“Private Finance Initiative (PFI) & Project Hand-backs”

Private finance initiative (PFI) contracts are a form of public private partnerships used in the UK since the 1990s. PFI is a way to finance and provide public sector infrastructure and capital equipment projects, such as roads, hospitals, and schools.

The private finance initiative (PFI) is a UK Government initiative with a procurement policy aimed at creating “public–private partnerships” (PPPs) where private firms are contracted to complete and manage public projects. It was initially launched in 1992 by the then government, and expanded by the subsequent governments. PFI is part of the wider programme of privatisation and financialization, and presented as a means for increasing accountability and efficiency for public spending.

The essential features of the Private Finance Initiative (PFI) in the UK are that capital investment projects (for the public sector) are financed as well as constructed by a  private company, and then leased back to the public sector over a pre-determined period (generally 25 to 30 years), and that generally the private company provides a range of services associated with the capital project (e.g. maintenance). The recent origins of the PFI can be seen to be a change in the rules governing private involvement in the late 1980s with the replacement of the previous so-called Ryrie rules : ‘Under the Ryrie rules, the use of private finance would only be allowed if the efficiency gains thereby generated were sufficiently large to compensate for the higher cost of private finance. But the PFI involves not only drawing upon alternative sources of finance for public investment but also that services related to the capital thereby constructed are also provided under the PFI contract. The idea of comparing a PFI project with a ‘conventional alternative’ financed through bonds with services provided by the public sector is central to the operation of PFI.

Under the PFI, the government is contractually committed to lease the project from the private sector company for a specified period (often 25 to 30 years) ahead (and on the other side the private company is contractually obliged to lease the project to the public sector). For the private company this provides a guaranteed future income stream (usually in real terms with price to be paid for lease and services linked  to the retail price index). For the government, there is the contractual obligation to make those future payments.

PFI and PF2 contracts have been used to fund the building of schools, hospitals and other infrastructure, but their use has declined significantly. In 2012, the government replaced the PFI model with PF2, but this has only been used six times since. 86% of PFI and PF2 contracts were signed before 2010. PFI and PF2 have also been criticized by the Public Accounts Committee for their inflexibility, whilst the Office for Budget Responsibility has identified private finance initiatives as a fiscal risk to government. The National Audit Office estimates that some 200 UK private finance projects will expire over the next ten years.

Recent trends & lessons learned from hand-back of latest contracts:

Experience in PFI projects which have expired or which have terminated early either voluntarily or as a result of a problem during the construction or operation phase demonstrated that:

• The contractual hand-back process varies considerably across contracts with particularly early contracts not having any hand-back provisions at all.
• Certain circumstances including where there is a dispute can merit a process which is almost entirely outside the contractual terms
• While early termination might appear politically attractive on its face, procuring authorities can encounter difficulties resourcing project administration
• Where hand-back is to be combined with retendering there is a natural desire for the transition to the new project to be seamless but in practice the timing pressure that it introduces can make it unavoidable to take shortcuts in structuring the retendered project
• The costs of termination can be much higher than the procuring authority might originally have forecast, particularly owing to swap termination costs in the current low interest rate environment which looks set to continue for some time.

Preparing for expiry

Preparation can be split into two phases: understanding how the expiry process works contractually and assessing what assets and services will be required after the contract ends. These two phases need to be considered simultaneously as the contract outlines whether or not assets are due to be returned, which in turn affects the decisions around the future service arrangements after expiry.

Understanding the contract

The PFI contract is central to preparing for and managing the expiry process. These contracts are long, complex documents and in most cases, the parties to the PFI contract will have made amendments over time to change service requirements or achieve specific savings. The authority then needs to request a copy of the contract from the special purpose vehicle (SPV) or other parties such as lawyers. Depending on the number of variations, it can take a considerable amount of time to gather together the PFI contract.

