Introduction

Between 1997 and 2003, 22 Federal Airports were privatised raising more than $8.5 billion in Commonwealth sale proceeds. The airports privatisation program involved leasehold, rather than freehold, sales. As a result, the Commonwealth has an ongoing interest in airport operations, both as landlord and because 21 of the 22 airport sites revert to the Commonwealth at the conclusion of the Airport Lease.¹

Post-sale management of the rights and obligations established by the sale documentation is the responsibility of the Department of Transport and Regional Services (DOTARS). In June 2004, the Australian National Audit Office (ANAO) tabled a report titled Management of Federal Airport Leases² (referred to in this report as the original audit). The objectives of the original audit were to assess whether DOTARS had developed and implemented an appropriate framework and procedures to administer lessee obligations entered into as part of the 1997 and 1998 leasehold sales of 17 Federal airports.

In the original audit, ANAO recognised the significant changes that had occurred in the aviation environment since the first sales in 1997. However, ANAO found that DOTARS had taken too long to develop procedures to administer important aspects of lessees' contractual obligations. In addition, although DOTARS had, from 2002, taken steps to improve its approach to contract administration, there was room for improvement in a number of areas. The nine recommendations related to the administration of the cost recovery provisions of the sale documentation, management of contingent liabilities (specifically, letters of comfort), conduct of lease reviews, the administration of airport insurance policies and oversight of aeronautical infrastructure development at the airports. DOTARS agreed with six of the recommendations, and agreed with qualification to the remainder.

The Joint Committee of Public Accounts and Audit (JCPAA) reviewed the original audit and made three recommendations relating to cost recovery in future asset sales, administration of the airport insurance arrangements and performance reporting in Annual Reports.³

The objective of this follow-up audit was to assess the extent to which DOTARS had implemented the nine recommendations contained in the original audit.

Overall audit conclusions

Since the report on the original audit tabled in June 2004, DOTARS has significantly improved and enhanced its practices and procedures across the full range of its lease administration responsibilities. Specifically, a comprehensive framework for lease administration has been developed and is being progressively implemented. Of particular note is that:

• through the timely and effective conduct of lease reviews, DOTARS is now in a position to be able to identify and address all significant areas of concern in respect to lease administration;
• DOTARS has procedures in place to effectively manage airport insurance risks with it assessing that as of August 2006, each airport had in place insurance cover that has removed most Commonwealth risk; and
• six of the ten lessees that committed in their respective sale agreements to a specified amount of aeronautical infrastructure development expenditure over the first ten years of the lease have been assessed by DOTARS to have fully met their contractual obligation. The remaining four lessees have been assessed as meeting the first five year stage of this commitment.

In this context, significant attention is now being given to post-sale management of leased Federal Airports. This reflects the extent and significance of the Commonwealth's rights and obligations under the sale documentation.

Key Findings

Cost recovery (Chapter 2)

The cost recovery clause in the Airport Lease was drafted to reflect DOTARS' preferred position, enunciated at the time of the first sales in 1997, that it be able to recover its reasonable lease administration costs. This was to address the risk that future costs were greater than expected and/or that the lease management function was not Budget-funded.

DOTARS has addressed a recommendation of the original audit that the Department consider the merits of exercising the contractual right to recover its lease administration costs. In doing so, DOTARS found that a statement made to bidders by the Commonwealth in the second phase of the sales (in 1998) had undermined the Commonwealth's contractual rights to recover lease administration costs for 14 of the Federal Airports. In this context, DOTARS has concluded that implementing a cost recovery process for only some of the airports could be perceived as being inequitable, would be difficult to administer and may be an inefficient use of resources. Accordingly, a decision has been made not to recover lease administration costs except in special circumstances. DOTARS' decision not to seek to recover lease administration costs is consistent with the Department of Finance and Administration's (Finance) response to a JCPAA recommendation arising from its review of the original audit.

Lease Reviews (Chapter 3)

DOTARS conducts lease reviews to ensure that it is sufficiently well informed to be able to assess an airport operator's compliance with the requirements of the Airport Lease. ANAO found that significant improvements have been made since the original audit to the conduct of lease reviews. Of note is that:

• a risk assessment of the management of airport lease reviews has been conducted, with risk treatments designed for all medium and high risks;
• lease review guidelines and document templates have been developed and implemented;
• there has been a noticeable improvement in the frequency with which lease reviews have been conducted, with the leases of all Federal Airports reviewed at least once since the original audit; and
• there has been continuing improvement in the documentation of lease review assessments, providing a sound basis for more effective follow-up of issues with lessees and finalisation of reviews.

Airport insurances (Chapter 4)

Insurable risks for airports arise both from their aviation-specific activities and general commercial activities. As part of the privatisation process, the Commonwealth sought to limit its risk from operations on the leased Federal Airports by imposing insurance coverage requirements on airport lessees, addressing aviation liability and property damage and business interruption.

Following the completion of the original audit, a number of initiatives were taken by DOTARS to improve the administrative framework for oversight of insurance obligations. Notable enhancements include:

• consolidation of responsibility for oversight of airport insurance arrangements to one section of the DOTARS' Airports Branch;
• finalisation in November 2005 of Guidelines for the Assessment of Insurance Coverage at Leased Federal Airports;
• maintaining contractual arrangements that provide ongoing access to expert, independent advice on lessees' insurance policies;
• a significant improvement in the timeliness of follow-up of reports from the contracted insurance adviser; and
• a more active interest being taken in administering the insurance provisions, including taking action to address deficiencies in insurance cover at certain airports.

