Many PFI contracts are about to reach their first price review, when the contractor can apply for more money. This is likely to lead to some old friends falling out
The issue of PFI/PPP contracts and changes in the amount paid by the public sector client has been brought into focus in Scotland by a skirmish over Edinburgh’s Royal Infirmary.
The tussle was between NHS Lothian and Consort Healthcare – the project company led by the Royal Bank of Scotland and Balfour Beatty. It was begun by Consort’s application for an extra £1.1m a year for the patient movement, portering and security services it provided at the hospital. NHS Lothian disputed Consort’s uplift and has initiated court action.
Many other PFI projects are approaching the price review stage. So how exactly is this done?
And what are some of the issues surrounding the reviews?
To get to grips with this matter it helps to understand some of the principles behind PFI contracts. One is “value for money”. This will not be achieved if the project company is asked to take such a large risk that it has to substantially increase its bid price.
By providing a mechanism in the contract whereby some of the risk of price inflation and increased cost is addressed, there is no need for the project company’s bid price to be increased to cover all of that risk. Similarly, if the project company’s risk falls over a period, its public sector client will be looking for a reduction in the price paid.
The price paid under a PFI contract is known as the “unitary charge”. The annual unitary charge will be fixed at the start of the project and can only be changed in certain specified circumstances.
Hence the use of price adjustment provisions within PFI contracts. By providing mechanisms that allow the unitary charge to be adjusted up or down at periodic intervals to reflect unforeseeable changes in cost or cost efficiencies, this cuts the risk to the project company at bid stage. It also reduces the public sector clients risk of paying an uncompetitive price in the future.
Typically, only what are known as “soft services” (that is, services that do not involve significant capital outlays) such as catering, cleaning, housekeeping and security will be subject to price adjustment. Some PFI contracts do however allow for adjustment of certain “hard services” (for instance, landscaping and vehicle maintenance).
Consort is seeking an extra £1.1m a year for the patient movement, portering and security services it provides at Edinburgh’s Royal Infirmary
Price adjustment is normally done by one of two possible means – benchmarking or market testing.
Benchmarking involves the project company comparing the costs it is incurring in providing services against the comparable costs of providing such services in the market place. In simple terms, if the market costs are less than the project company’s costs then there should be a reduction in the price paid by the public sector body for the services; if on the other hand the market costs are higher, then the project company may be entitled to an increase in the unitary charge.
One of the main challenges in benchmarking, apart from understanding what the contract says about it, is what comparators are to be used. The difficulty is finding appropriate information that can be relied upon as accurate and honest and which ensures that what is being compared is like for like.
In the guidance produced by the government (Standardisation of PFI Contracts – Version Three), the preferred method of price adjustment is benchmarking. Where benchmarking is not appropriate, for example where there is insufficient data to enable a comparison to be carried out, then market testing may take place.
This involves a process of going out to the market to tender for the services in order to test the value for money element of those services. Once tenders are received, the project company then has to pick the “best” one. This can result in the party that is providing the services for the project company being replaced.
The sums involved here are large and there are substantial amounts of money to play for.
The action in Scotland is likely to be the first of many.
Lindy Patterson is a partner at solicitor Dundas Wilson. Email her at: firstname.lastname@example.org