PFI: the state of the art

The restructuring of recent high-profile private finance initiative projects into public-private partnerships has opened the way for innovative solutions to legal and commercial constraints. It is clear that the government will not be put off the idea of privatisation, contracting out or outsourcing by mere technical, legal or accounting problems, and this in turn means that the scope of PFI is expanding.

High-profile projects have, however, had to overcome legal and commercial obstacles in order to proceed effectively.

These have prompted the public sector to adopt a more interventionist approach when projects face difficulties, and to demand greater visibility during construction so that monitoring becomes easier. But this greater intervention does not mean increasing financial assistance or intervening openly in the design or construction process.

There are accounting and legal constraints on the way in which property can be held for the purpose of providing a service to the client – for instance, the Accounting Standards Board has issued guidelines tightening the rule for how PFI projects are entered on the balance sheet. Competition law imposes strict limits on the amount of state aid that can be provided to the private sector, and taxation law limits the right to claim for capital allowances, depending on how the eventual assets are held.

The principal solutions include "hive-down" agreements, identifying and transferring contractual rights, assets and liabilities to new operating companies; using trusts for shared assets; and using "step-in right" agreements to preserve rights if problems arise in the future.

These devices mean that the legal constraints imposed by taxation, competition law and privity of contract can be overcome, and the rights and assets can be used by those who need them (whether operator, owner or eventual user) at the times they are needed.

In seeking a sensible way to overcome the problem of arranging finance, the government has indicated a willingness to underwrite, in limited circumstances, the financing of debt on certain major projects.

In particular, the use of "last resort" guarantees for bond issues has meant that the problems of the private sector in arranging finance have at last been addressed. The government has also proposed the idea of a central funding bank for PFI projects, which will increase the availability of rapid and long-term financing.

Traditional PFI projects tended not to distinguish between design, production and fabrication because the specification focused on outputs or performance. In any case, by the time of contract award, the design can only have been developed in outline.

The consortia now involved in these projects appreciate the significance of finding the right balance between quality design and project management to sustain profit for the consortium while staying within the constraints of those funding the project. The client, too, has a vested interest in good design and project management because, ultimately, it may wish to take back the asset at the end of the concession and so should require that it will have a high residual value.

Two problems for designers and project managers have been: how to limit liability for potentially huge losses if their design or management is defective, and how to ensure that sufficient funds are available to carry out quality design and project management. Two solutions are: liability caps and cost control.

Although there is nothing new about limitations of liability, the contingent liability itself is largely replaced by a "gain/pain" sharing mechanism depending on the cost of the completed project. The fees of the design/project management team are also linked to the gain/pain mechanism, giving the team a greater incentive to control contractors' costs and thus allowing resources into good design.

Dispute resolution poses two challenges for PFI or PPP projects: the diversity and multiplicity of contractual arrangements between the parties, and the specific requirements of the Construction Act 1996.

The solution is one central dispute resolution agreement between all parties, together with specific provisions for parties to "accede", creating a new "court" and jurisprudence for the length of the concession contract. The process uses the most up-to-date alternative dispute resolution techniques and arbitration by distinct panels: technical, financial and operational. A panel can, at the same time, act as adjudicator for the purposes of the act, thus ensuring a decision within 28 days. A claims handling agreement allows a wide number of parties to pursue claims jointly, with a mechanism to provide for allocation of the proceeds of claims.

The construction process for PFI or PPP projects will have a large number of interfaces both with other projects and existing services. One solution is to provide for matters that cross boundaries and are related to design integrity or safety to be referred to an interface committee that can override conflicting site instruction or notice. Where key personnel must be shared because of their unique experience, an agreement can provide for "body shopping" at cost, to enable them to be used for different parts of different projects at different times.