Getting defects right

Once a PFI facility, such as a school or hospital, is designed and built, the private sector project company's main obligation is to keep the facility open for business. The project company's payment stream depends on this. It should therefore carefully manage the risk of any defects that render the building unavailable. The ability of the company to repay the funds borrowed to finance the project will depend on regular receipt of payments from the public sector. If these payments are interrupted when a defect causes unavailability of the PFI facility, the price for the project company can be high.

The cause of the defect will not generally be an issue. If the net result is that the facility is not available for use, Project Co will suffer deductions in the amount it is paid. Those deductions will continue until the defect is remedied.

The project company's funder will be keen to ensure that company is insulated from the risk of defects impacting on the payment stream. This is generally achieved by passing the risk of defects to the project company's subcontractors. However, at subcontract level, the cause of the defect takes on greater significance. A defect may be a consequence of bad design, faulty workmanship, negligent supervision or inadequate maintenance. It may be a combination of any one or more of these. As far as the building contractor and facilities management contractor are concerned, neither will want to find itself liable and without redress for a default or omission of the other. On the other hand, the project company may wish to avoid becoming embroiled in a dispute over apportioning liability in the event that fingers are pointed both at the building contractor and the FM contractor.

As far as the building contractor is concerned, it will look to enter into a contract which usually limits its liability to 12 years. During that time, it is difficult to argue that the building contractor should not be liable for design and construction defects. But the FM contractor has to keep the facility open throughout the contract period, which is usually 25 or 30 years. Should the obligation on the FM contractor to keep the facility open for business extend to an obligation to remedy all defects regardless of cause? Clearly not, unless the FM contractor is given redress against the party ultimately responsible for the defect.

With this in mind, one method to reduce these risks is to pass them to the FM contractor as part of its general responsibility to keep the facility open for business. When the defect has been caused by bad design or workmanship and is the fault of the building contractor, the FM contractor must then pursue any rights of action directly against the builder. A direct right of action in contract is established between the two subcontractors through a co-operation or interface agreement to which both are party. In essence, the building contractor will undertake to the FM contractor to comply with its obligations in its building contract with Project Co. If it does not, then it will be in breach of its undertaking to the FM contractor contained in the interface agreement.

Another way of dealing with the risk of defects is for the project company to pursue the building contractor when the defect is caused by bad design or workmanship. If the project company does not have rights or remedies against the building contractor, then it is able to pursue the FM contractor. This avoids the necessity of a co-operation agreement and leaves the project company with responsibility for pursuing the claim. However, when a defect is partly caused by faulty design or construction and partly by bad maintenance, the project company may find itself pursuing both of its principal subcontractors.

So for the project company and its principal subcontractors, the impact of defects can be expensive. One development that may provide some comfort to the parties is the introduction of insurance products specifically designed to cover the impact of defects in the PFI facility. Insurance products that address the risk of defects over the life of a PFI contract are now coming on the market. Although these insurance products will obviously have a cost, they may ultimately bring down the price of defects in PFI.