Time is money

A cornerstone of the government's PFI strategy is the management of risk in a value-for-money environment. In asset-based PFI transactions involving, say, the design and construction of a hospital or school, one risk the private sector must manage is achieving completion of the facility on time.

Late completion is a genuine risk to the private sector because payments trigger on completion. The only exceptions to this rule are extensions of time for a limited series of events.

However, the scope to play a Get Out of Jail Free card by claiming an extension of time, together with the associated costs of the delay, is much narrower than in traditional procurement. The reasons for this can be found in the structure of a typical PFI contract.

Most PFI contracts are to design, build, finance and operate a facility for an extended period, 20 to 30 years, sometimes longer. The contracts are usually entered into by a company formed specially for the project – a special purpose vehicle or SPV – and the procuring authority in question.

The SPV negotiates the deal with the authority through its shareholders, which usually include the construction contractor. The SPV must fund the design, construction and operation of the facility itself. Funders will require the SPV to remain as risk-free as possible. This means the SPV must pass risk on by subcontracting its primary obligations.

The construction obligations are mostly subcontracted through a fixed price design-and-build contract, which is tailored to reflect the obligations and the liabilities of the SPV in the main concession agreement.

This includes the obligation to complete by a certain date, and the limited grounds to extend that date.

Why is time so important? As mentioned, the SPV usually receives no money from the procuring authority until the facility is "complete". To be complete in PFI terms, the facility must in general be operational, only then does the authority begin paying.

A time overrun can be catastrophic, because it delays the start of the income stream from the procuring authority. It is from this that the SPV will repay the loans it has taken out – principally for design and construction. Any delay in starting repayment attracts hefty charges and costs.

These will almost invariably be recouped from the construction contractor through liquidated damages – another reason for timely completion by the construction contractor.

And if there is a delay? The industry has adopted a different approach to extensions of time from that found in the usual standard forms – the grounds for an extension are much narrower, the monetary consequences less beneficial – and more risk is shouldered by the contractor. In the early days of the PFI, these grounds and consequences were hotly debated deal by deal, but as the market has matured the government has produced PFI guidance that standardises the events giving rise to an extension of time. Some events give rise to time extensions, a minority to time and money.

The narrow circumstances provided for in the guidance are a breach by the procuring authority, a variation by the authority or a specific change in law – health-specific in a hospital PFI or education-specific for a school PFI – or the following:

• Fire, explosion, lightning, storm, tempest, flood, bursting or overflowing of water tanks, apparatus or pipes, ionising radiation, earthquakes, riot and civil commotion
  
• Failures by statutory undertakers
  
• Any accidental loss or damage
  
• Failures or shortage of power, fuel or transport
  
• Blockades or embargoes
  
• Labour disputes that affect the construction industry or a sector of it.

Usually only a breach by the procuring authority or a specific change in law will give rise to an extension of both time and money. For the others, the financial consequences of the delay remain with the SPV, as does the imperative to pass the risk of such financial consequences to the construction contractor. This represents a very different approach from, say, JCT, and creates an obvious incentive to complete on time.

So where the SPV is granted an extension of time, the construction contractor will usually be entitled to an extension of the same duration. But paradoxically, where time but no money is given, the contractor could find itself contractually bound to pick up the SPV's financial costs as well as its own.

This is because the government's PFI guidance introduced one further incentive to hit headlines that applies even where an extension to the date for completion, or the date from which the SPV is obliged to commence its services, is given. What is it? According to the guidance the overall period is fixed and runs from the signature of the contract – so even if the date for completion of the construction is extended, the overall period is not.

This means the SPV's revenue period is reduced for any delay where there is an extension of time.

Extending the overall contract period would keep the revenue period for the SPV intact and reduce the incentive for the SPV to manage the effects of a delay and restore service as soon as possible.

What is clear is that the ball game has changed significantly, and that in PFI-based contracts time is almost always of the essence.