Preparing for expiry of your PFI contract
Over 200 PFIs will expire over the next decade. But are public bodies prepared? And what happens when a PFI contract expires? Steve Johns explains.
In June the National Audit Office published a report into public bodies’ preparedness for the approaching wave of Private Finance Initiative expiry. It was swiftly followed by guidance from Local Partnerships on the same topic. These two publications have put expiry of PFI contracts firmly on the agenda for the first time.
The NAO report contains some thought-provoking statistics. While few PFIs have reached expiry to date, around 50 will do so over the next five years and 200+ during this decade. That may seem some time away, but the NAO concluded that authorities should start planning seven years in advance. Suddenly, the end of those PFIs does not seem so distant after all.
As each PFI expires, something will need to replace it. So authorities must both manage the expiry process in accordance with the PFI contract terms and decide upon future arrangements for the relevant asset and services. And they must do this while continuing to undertake 'business as usual' contract management; indeed as a PFI draws to a close, diligent contract management may be more important than ever to ensure standards are maintained.
For the public sector generally, managing the process of closing down PFI contracts over the next 15 years will be a challenge. There are 700+ extant PFI contracts, spread across 328 different authorities. 182 authorities have only one such contract. There is much more consolidation on the private-sector side – 10 investors own half of the contracts. The risk of an imbalance in resource and expertise is plain to see.
It is clear that advance planning is essential. So what steps should authorities be taking?
1. Identify objectives and develop a timeline to expiry
In most cases, the key objectives of authorities are likely to be to:
- ensure the relevant asset is in the appropriate condition on the expiry date;
- prevent any disruption to service provision. How these are best achieved will depend upon the specific contract and context – for example, if the asset does not revert to the authority on expiry, the authority will have different issues to consider.
2. Understand the contract
Gaining a clear understanding of the contract is one of the key preparatory steps an authority should take – how is expiry dealt with contractually, what steps need to be taken and processes followed?
In most projects, the asset reverts to the authority on expiry, but on a sizeable minority of PFIs that is not the case – at least not automatically. Authorities need to understand their position in this regard, as this will form an important component of the options appraisal for future service provision.
Most contracts provide for surveys to be undertaken 1–2 years prior to expiry to ascertain asset condition and permit the authority to make retentions from the monthly unitary charge to cover the cost of any rectification work identified. Conceptually this is a simple procedure, but thought will be required about how to implement it in a manner that minimises the risk of dispute – use of an independent surveyor perhaps?
In order to put themselves in the best bargaining position, authorities should also seek to understand the wider commercial picture, such as which party holds any lifecycle funds and who stands to gain from savings. The position of the funder is also important, as the funder's requirements and oversight help keep the contractor in line. But debt is always profiled to be repaid several months before contract expiry – it will be useful for the authority to know exactly when that will happen.
Finally, there will be ancillary matters to manage – TUPE, pensions, documentation/records, IPR. All need careful consideration.
3. Engage with the contractor
The path to expiry will be smoother if the parties are working to a common understanding of the contract provisions and timeline. If there are deficiencies in the contract drafting, it may be of benefit to agree changes well in advance or to put in place an expiry protocol. Early PFIs will present particular challenges in this regard as they do not benefit from the standardised drafting that was gradually introduced by Treasury as PFI was rolled out.
In some cases, third parties may need to be involved. Particular issues arise in relation to schools that have become academies, given that the asset will not revert to the authority but to the academy trust.
4. Assess asset condition
While the contract will provide for a formal survey process, it will benefit the authority to inform itself about the asset condition before that process begins. This will allow the authority to raise concerns sooner and avoid a scenario in which a large number of costly items are identified at the very end of the contract term – a recipe for dispute. Authorities need to be conscious of the fact that their counterparty is a special purpose vehicle established specifically for the project, which will be wound up after expiry. As such, it is unlikely that there will be any recourse for breach of contract claims after the expiry date.
5. Allocate resource and access support
Additional resource will be required to manage expiry while the authority continues to undertake day-to-day contract administration activities. In considering resource needs, authorities should be cognisant of the potential for disputes as the finish line approaches, most likely around the condition of the asset. Authorities should access support where possible, from Local Partnerships, the Infrastructure and Projects Authority, sponsoring departments, other authorities and external advisers. For authorities with multiple PFIs, consider how the knowledge gained can be retained for future expiry exercises.
6. Plan for the future
What follows the PFI? Authorities will need to undertake options appraisals, and options may include mothballing the facility, taking services in-house or procuring a new service provider. Cost implications of maintaining the facility into the future will need to be considered, in the absence of PFI credits.
Decisions about future use may impact upon the expiry process. If elements of the asset are to be mothballed or repurposed, there may be no need for those elements to be handed back in the condition required by the contract, so the contract standards could be relaxed leading to cost savings. Alternatively, the authority may wish to push a variation through the PFI contract before it ends so that the facility is fit for its future purpose after expiry.
7. Review current provision
Starting to plan for expiry also presents an opportunity to review current operation of the contract to ensure it is fit for purpose as it enters its final years. Could any variations be introduced to better align the services to the authority’s needs? Is the performance mechanism being effectively applied? Have benchmarking exercises and insurance premium risk share reviews taken place? Is there any potential for a refinancing?
Careful preparation will help ensure the expiry process is positive for all parties, and realise the ambition held at the outset of these projects: that the assets are returned to the public sector in robust condition ready for many more years of useful life.