Be proactive on expiring PFI and PPP project contracts

The UK's National Audit Office (NAO) recently warned that many public sector organisations are not preparing far enough in advance for the expiry of PFI contracts, with the Infrastructure and Projects Authority (IPA) of the view that preparations should begin at least seven years prior to the scheduled end of contracts.

This lead time reflects the significant strategic decisions that need to be made about the future of the assets subject to PFI and PPP contracts as well as the contractual and regulatory risk that needs to be managed.

Major questions have to be answered about what to do with facilities and related service provision upon contract expiry and any significant costs and risks associated with handback of facilities, land, assets and staff at expiry. Specific issues which need to be considered include assessing the handback condition of key assets and any associated backlog maintenance, environmental protection, disclosure of commercially sensitive information, and compliance with public procurement rules in cases where authorities elect to continue outsourcing services.

What are PFI/PPP projects?

PFI is a form of public private partnership which was introduced in the early 1990s as a way of using private sector skills and finance to provide public services. It allows the private sector to obtain finance to design, build and operate a facility for the benefit of the public via a 'special purpose vehicle'. In return, the public sector grants its private sector partner a long-term contract to run the facility and will pay a monthly fee over the life of the project to repay the loan. 

More than 200 PFI contracts are due to expire in the UK over the coming decade and there are over 700 such projects in total While most of these projects are accommodation projects, particularly in core strategic sectors of health and education, PFI and PPP contracts have also been popular in other areas of public services, such as in defence, waste and water, as well as roads.

The NAO report

Last month, the NAO published a new report which identified a lack of "strategic or consistent approach" to the way PFI contracts are managed in relation to expiry in the public sector in England.

Given that approximately 80% of PFI projects in England are owned by local authorities or public bodies outside of central government, this raises questions about the level of standardisation there will be within the public sector towards the forthcoming expiry of PFI contracts. 

The NAO warned that a lack of coherency across public sector owners "risks failing to secure value for money during the expiry negotiations with the private sector".

The time needed to prepare for the expiry of contracts "will vary across contracts depending on the complexity and the treatment of assets on expiry" but is "often underestimated", the NAO also said, warning that a lack of preparation could push up the price of, or cause disruption to, public services in future.

The report identified that some public sector bodies fail to monitor how assets are managed or maintained by private sector operators, and that there is a resultant lack of understanding within some authorities about the condition of those assets and, as a result, a risk that those assets will be returned in poorer condition than the contract stipulates.

The "potential for disputes" arising from "a misalignment of investor and authority incentives at contract expiry" was also highlighted in the report, as was the fact that many of the early PFI contracts may not be clear about "the roles and responsibilities of the parties at contract expiry".

These myriad issues identified by the NAO emphasise the importance of early engagement.

Strategic and contractual issues

The expiry of PFI contracts raises major strategic and contractual considerations for both the public and private sector.

Public sector owners need to decide what the future holds for assets operated and services provided under PFI contracts – whether they should seek to trigger extension clauses in their existing contract with operators, re-tender the contract and seek another operator (potentially with a complete reconfiguration of the service required from the asset), bring the asset back under public sector operation, or even sell the asset if there is no longer a need for it.

For their part, private sector operators need to decide whether – if this is an option – they wish to continue operating services or assets, how they might renegotiate the price of any extensions, whether they are willing to compete for re-tendered contracts, or see value in acquiring assets that may be put up for sale. Where handback is expected, both parties would be well advised to agree the protocols for any handback surveys required to assess the condition of the key assets.

As well as wider strategic issues, there are specific contractual issues to address will differ from project to project and across sectors, but consideration will typically need to be given to:

• how to address the use and treatment of PFI assets after the PFI contract ends and the impact on the asset's residual value;
• how contract term extensions within the terms of the contact might be triggered in a way which complies with public procurement regulations;
• what the contract says about the 'handback' of assets – provisions can vary greatly, especially for early PFIs;
• assessment of the handback standard – the contract will typically stipulate the condition PFI assets need to be in to be 'handed back' at the expiry date, however. In particular, there is a high risk of disagreement about upgrade costs to bring the asset condition up to the handback standards;
• environmental risks – there may be site clean up provisions in the contract. These are especially relevant in some environmental sectors such as water and waste;
• TUPE and pensions issues – TUPE regulations provide protections for employees when the business they work for changes hands. The TUPE regime will apply where there is a handback of operational services to the public sector upon expiry of the PFI contract. Are there any potential pensions issues to be addressed upon expiry and where does this risk sit?;
• information and data transfer risk balancing data protection law, commercial sensitivity and the need to have access to sufficient information to support service provision;
• the transfer of land, lease arrangements and other assets, such as stocks and spares, vehicles and equipment.

These strategic and contractual issues cannot be addressed overnight