph/wp-content/uploads/2011/01/Republic- Act-7718.pdf. Cabayan, I. (2011) “PIATCO slams judge”. Journal Online, 22 July 2011. http://www.journal.com.ph/index.php/news/metro/9890-piatco-slams-judge. Cacho-Olivares, N. (2003) “Nixing Pancho’s $20-M demand led to GMA, SC Piatco voiding”. The Daily Tribune, 9 June 2003. http://web.archive.org/web/20030620084633/www.tribune.net.ph/20030609/headlines/200 30609.hed01.html. Cacho-Olivares, N. (2003) “GMA ‘aide’ asked Fraport to invent evidence”. The Daily Tribune, 10 June 2003. http://web.archive.org/web/20030619161725/www.tribune.net.ph/20030610/headlines/20030 610.hed01.html. Creative Point International, Inc. (2011) “An Illegal Airport Contract Nullified”. http://creativepointonline.com/index.php/an-illegal-airport-contract-nullified. Farolan, R.J. (2011) “Impossible Dream”. The Philippine Daily Inquirer, 17 April 2011. http://opinion.inquirer.net/inquireropinion/columns/view/20110417-331708/Impossible-Dream. “Fraport takes on Philippines in NAIA-3 row again”. ABS-CBN News, 1 April 2011. http://www.abs-cbnnews.com/business/04/01/11/fraport-takes-philippines-naia-3-row-again.
    • 20 Forbes.com. (2005) “Manila Hotel Corp acquires Piatco stake from Fraport – report”. Forbes.com, 29 August 2005. http://www.forbes.com/feeds/afx/2005/08/29/afx2195595.html. Gonzalez, M.M. (2011) “Palace tells Piatco: Time to move on”. Business Mirror [online], 17 November 2011. http://www.businessmirror.com.ph/home/top-news/19503-palace-tells- piatco-time-to-move-on. JICA. (2002) “Ninoy Aquino International Airport Terminal 2 Development Project”. Japan International Cooperation Agency Assessment Report, September 2002. http://www.jica.go.jp/english/operations/evaluation/oda_loan/post/2002/pdf/083_full.pdf. Kritz, B. (2011) “Aquino Officially Reneges on Pledge to Build Philippine Infrastructure”. GR Business Online, 22 June 2011. http://grbusinessonline.wordpress.com/2013/06/01/aquino- officially-reneges-on-pledge-to-build-philippine-infrastructure/. Lagustan, N. (2011) “Farolan mistaken; Ramos pushed airport dev’t.”. The Philippine Daily Inquirer, 9 May 2011. http://opinion.inquirer.net/4883/farolan-mistaken-ramos-pushed- airport-dev’t. Landingin, R. (2007) “The Battle for Manila’s Gateway”. Newsbreak, 14 September 2007. http://philippineairspace.blogspot.com/2009/07/battle-for-manilas-gateway.html. PCIJ. (2003) “Special Report – Open for Business”. Philippine Center for Investigative Journalism iReport, IX(3), July-September 2003. http://pcij.org/imag/SpecialReport/business4.html. “Collapse of Fraport-Manila Hotel deal won’t affect government cases — OSG”. The Philippine Star, 3 February 2006. http://www.philstar.com/Article.aspx?articleId=319746. Quemado, G.U. (2002) “Graft charges against Phil minister dropped”. Cargo News Asia, 8 April 2002. http://cargonewsasia.com.hk/timesnet/data/cna/docs/cna6794.html. San Juan, J.R. (2011) “Singapore Court affirms ruling vs. Piatco”. Business Mirror [online], 16 November 2011. http://www.businessmirror.com.ph/home/top-news/19450-singapore-court- affirms-ruling-vs-piatco. San Juan, J.R. (2013) “CA orders government to pay Piatco $240 million plus”. BusinessMirror [online], 8 August 2013. http://www.businessmirror.com.ph/index.php/en/news/top- news/17687.
    • 21 Villamejor-Mendoza, M.F. (2011) “Equity and Fairness in Public-Private Partnerships: The Case of Airport Infrastructure Development in the Philippines”. Paper presented at the Echo Seminar on Recent Developments in Philippine Public Policies: Issues in Equity and Fairness, Philippine Society for Public Administration (PSPA), 17 August 2011. http://www.up- ncpag.org/main/research-and-publications/ncpag-research-center.html. Wallace, P. (2002) “NAIA-3 to Open in December?” The Wallace Report, September 2002. http://www.dataphil.com/special/naia3.pdf. Zambrano & Gruba Law Offices. (2011) “Public-Private Partnerships in the Philippines: A Practical Guide for Business”. Legal Update, 10 January 2011. http://www.legal500.com/assets/images/stories/firmdevs/new_public- private_partnership.pdf.
    • 22 About the Author Ben Kritz is a veteran of the automotive industry with over 10 years' experience in logistics and fixed operations management, and has moonlighted as an occasional business news correspondent in the US and abroad for the past 25 years. Now an independent management consultant, Ben advises a diverse group of clients across Asia in sectors as varied as air transport, auto sales and marketing, and small- and medium-enterprise development. His column on business and economic issues in the Philippines appears three times a week in The Manila Times.