Breaking up need not be hard to do: preparing for PFI contract expiry

by Laura Bowler, Senior Associate, and Gemma Essex, Senior Associate

When any long-term commercial relationship comes to an end, patience, compromise and cooperation will often be required in order to avoid an acrimonious parting. Long term PFI project contracts provide fertile grounds for valedictory disputes: when the project assets are handed back to the public authority at the end of the services period, the public authority will expect the private sector project company to fulfil its contractual obligations apropos the standard and condition of the assets that are to be handed back. The public authority will usually want the project company to fully fund all repair and replacement costs before it relinquishes responsibility for maintenance and lifecycle works but the opacity of the contractual requirements for handback can lead to unreasonable expectations on both sides, which in turn fuels disputes. 

Managing the hand back process to minimise the risk of such disputes can require very careful relationship management between the public and private sectors. As Laura Bowler and Gemma Essex outline below, the potential for relationships to sour with disputes the inevitable consequence, has at least been recognised by the government.

Handback mechanisms: an ancien régime? 

During the 1990s and into the first decade of the 20th century, PFI projects were a politically acceptable procurement route to fund the construction, operation and maintenance of infrastructure and other public assets.  

PFI contracts were necessarily of long-term duration, so that the public sector project companies could recoup their initial construction CAPEX spend via public sector monthly payments across service periods typically of between 20 and 35 years.

Drafting PFI contracts handback mechanisms during the 1990s necessarily required some crystal ball gazing: those doing the drafting had little idea of the political and economic landscape that would prevail 30 years in the future, and more importantly, of how the assets would perform in the framework of the lifecycle and maintenance obligations that would apply over the services period. Many PFI contracts were completed against the clock in frenetic circumstances and with a multitude of agreements to check and finalise it is not surprising that clauses that would not be needed for several decades attracted less attention.

With a small number of PFI projects having already come to an end but with an increasing number approaching services period expiry, the general impression is that with the dust blown off, handback mechanisms are frequently deficient. By way of a fractious starting point, many PFI contracts do not make clear which party is to bear the cost of the pre-handback survey that will be required to assess the condition of the assets: for a large hospital, the cost of a full survey could be sufficiently high to trigger an initial dispute over who is to pay for it, before the condition of the assets has even been considered! Even where well crafted, PFI contracts typically prescribe the required standard and condition of the assets at handback in complex but necessarily non-absolute terms, that are open to interpretation. For example, NHS Estate Code condition B requires that all internal finishes, fixtures and fittings shall be, “sound, operationally safe and exhibiting only minor deterioration” which leaves plenty of room for argument.

With both the public and the private sector parties often left in something of a contractual no man’s land vis-à-vis the handback process and their respective obligations, it come as no surprise that disputes, often concerning polarisingly large amount of money, will fester and grow.  

Official guidance

It is generally accepted that the inherent risks of disputes associated with PFI contracts (or any contracts) can be mitigated by cooperation, communication and contractual compliance. Whilst the government has no power to intervene in private contracts it has at least tried to foster a sense of reasonable pragmatism in the PFI industry.

The IPA guidance

During February 2022 the government’s Infrastructure and Projects Authority (‘the IPA’) published a 74-page document entitled, “Preparing for PFI contract expiry” and sub-titled, “Practical guidance for contracting authorities on managing expiry and service transition”.

This document was presented in four parts: 

  • Part A explained why managing the expiry and transition process was vital for ensuring value for money and the continuity of public services. Part A included recommendations on how to prepare for and manage the expiry and transition process. 
  • Part B was concerned with how to implement the expiry recommendations and included detailed guidance on actions that could be undertaken to ensure a successful PFI contract expiry and transition to future services provision. 
  • Part C was the summary section, providing a quick reference ‘grab guide’ for users, drawing together key recommendations on actions and processes.
  • At the end of the document the IPA included an expiry toolkit, which provided additional methods and materials to support public authorities in managing expiry and handback.

The IPA guidance in particular highlighted the importance of starting planning for expiry and handback well in advance – seven years was recommended – to enhance the prospects of ensuring that the process was sufficiently resourced, that the parties were clear on their respective roles in the process and so that potential disputes could be managed and amicably resolved.

