With PFI undergoing a possible resurgence, contractors and consultants should apprise themselves of the risks involved before they sign up
The report on the private finance initiative published in August by the House of Commons Treasury Select Committee was not exactly a wholehearted endorsement. The report found no evidence of savings and benefits sufficient to compensate for the relatively high cost of finance for the private sector. PFI, the report concluded, should be subject to stricter
rules and guidelines.
Nevertheless, it seems likely that PFI will continue to be used to some extent. For example, the education secretary Michael Gove has recently announced the launch of a PFI programme worth some £2bn in capital construction costs.
Contractors should get involved well before the project agreement is finalised, so as to ensure the transfer of risk is as reasonable as it can be
For building and engineering contractors, any news of government spending on projects must seem welcome, particularly in the current market. But contractors should not rush in to PFI projects without examining and negotiating the risks. This is a task for the contractor’s technical and legal team working together. These risks then need to be priced and, most importantly, built into the overall bid by the project company.
When PFI was first introduced, contractors had to get used to a far greater transfer of risk than they were accustomed to. This followed from the fact that the project company, being a special purpose vehicle (SPV) with no assets as such, could not take any risk itself (in theory at least) and so had to pass all risks out to its contractors and consultants. Contractors had to grit their teeth, particularly where they had little or no equity involvement in the SPV to compensate them.
This general position is unlikely to change, unless new funding methods are devised. Contractors should ensure that they get involved early at heads of term stage, and well before the project agreement is finalised, so as to ensure that the transfer of risk is as reasonable as it can be for a PFI project. There are many areas that need to be checked. Three key ones for the contractor’s legal team are as follows.
First, the overall dispute resolution system often ends up being unnecessarily complicated. It is based on the principle that, if there is a dispute, the SPV takes a back seat and lets the other parties resolve things. The mechanism for this is the “interface agreement” that all parties sign up to.
This system works where the number of parties is small but is less successful where various parties in the supply chain and consultants are brought in. The scheme can then become almost unworkable. It is not just the main contractor that is affected. PFIs in recent years have seen some extreme arrangements under which a specialist at one end of the supply chain might be required to take action against a consultant at the other if it wanted to recover increased costs.
Contractors should also be wary of attempts to add schedules to the interface agreement that increase its obligations to the FM contractor and others. Any such schedules should not deal with areas already covered in the building contract.
Secondly, in relation to claims against the public authority, contractors will inevitably have to deal with “equivalent project relief” clauses under which certain rights to compensation are limited to whatever rights the SPV itself has against the authority. All too often, the SPV pursues these claims on the contractor’s behalf, but with no great enthusiasm. This time around, contractors should press for the right to deal with the authority direct - perhaps using the SPV’s name. At the very least they should demand substantial input into the running or defence of any such claim.
Contractors can also expect to be on the end of some clever drafting at SPV level designed to disguise “pay when paid” (unlawful, under section 113 of the Construction act) as “pay when certified” (lawful in PFI building contracts from 1 October). In response, they should be prepared to use the comments of Mr Justice Jackson in the Midland Expressway vs Carillion case in 2005 - parties cannot escape the effects of section 113 “by the use of circumlocution”.
Finally, disputes have frequently arisen in PFI projects about when completion should have been certified. This can happen on any project of course, but with PFI, any delays are potentially catastrophic for the party at fault. The test for completion should generally be as objective as possible. Long lists of minor matters that can delay completion should be avoided.
Whatever else, contractors should not just sign up and hope for the best this time around. Disputes on PFI projects, though not always well-publicised, turned out to be rather more widespread than people might have expected when PFI was first launched nearly 20 years ago.
Ian Yule is a partner in Weightmans