Guy Cartwright, managing associate at Stevens & Bolton, examines the risks and costs of PFI contracts – and how construction companies can manage terminations and exits
A Private Finance Initiative (PFI) contract is a long-term agreement between a private company (the “contractor”) and a government entity with the aim of transferring the risk of large public projects to the private sector. The contractor may then enter into subcontracts with third-party contractors, and so on.
The complex and often high-profile nature of these projects, together with the number of parties that may be involved, can result in complex contractual frameworks and the potential for significant legal, financial and operational risks to contracting entities, unless care is taken.
Current state
The previous government announced in 2018 that it would no longer use PFI-style contracts for new government projects, citing the “high upfront cost of compensation” when seeking to terminate these arrangements.
However, recent reports indicate that Chancellor Rachel Reeves is weighing up a PFI-style contract for the new Thames crossing, indicating a possible change in approach.
In addition, many of the original PFI contracts entered into in the 1990s are coming to an end, with the parties seeking to wind down and properly exit these contracts.
Those involved in exiting PFI contracts or those seeking to enter into new PFI-style arrangements will want to take steps to mitigate the potential for unforeseen costs and liabilities and, in the worst cases, costly legal disputes.
Liability in PFI contracts
How liability is apportioned between the parties under each PFI contract will depend on the provisions of the particular contract, although there are some general themes.
Under PFI contracts, the contractor is typically responsible for the performance of the asset, with payments linked to performance, often in the form of detailed performance metrics and key performance indicators.
Care should be taken to ensure that performance metrics are drafted in a sufficiently clear manner, together with the inclusions of appropriate contractual remedies for non-compliance.
Financial liability caps and exclusions of liability will always be key points of negotiation, with each party seeking to mitigate the potential for its own liability.
PFI contracts will nearly always include detailed provisions around the contractual term and termination rights. These may need to be “flowed down” by the contractor to any subcontractor.
Under PFI contracts, the parties, and particularly the contractor, may have few if any rights to terminate the contract prior to the expiry of the full contract term (which can be upwards of 20 years), meaning that it can be expensive for a party to seek to engineer an early exit.
A failure to properly terminate the contract puts the terminating party at risk of a wrongful termination claim and these claims can be costly.
A key consideration for the principal contractor will be ensuring that the asset is returned in an appropriate state of repair and in accordance with the terms of the contract.
Failing to appropriately document the state of the asset, where relevant, at the start of the contract and then at regular intervals may make it difficult for downstream contractors to effectively “prove” it has complied with the terms of the contract, exposing itself to expensive compensation claims to make good and remedy defects.
Other places that issues, and potentially liability, can arise in PFI contracts, which contractors are sometimes not aware of, include:
- Redundancy costs: Liability for any redundancy costs of employees and workers of the contractor, and any subcontractor(s). Care must be taken when negotiating these provisions, particularly in large-scale projects to ensure the parties are clear on who is responsible for these costs.
- Transitional services: Contractor’s costs associated with performing any wind down and/or transitional services, fees for which may or may not be recoverable under the PFI contract unless specific provision is made. Contractors will want to avoid any nasty surprises at the end of the contract if they are unable to recover costs for performing these services. Specific provisions may also not apply to transitional services, and this should be clearly documented at the outset.
- Post-termination risks: A party’s failure to comply with any post-termination obligations, for example in the case of the contractor, returning or producing particular documents upon expiry, risks a breach of contract claim.
- Rights that survive: Liability arising from rights that survive termination, for example audit rights may survive expiry or termination of the contract. If a post-termination audit right that is invoked identifies, for example, accounting errors in the mechanism used to calculate fees, this could result in demands for repayment of fees.
Strategies for winding down PFI contracts to reduce the potential for disputes
Proper planning is key to reduce the risks of liability under PFI contracts. Examples of steps to mitigate risks include:
- Early preparation: Ideally start planning well before contract expiry. The National Audit Office recommends planning starts at least seven years before the project expiry date.
- Clear communication: Maintain transparent communication with contracting entities, including any downstream subcontractors and consider any changes to the contract that need to be formalised.
- Detailed asset surveys: Conduct thorough surveys to assess asset conditions, both on entry and before exit but ideally at regular intervals during term of the contract.
- Defined handover and wind down procedures: Clearly outline handover responsibilities in the contract. It is worth revisiting these at various stages of the contract to ensure that these remain appropriate.
- Consider any contractual variations or disapplications: Undertaking a detailed review of each party’s contractual obligations and rights up until the date of termination and then following expiry will ensure that there are no hidden surprises.
