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.

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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.

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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.

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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.

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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.