A new form of PPP model is being tried out in Scotland that will affect the way projects are refinanced and how profits are distributed
In 2005 in, in advance of the recent Scottish parliament elections, a new form of PPP model was pioneered for a West Coast schools project in Argyll and Bute. It involved 10 schools with a total capital value of £128.2m. The project, based on non-profit distributing (NPD) principles, was the first of its kind in the UK. The approach of the Scottish government suggests this is the beginning of a new form of PFI in Scotland.
How does this model differ from a typical PFI project? How will contractors and service providers in this market view the model? Will it change the key players in the PFI market?
As we know, in a typical PPP project the company set up specifically for the project subcontracts all its obligations to a building contractor and service and facilities management providers.
There is speculation that those most likely to find this model attractive are the contractors and facilities managers, who are also shareholders
The project company is typically financed by a mix of senior and junior debt. Senior debt is provided by banks or capital markets. In simple terms it is a bank loan, which the project company uses to finance construction costs. The project company repays that loan when it starts to receive payment from the authority for the services it provides. It is referred to as “senior debt”, as it is paid off first. Junior or sub-debt is often provided by subcontractors involved in the project or third party investors. The junior debt providers are also the shareholders in the project company. Their investment is not repaid until the end of the project, although they may receive dividends throughout its lifetime.
We have all read of the market that has emerged, often referred to as the secondary market, from the sale of interests in or refinancing of PPP projects. The aim is to find better, cheaper finance. The project company wins as it pays less for its borrowings but still receives the same income from the authority. As far as senior debt providers are concerned, if they are ousted as part of a refinancing, the loan agreements will compensate them accordingly. Junior debt shareholders could make big profits if they leave or sell their shareholding and debt.
In projects based on NPD principles, the parties and contracts remain largely unchanged. Funding continues to be obtained by the project company through a mix of senior and junior debt. The project company, however, operates quite differently. The major difference is that it is not allowed to distribute any profit to junior debt shareholders. Instead, the profit is paid to a charitable body, nominated by the authority for use in the community, including possible reinvestment into the project in question. The authority and the charity appoint directors to the board of the project company and they are afforded certain controls over the management decisions of the project company.
The Scottish government has indicated that the NPD model will be the norm for all future PPP projects in the short term, unless there is good reason to do otherwise
One such control relates to the decision to refinance the borrowings, which will typically lie with the independent director. Unlike a traditional PPP, the decision of when to refinance is taken out of the junior debt providers’ hands. Thus, the timing of any refinance isn’t necessarily geared to maximising profit for the junior debt shareholders. For senior debt holders a refinancing under an NPD model makes little practical difference. There is speculation that those most likely to find this model attractive are contractors and facilities managers that are also shareholders. They will be able to get returns from elsewhere in the project.
The Scottish government has indicated that the NPD model will be the norm for all future PPP projects in Scotland in the short term, unless there is good reason to do otherwise. They have put a document entitled Scottish Futures Trust out for consultation, seeking comment on their proposals for new ways of funding public sector projects in the future.
Since the first NPD back in 2005, two further schools projects using the NPD model have closed and one in the health sector has just recently been advertised.
Lindy Patterson is a partner in Dundas & Wilson
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