The expiry of PFI contracts
Many years from inception the Design Build Sub-contracts entered into by PFI contractors, such as Bovis Lend Lease, on PFI projects are nearing the end of the 12 year liability period, which runs from the date of Practical Completion. The Leeds Oncology PFI hospital project commenced in 2004 and Practical Completion was achieved in 2007. l was involved in drafting the Medical Equipment and Facilities Management Sub-Contracts on Leeds Oncology and on Queen Mary’s Hospital Roehampton and the associated documents. The life of the Medical Equipment Sub-Contract for Leeds Oncology will come to an end this year and the Handback procedure will be implemented in respect of the Medical Equipment.
What will happen on expiry and what will the fall out of their coming to an end look like? The National Audit Office Report of last year warned and recommended that planning for PFI expiry should commence seven years before the exit date.
Local Partnerships (a Joint Venture between Local Government Association, HM Treasury and the Welsh Government) in their report “Preparing for the Expiry of Private Finance Initiative observes as follows:
“One of the most important decisions that needs to be taken is whether the public authority intends to continue to use and operate the assets, or whether it intends to vacate and dispose of them. Within this decision-making process is the consideration of an extension of the existing arrangements or a re-procurement, to look for someone else to manage and maintain the assets into a future lifecycle. Unless the authority has decided to cease provision of the services, consideration of the future for the assets will require a full appraisal of all options available. If the ownership of the assets does not revert automatically to the public authority”
Background to the Bovis involvement in PFI
The involvement in PFI at Bovis began in circa 1995, when they were working with the John Major Conservative government. As the general election loomed for the Major government, Bovis spoke to the Labour Party in anticipation that they would win the general election. Bovis then worked with the Labour Government and the Treasury to help produce the PFI financial and legal structure for the first real PFI, the Phase 1 conversion of half of the Treasury building on Whitehall. This was deemed a success by Gordon Brown and the next major phases were hospitals, followed by schools.
The Labour Government wanted PFI to be able to renew existing buildings or build new buildings but to keep the cost off of the public borrowing balance sheet. Bovis entered into most of the early PFI contracts.
Bovis was involved in the setting up of the individual project SPV companies e.g. the Exchequer Partnership for the two phases of the Treasury Whitehall building and Catalyst companies for each of the PFI hospitals. The legal documents were being developed by government over the early years as they tried to address risk and the different types of services in each PFI. The documents in the first 5 -10 years of PFI were based around a core set of documents but were bespoke for each scheme and I have the knowledge of many of these. PFI began to slow even before the financial crash of 2008 and when Cameron/Osborne came to power they suspended PFI projects.
The Building Schools for the Future contacts contain a procedure for a final survey to be carried out 18 months before the expiry date, to assess whether the facilities have been and are being maintained by the Contractor and Project Co can notify them of the rectification and/or maintenance work required to bring the condition of the schools to the required standard and specify a period to the carrying out of works. The cost of the survey from the Contractor is withdrawn from the retention fund.
There are similar provisions in the Hospital PFI contracts.
On expiry of the Medical Equipment Contract for Leeds Oncology, in respect of the equipment the Trust can step into an Equipment Availability Agreement with the relevant manufacturer, extend the Equipment Term or allow the Medical Equipment Agreement to expire.
The Estates Management (EM) Contractor must ensure that the Facilities satisfy the Handback Requirements on Leeds Oncology. After a joint inspection the EM must submit proposals and estimates concerning the Handback Works and the EM must carry out the works at their own cost even though they may be higher than the Handback Account that is to be set up.
The role of the private sector and the SPV
In PFI contracts the government or other public sector body is responsible for a service or facility, the use of the building or other assets. The private sector provides the capital, designs, builds and operates the facility and services over the contract term of thirty years or so. The private sector provider has responsibility for services and there is a mechanism for payment of fees by the public sector. The public sector pays the private sector funded fee for the service over the life of the contract. The payment of the fee is dependent on the performance/value of use of the facility and associated services.
The creation of a “Special Purposes Vehicle” (SPV) consortium made up of a building contractor company, a facilities management company and Equity Finance Providers entered into the Project Agreement. The SPV company designed and built a facility and it was run for a number of years and it provided a fully managed facility to the client under a number of sub-contracts.
The transfer of the operational risk to the private sector is an essential feature of PFI projects. Payment is based upon performance so that the responsibility and risk throughout the contract term is in accordance with the output specification with the Health Trust, in the case of PFI hospitals, or the Educational Authority, in the case of PFI schools.
