The government is procuring the facilities for any and every public service you can think of using the PFI model, and contractors have been at the forefront of providing equity finance for these projects. They have done so in the expectation of securing construction contracts or, better still, long-term maintenance contracts.
The structure of PFI contracts is one that contractors are familiar with. A long-term contract for the provision of facilities is, of course, quite different from a lump-sum construction contract but it has to deal with the same kind of risks, such as delay in the completion of construction, the standard of subcontractors’ performance, changes instructed by the employer and so on.
Construction is financed by limited recourse loans. That is to say that the lenders loan the money to a limited company formed specially for the purpose of providing the service required by the public authority. The project company has no assets other than the facility itself and the right to receive the income from its use, which is governed by a concession agreement between the project company and the public authority.
The significant differences between PFI and non-PFI contracts arises from the nature of the non-recourse loan structure.
There is no standard form of construction contract for the PFI, and the Treasury taskforce does not propose one. In practice, the construction contract is based on a standard form with as many amendments as necessary. The lenders to the project company need a high degree of price certainty so design-and-build contracts are the norm for new construction.
The construction phase is the most risky for the lenders to the project because the project company has no income and no assets until the facility is operating. Contractors are therefore likely to be asked to take on more risk than usual.
Typically, all ground risk, the risk of delay caused by fire, the discovery of antiquities, strikes and the failure of statutory undertakers is passed to the contractor. Refurbishment of existing buildings offers specific difficulties as contractors are often asked to carry out a survey of the buildings and to take on the risk of latent defects in the existing structure. This is because the public authority will not warrant its condition and the project company cannot take the risk.
Liquidated damages are often substantial. They always include any interest payments to be made to the leaders during the period of delay and sometimes include the loss of revenue to the project company caused by the delayed commencement of the service.
Some public authorities recognise that they will get a better price if they agree to relieve the contractor of liquidated damages for delay, but lenders usually still require interest and repayments, if any, to continue. Some of these risks can be insured, others are best managed by the contractor.
Contractors also face what at first glance appears to be a greatly increased credit risk because the client often has no assets and no income. In practice, the lenders to the project company and the authority granting the concession both have a vested interest in seeing the construction phase through to completion, having invested vast amounts of time, effort and money in getting the project off the ground.
As a result, the lenders and the public authority will have the right under separate agreements with the contractor to “step in” to the shoes of the project company and continue with the job. The authority’s rights will be subsidiary to the lenders and either may “step out” again and hand the completed facility back to the project company to enable it to undertake the service or transfer it to a replacement project company.
In a nutshell …A PFI contract is unusual because the client is a specially formed company that initially has no assets. This means that the contractor has to bear more risk than is usual, although this is offset to some extent by the lenders’ and public authority’s willingness to temporarily take up the role of client
Christopher Hill is a managing partner of solicitor Norton Rose’s construction and engineering group.