Albeit primarily aimed at public sector bodies preparing for PFI contract expiry, the IPA’s guidance recommended a collaborative approach to PFI contract management and was therefore relevant to both public and private sector parties.

The White Fraiser Report

During November 2022 the IPA commissioned an independent report on the status of behaviours, relationships and disputes across the PFI sector with a view to making recommendations for improvements. It was expected that the report would examine the extent to which negative working practices had arisen across the PFI sector, the reasons why and go on to consider recommendations for improvement.

The report, prepared by the eponymous duo Barry White and Andrew Fraiser, was published on 20 July 2023. The White Fraiser Report set out several (anonymised) findings and observations that were entirely familiar to anyone who has been closely involved in the PFI sector over the last ten years, including as follows:

  • The authors acknowledged the widely recognised public sector contention that the private sector could be reluctant to engage in proactive performance management of service provision, until forced into doing so by the robust application of complex dispute mechanisms. Likewise the common private sector complaint that project companies are often taken unawares by sudden shifts in their public sector partner’s approach to contract management.
  • That an oft-reported catalyst for the public sector adopting a shift in approach is the instruction of consultants who rather than aiming to facilitate ongoing improvements in service delivery, usually counsel aggressive application of the contract payment mechanism, seeking to penalise historical performance to benefit the public sector’s budget position.
  • That such unprompted changes in approach deny the parties the opportunity to collaboratively consider how any such change in approach can best be implemented to maximise performance delivery. More often than not, such changes in approach can quickly escalate into complex and potentially avoidable disputes, that are inimical to developing or maintaining any culture of cooperation between the  project stakeholders.
  • Notwithstanding the propensity for conflict, only around 1% of PFI contracts lead to disputes requiring the third-party intervention of a dispute resolution procedure. (It will be of no surprise that healthcare remains the sector in which disputes are the most prolific.)
  • Despite the small proportion of projects embroiled in ongoing disputes, such projects often require the most attention. In circumstances where the squeaky wheel gets the oil, projects in which the parties are engaged in long-running disputes will necessarily occupy much of the time, cost and resources of project companies – which can only serve to dissuade future investment in UK infrastructure.

By way of an antidote, if not a panacea, the White Fraiser report introduced the concept of a “reset” period in which the parties sit down and review their contract management position afresh and agree on an approach to contract management going forward and in the run up to expiry.

  • The reset period is premised on the private sector partner being granted relief from payment of accruing contract deductions for a period of, say, six to twelve months whilst they improve project performance to the contractual standards required by the public sector. (This approach could be considered somewhat aspirational and potentially impossible in circumstances where an acrimonious dispute is already underway.) 
  • The “reset” idea is predicated on the public sector providing the project company with the opportunity to deliver assured performance standards over a time period in which deductions continue to accrue but are not applied. However, the idea has, with some justification, been characterised as merely, “kicking the can down the road”.
  • For a reset to generate genuinely beneficial progress requires redefinition of the parties’ ongoing relationships. In the case of healthcare project agreements, it stands to reason that delivering the best performance for staff and patients alike should be reason enough for all parties to engage in a collaborative reset period in good faith.

The report endorses the reset approach and gives a stark warning to parties failing to act accordingly:

“We are satisfied that the ‘reset’ approach will provide all parties with not just the opportunity to achieve assured performance of PFI Contracts, but also an opportunity to enrich the relationships and goodwill between them. Some SPVs and/or Public Authorities may, instead, choose to bury their heads in the sand and hope things improve. Our view on this is clear. They won’t”.

Where the public sector’s primary motivation is maximising deductions (whether or not encouraged to do so by rapacious consultants) and the private sector is desperate to generate shareholder value or mitigate budgetary constraints, the goodwill of other stakeholders seeking to deliver the best performance of the asset will inevitably be undermined. Equally, where there are contractual limitations placed on parties with entrenched positions, whether there is sufficient incentive to prioritise service delivery in circumstances where there is little accountability or financial advantage, remains to be seen. 

