The PFI term for this is refinancing, and the monetary benefit won by the project company is the refinancing gain. If you had no knowledge of the PFI, you might think that any such gain should be kept by the contractor. After all, it took the risk, and if anything had gone wrong, it would not have been able to go back cap in hand to the authority.
This is not the approach generally taken by the public sector. Its line is that a project must be shown to be value for money compared with the "public sector comparator". That is, the PFI cost must be less than that of traditional procurement. If the project company can, as a matter of course, expect to make a windfall gain by refinancing, this should be factored into the financial model at the outset, or the authority is arguably not getting value for money. Further, the authority will argue that the refinancing is often only possible because of the strength of the authority's commitment to pay for a service over a long period at a predetermined price.
These issues came to a head in June when the National Audit Office published a report showing that Tarmac (as it then was) and Group 4 had made a considerable profit on one of the first PFI prison contracts (Fazakerley). This resulted in a number of different approaches being taken to refinancing in the market.
The latest guidance on the standardisation of PFI contracts issued by the Office of Government Commerce, in conjunction with Partnerships UK, makes clear that authorities should welcome refinancing proposals in principle. The guidance adopts the straightforward compromise position of splitting any gains 50-50. This idea had been discussed during the two-year consultation period, and therefore came as no surprise. More interesting are other connected points in the guidance on this topic.
First, what is a gain? The definition is widely drawn. It covers not only replacing the banks but also any changes to the loan arrangements that lead to a refinancing gain. There are exemptions available to the contractor. Any refinancing anticipated in setting the annual charges will be excluded. Also, the refinancing provisions in the guidance are not designed to prevent contractors from selling their equity shares and loan stock in the project. Contractors will need to be alert to what is covered so as to give the required notices, because of the harsh sanctions for failing to comply (see below).
Second, when should any gain be paid over – as a lump sum or by an adjustment to the unitary charge? The guidance allows the authority to choose, but then requires the parties to negotiate in good faith. Contractors should ensure that the authority is not given the power to insist on a lump sum to the detriment of the refinancing, and that the authority does not receive its share of a refinancing in a more beneficial way than the contractor does.
Third, the guidance gives the authority the power to veto a refinancing, except when this has been done as a rescue operation for the project and where lenders have stepped in. The right of veto cannot be used as a bargaining tool to extract a better than 50% share.
Finally, any unauthorised refinancing may turn out to be painful for the contractor. The authority can terminate and pay a compensation equivalent where there is a wilful breach of the clause prohibiting corruption (only the senior debt is repaid). Contractors may want to draft a clause allowing an amnesty for minor transgressions.
The new guidance should substantially reduce the hours of negotiation that used to be spent on refinancing clauses. That is what we all hope, at least – just don't bet your mortgage on it.
Ian Yule and Stephen Kenny are partners in solicitor Wragge & Co.