Letters of Comfort (Chapter 5)

A letter of comfort is an instrument that is used to facilitate an action or transaction but is constructed with the intention of not giving rise to a legal obligation. Commonwealth policy is that, in general, letters of comfort should be avoided because they may lead to an actual liability. The letters of comfort issued in relation to Federal Airport leases relate to the Commonwealth allowing sub-lessees to remain on the airport site as a lessee in the event of early termination by the Commonwealth of the Airport Lease.

Since the original audit, only one new letter of comfort has been issued (in February 2005). In terms of this and the five other letters of comfort, ANAO found that DOTARS has improved its administrative arrangements. All letters of comfort are included in the Department's Indemnities Register and safe custody arrangements for the instruments are now in place.

Airport Development Obligations (Chapter 6)

The Sale Agreements for 10 of the airports included a commitment from the lessee to a specified amount of capital expenditure on aeronautical infrastructure development over the first 10 years of the lease. In total, the 10 airports were required to undertake capital expenditure of $699.8 million. The Obligations are divided into two five year periods (referred to as Period One and Period Two).

Four of the nine recommendations in the original audit related to the administration of the airport Development Obligations. In this context, action has been taken by DOTARS to address each of these recommendations, as follows:

• in September 2005, administrative responsibility for Development Obligations was consolidated in one section to improve the consistency of assessments and subsequent decision making;
• in October 2005, revised administrative guidelines were promulgated;
• in most instances, DOTARS is now obtaining Annual Expenditure Plans from lessees, although most Plans are not received on time;
• Annual Airport Development Cost Reports on airport development expenditure by the lessees are being obtained in a more timely manner, although timeliness could be further improved; and
• there has been greater rigour apparent in the analysis of information provided by lessees and more timely follow-up of concerns with lessees.

ANAO identified opportunities for further improvements in DOTARS' approach to assessing the achievement of relevant airport's obligations to undertake capital expenditure. Specifically, there was variation in the level of detail provided by different lessees, there have been inconsistencies in the nature of expenditure that has been accepted or rejected for different lessees and there is some uncertainty that some of the expenditure that has been accepted by DOTARS fairly reflects aeronautical infrastructure development expenditure. In addition, DOTARS could have been more timely in its analysis and raising of concerns with lessees. This would have better protected the Department's ability to exercise its rights under the Sale Agreements to have any shortfall in expenditure paid to the Commonwealth.

As of December 2006, ten lessees had been assessed as having met their Period One Development Obligations. In addition, six lessees have been assessed as meeting their Period Two Development Obligations in advance of the due date (2007 for some lessees and 2008 for others). Accordingly, ANAO has not made any further recommendations in this area.

Agency Response

DOTARS provided a summary comment on the report, as follows.

As previously stated in response to Australian National Audit Office Performance Audit Report No.50, Management of Federal Airport Leases 2003–04 the Department remains committed to continued development and implementation of initiatives for the efficient and effective oversight of the leased Federal airports. This will continue to be achieved through improvement of the Department's regulatory, contractual and operational oversight processes, and the continued appropriate allocation of resources according to risk.

Effecting long-term, sustained change does not occur spontaneously and requires considerable time to ensure that any new procedures and processes are adequately developed and ‘bedded down'.

As part of its continuous improvement, the Department has, as noted by the ANAO, made significant progress in the management of its oversight of the Federal Airport leases and Sale Agreements since the tabling of the Audit Report No.50, and developed a range of strategies and initiatives to improve its oversight activities. Significant focus has also been placed on the review and improvement of the Department's performance reporting in regard to this matter.

The Department considers that it has implemented the recommendations contained in Audit Report No.50 and put in place ongoing processes and procedures for the Department to discharge its ongoing lease management responsibilities effectively.

In particular, management of airport leases and sale agreements has been improved by implementing a broad range of measures including:

• centralising airport insurance and airport development obligations oversight;
• relevant guidelines being reviewed, updated and implemented;
• implementing improved procedures and processes for annual lease reviews to ensure they are undertaken in an efficient, effective and consistent manner;
• development and implementation of a Register of Contingencies and appropriate safe custody arrangements for Letters of General Assurance issued by the Department; and
• consideration of the Department's cost recovery of administrative costs associated with lease oversight.

In view of these improvements the Department's performance reporting on these matters has also been enhanced to include further details of the airports' compliance with their contractual obligations.

The Department is cognisant of the need to continually improve its processes and will take into account comments made by the ANAO in this audit.

The Department acknowledges the effort of the leased Federal airports in responding to the Department's implementation of the recommendations in Audit Report No.50.

Footnotes

1 The exception being Hoxton Park. It was sold with a shortened five-year lease, after which time it is to revert to freehold title. The five-year lease can be extended a further two years upon agreement between the Commonwealth and the lessee.

2 ANAO Audit Report No.50 2003–04, Management of Federal Airport Leases, Canberra, 4 June 2004.

3 Report 404, Review of Auditor-General's Reports 2003–04 Third & Fourth Quarters; and First and Second Quarters of 2004–05, Joint Committee of Public Accounts and Audit, November 2005.