The executive summary in the White Fraiser report sets out the following robust observation on the conduct of parties to PFI contracts:

“… feedback from consultees to suggest that the manner in which a number of Public Authorities have implemented their change in approach has often involved overly draconian (if not forensic) enforcement of the terms of the PFI Contract accompanied by, on occasion, unprofessional behaviour. When this approach has been taken by Public Authorities, disputes have typically resulted, relationships have broken down and accompanying goodwill has been lost. More worryingly, we heard stories of how this approach has had a negative impact on the wellbeing of individuals”.

Whilst the White Fraiser Report does not relate exclusively to the handback or expiry of PFI contracts, the report’s findings regarding the current state of PFI relationships and party conduct, collaborative or otherwise, are relevant to the attitudes that will govern the outcomes for the increasing number of projects approaching expiry. 

Practical steps for handback

It must be right that in order to prepare for a hopefully successful handback, the parties should be encouraged and incentivised to start discussions early with a view to agreeing the (or a fresh) applicable process for assessing the condition of the assets to be handed back to the public sector and facilitating a transition that ensures continuity in service provision.

In the light of the IPA guidance and the White Fraiser report, set out are below some practical steps that parties may consider implementing to assist the handback process: 

  • Be prepared: As noted, the IPA guidance recommends that planning for handback should begin a minimum of seven years before the expiry date. Although this may seem overly cautious and unnecessary, in the context of the day-to-day project activities, underestimating the time and cost associated with handback risks unnecessary disputes.
  • Best-laid plans: By failing to prepare, parties are preparing to fail. Initiating discussions around expiry requirements (including the condition of assets) and agreeing a plan before commencing the handback process will assist in both establishing communication between the parties as they clearly define the parameters of the handback process and ownership of the assets. This is all the more important if at some point during the service period, the contract and the project company’s obligations have been materially varied. 
  • Clarifying the contractual status of the asset: This should be done from the outset - so that the parties start on the correct footing - and regularly updated, particularly where there have been variations and/or market testing, so that there are no surprises when the handback stone is turned over.
  • Build relationships: Identify key individuals from each party to minimise confusion and encourage collaboration between the parties. Ideally, parties should engage or nominate specific individuals to manage the transition process, in order that operational resources are not compromised. 
  • Financial arrangements: Regularly review the financial arrangements, including any outstanding payments, penalties or cost-sharing provisions, seeking confirmation that all financial obligations are met as specified in the contract or otherwise agreed.
  • Asset condition: PFI contracts typically contain a requirement for a handback survey to ascertain the condition of the asset. Carrying out a preliminary condition survey on the assets and assessing what needs to be handed back and, importantly, what condition it is required to achieve under the contract will help ascertain the scope of work required to bring the asset to the required standard. 
  • The IPA guidance suggests that such an initial survey should take place around five years before expiry, with a final survey taking place around two years before expiry. Whilst the timing of these surveys can be agreed between the parties, the IPA guidance sensibly warns that the duration of such surveys is typically underestimated and so should be commenced sooner rather than later, to enable any work that needs to be undertaken to be carried out before handback. 
  • Where the contract makes no express provision (and project agreements frequently do not), the parties may wish to consider agreeing the appointment of an independent third party to carry out the survey to reduce the scope for disputes generated by perceived bias. By assessing the current condition of the assets, parties should be assisted in the formulation of plans to determine any work that will be required for handback. 
  • Moving on: The public authority will need to consider not only who will be taking over from the project company on expiry of the PFI contract, but specifically whether the services are going to be brought back in house or re-procured via a new contract with a different private sector partner. Ideally, the post expiry service provider should be involved in the handback process as early as possible, so that the parties can plan for the transition from the PFI arrangement to a new operational model. This ensures a smooth transition between the PFI and post expiry service provision whilst maintaining service continuity and minimising disruption.
  • Stakeholder engagement: It will be of fundamental importance to engage with stakeholders, including employees, service users, and the public to keep them informed about the plan and address any concerns or questions they may have. Engaging with stakeholders should assist with the seamless transfer of data, information, and knowledge from the project company to the public sector or to the new private sector service provider.

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