The payment mechanism contains an availability element which is paid in full if the facilities/service is fully available but withheld if any part of the facilities or service is not available. A performance element is paid in full if required performance standards are met, but which is subject to deductions where performance is substandard.
Performance penalties and deductions
The Estates Maintenance contractor carries out maintenance services throughout the operational term and if they are found to be in breach of their obligations they will suffer penalties and unavailability deductions.
On the Leeds Oncology and Queen Mary’s Hospital Roehampton Hospital PFI projects the interface between the D&B contractor, EM Contractor and the Medical Equipment Contractor are set out in each of their subcontracts and are governed by a co-operation agreement that contains dispute resolution procedures. They will agree complex schedules identifying what constitutes a defect and what is a maintenance issue, to set out their respective roles and any disputes over to which each sub-contractor is liable can be determined by an allocation of responsibility by the SPV (Project Co in the hospital contracts) and which can be challenged in the Dispute Resolution procedures contained in the Co-operation Agreement.
The Sub-contractors waive their rights to claim against Project Co but this waiver does not prejudice their rights against the other sub-contractors under the Co-operation Agreement.
Project Co makes an initial assessment of the matter in respect of any failure event deductions and/or quality failure deductions which are subject to reallocation in the Co-operation Agreement.
The payment mechanism in PFI contracts ordinarily allows authorities to make deductions from the unitary payment where there is a failing in the provision of services or original construction. The project company may adjudicate to recover what it has incurred.
Can the unavailability, performance deductions and penalty points be challenged as an unlawful “penalty”?
On Handback at the expiry, the mechanisms of unavailability deductions and penalty points come into play, so that these can be deducted from the “Handback Account”. A question that may be raised in any dispute in the Handback process is whether the unavailability deductions or penalty points are an unlawful “penalty”. This would be answered by examining the case law on Liquidated and Ascertained Damages (“LADs). Recent developments in case law upon LADs have decided that the commercial reality and the accepted purpose of a liquidated damages clause is what maters when deciding upon the validity of a liquidated damages clause. (Triple Point Technology Inc v PTT Public Company  UKSC 29, the Supreme Court). The purpose of including a liquidated clause is to provide a remedy that is predictable and certain for a particular event. The courts have decided that LADs in a Building Contract will not be penal if they are in the “legitimate interests” of the Developer, Employer or Contractor that imposes them. The Supreme Court in Cavendish Square Holdings – v- Talal El Makdessi and Parking Eye -v- Beavis  UKSC67 decided that whether the LADs clause is a genuine pre-estimate of loss or not is whether it is out of all proportion to a legitimate interest (of the developer, employer or main contractor) enforcing it.
The Technology and Construction judgment of Alfred McAlpine Capital Projects Limited -v- Tilebox Limited  EWHC 281 dealt with the question of when will an LAD’s clause be interpreted as a penalty clause? In this case the court decided there had to be a substantial discrepancy between the level of damages stipulated in the contract as LADs and the actual level of damages that were likely to be suffered before the courts would say that the agreed pre-estimate was unreasonable.
The court said if the question of LADs was the subject of specific debate between the parties to the contract before the contract is executed and LADs was considered not only by the parties but also by their legal advisors then the court would find that the agreed liquidated damages was reasonable.
The Supreme Court in Cavendish ruled that the test of whether a LADs clause is legitimate or not in a building contract is whether it is out of all proportion to any legitimate interest of the employer/owner/developer in achieving the target completion date.
The Cavendish decision will no doubt inflate the amount of LADs in the name of “legitimate business interests” and Contractors will cry foul that they are in truth “extravagant”. These arguments may well come to the fore in Handback disputes, at the end of the life of the particular contract.
The PFI hospitals may have fire safety related problems for example or faulty alarm or sprinkler systems or other defects such as failing pipework, defective ventilation systems, or failings in walls or foundations. If the building achieved practical completion more than 12 years ago, the project companies may struggle to pass deductions or costs of repairs through to the building contractor because this 12 year limitation period will have expired or will soon expire. If the project companies cannot bring a claim against the building contractor for defects for this reason and if it cannot pass some losses through to the EM Sub-Contractor the cost of repairs could fall to the authority and they could be forced into insolvency as a result.
PFI Building Contractors and Facilities or Estate Management Contractors can contact me for advice and representation in the resolution of disputes arising from the expiry of the PFI terms contained in their contracts and upon the operation of the dispute resolution and other procedures that govern them in the PFI contracts and in the drafting of Novation and Assignment of the sub-contracts, to transfer the contracts to a new service provider or building contractor, if this is desired by the awarding authorities upon expiry.