A planned construction spend of £3.6bn makes the Ministry of Defence a client worth courting, but contractors must meet exacting standards or face tough penalties.
Working for the Ministry of Defence has always been risky for contractors, but, on private finance initiative projects, the pitfalls are even greater. So contractors and bankers planning to bid for new PFI projects worth more than £3.5bn are gearing up for a roller-coaster ride where the risks – and rewards – are high.

The MOD has £6bn of PFI projects in the pipeline, but 40% of this will be spent on tanks and aircraft. Much of the rest will go on the ministry's London headquarters – where an Amey/Kvaerner team is preferred bidder – and a string of barracks projects.

Competitions for Colchester and Chelsea barracks are already under way and have shortlisted bidders; Kier, Tarmac, Bovis and Sir Robert McAlpine are among the prime movers.

Senior MOD sources have told Building that, following on from these, garrisons at Aldershot and around Salisbury Plain are likely to be redeveloped as PFI accommodation projects. Several training colleges are earmarked for PFI treatment, including RAF Halton, a cadet training establishment in Buckinghamshire, and the Army Training and Research Agency's dozen or so bases.

Understanding the MOD

Industry experience of MOD PFI is limited. Laing has had the best taste of what to expect through its Joint Services Command & Staff College project in Oxfordshire. It was also among the top contractors, accountants, lawyers and bankers that took part in a seminar organised by law firm Simmons & Simmons last month to outline the ups and downs of working on MOD PFI projects.

The MOD is as strict as any PFI client on insisting that its new facilities are available on time, and it has rigorous procedures for terminating contracts. As Laing commercial manager Stephen Cooper says: "You've got to know the risks inside out. The risks on these projects are big and could be company-busters if you're caught out. If you're late, damages can run to £350 000 a week.

"The major risk is the guaranteed maximum price you have to give – all design development has to be wound up within the budget, and you get no extensions for issues like ground conditions.

"You can't escape statutory rules such as disabled access regulations insisting on lifts and ramps that you wouldn't need to provide for the private sector. And you've got to understand the MOD has a different lifestyle to you and I. You have to understand rank and what their people expect.

You’ve got to know the risks inside out. The risks on these projects are big and could be company-busters if you’re caught out

Stephen Cooper, Commercial Manager, Laing

"You also need to meet and charm the planners," he adds. "The MOD has traditionally been exempt from planning, so they were glad to see us coming to negotiate for the ministry over our project." Bankers, too, are wary of the risks of working for the MOD. At the same Simmons & Simmons seminar, Fraser Greenshields, a senior manager at leading PFI lender Royal Bank of Scotland, explained the risk of "termination" on an MOD PFI project.

Greenshields said the inflexible attitude that can be encountered when working for the MOD is most apparent in negotiations over "corrupt gifts" clauses in contracts. The ministry is particularly touchy about corruption, and banks risk losing millions if, for example, a subcontractor takes or attempts a bribe, leading to the whole contract being cancelled. The MOD would get the asset, but the private sector consortium that provided it would be left with huge losses.

Apportioning the risk

The MOD is understandably concerned about glitches that might put a vital PFI asset out of action. Private sector firms are, equally understandably, concerned about the harsh penalties imposed if they do. At the seminar, Greenshields called for a "cure period" following a breakdown to allow remedial action before costs were incurred. He said: "We are looking for some grace for the private sector to put something right. There is a danger that people see PFI as a panacea for all service issues, but ultimately, you will hit snags whether a project is privately funded or not." The MOD itself takes a robust attitude to these complaints. If the private sector is unwilling to absorb sufficient risk on a PFI project, it will simply procure it some other way. At the same time, its 17-strong, in-house PFI team has won Treasury praise for being one of Whitehall's most advanced departmental PFI units, and it is currently exploring a range of standard "templates" for its contracts.

Peter Ryan, the team's new head, started in January. His experience of construction dates back to 1991, when he handled the financial aspects of the notorious Trident shore facilities programme. The Major Contractors Group has already arranged to meet him.

Room for manoeuvre

But defence work is not all danger and digging in. One senior MOD source stresses that, although "there is no substitute for the rigorous testing of each other's positions", the ministry is "not interested in screwing the industry to the wall or preventing profits".

And on some risks, the MOD is flexible. It accepts it cannot attempt to transfer "demand" risk, whereby contractors' payments are docked if the client has less need of a facility. One senior source explains: "Say the army needs to redeploy from Salisbury to East Anglia, they might need 1000 beds at Salisbury instead of 2000. It's best for that risk to remain with us." The MOD also says it is less obsessive about security than might be imagined, pointing to the huge swaths of its work that have already been contracted out. And, although information flow may be limited through the contract, foreign banks are not seen as a particular risk because funders take an arms-length approach to deals.