Handover provisions

• A PFI contract should include handover provisions which set out several rights and obligations for the SPV and the authority. HM Treasury’s standardization of PFI contracts provides guidance on what the handover provision should contain and include:
• an asset register and condition of these assets at the end of the contract;
• procedures for identifying the amount, cost and responsibility for paying for any rectification work;
• requirements for asset condition surveys and other inspections prior to handover, including procedures for appointing and paying for a surveyor;
• the creation of a retention fund for rectification work identified in the asset condition survey;
• the transfer of all relevant documentation to the authority, such as data on service users (pupils, patients or prisoners), maintenance history, manuals, compliance reports and manufacturers’ warranties;
• procedures outlining how knowledge and skills are to be transferred at expiry and the treatment of employees;
• the treatment of confidential data; and
• details about the exit process and dispute procedures

Asset ownership options and future service requirements

• The ownership of assets at expiry will be dictated by the contract. Assets will either fully or partially transfer to the public sector or remain with the private sector. If the assets return to the public sector, authorities have four options: sell the asset if the service is no longer required, tender out the service element to a new private sector provider, operate the service in-house, or do nothing.
• In some instances, the future ownership of assets and responsibility for administering the PFI contract are not aligned. Schools which have converted to academy status are outside of the remit of the authority and are run by independent academy trusts. These trusts are funded directly by the Department for Education (DfE).
• The responsibility for administering the PFI contract, however, remains with the authority until it ends. The authority may not be incentivized to use its resources to manage the expiry process effectively knowing that they will not retain ownership of the assets. According to DfE, around 300+ schools with PFI contracts have been converted to academy status.
• The authority will need to assess whether the service provided under the PFI contract, such as operating a waste disposal plant, will be required once it has expired. The requirement for the service depends on many different factors, such as changes in demand, technology or wider government policy.
• Once the nature of the future service is established, the authority will need to decide how this will be delivered post-expiry. Options include running the service in-house using existing public sector resources, procuring a service delivery contract with a new private sector provider or extending the existing PFI contract. The breadth of options may depend on the resources and skills available to the authority. A government department or large authority may be able to absorb expiring PFI contracts into existing operations, but this may not be a viable option for smaller authorities.
• The authority will need to consider the resource requirements of maintaining assets after they take over management at the end of the contract. This is particularly important for authorities that have been receiving PFI grants, as this additional source of funding will expire when the contracts end.38 Where PFI assets are not returned in the stipulated condition and subsequently require more than expected maintenance work, the authority’s maintenance backlogs across its entire estate will increase.

Timing of preparation

• The timing depends on many factors, such as the complexity of the contract, number of assets, handover provisions, resourcing and how the assets are treated on expiry. Preparations should start before it is contractually required, and the IPA’s guidance recommends starting seven years in advance.43 Evidence from HE and the Department for Environment, Food & Rural Affairs suggests starting preparations more than seven years in advance to enable a full assessment of the assets and options.
• Experience from expired PFI contracts suggests there is a risk that authorities underestimate the preparation time. Unforeseen events such as disputes caused additional challenges which impacted the expiry timelines. Evidence from a lessons learnt exercise conducted by the Department for Work & Pensions on the PRIME (Private Sector Resource Initiative for Management of the Estate) PFI contract concluded that expiry preparations should have started earlier.

Delivering the contract expiry

• After the planning stage, the authority needs to ensure the SPV meets all the contractual obligations for expiry to ensure a smooth transition to the post–expiry arrangements. An authority needs to be aware of the contractual tools available to ensure the SPV adheres to its expiry obligations and it knows how to resolve disputes.

Ambiguity

• Ambiguity in a PFI contract or lack of cooperation can be resolved in one of two ways: early engagement with the SPV to negotiate an agreed position or by going through a formal dispute resolutions procedure. Resolving any issues requires a balanced approach from both public and private sector parties. Relationships will come under greater strain as earlier PFI contracts start to expire, as these are exposed to greater ambiguity. A lack of compromise in the short term may damage relationships and hinder future expiry negotiations.

Disputes

• If any contractual ambiguity cannot be resolved via negotiations with the SPV, the remaining option is to go through the formal disputes process. Each PFI contract will set out a formal procedure for handling disputes, called the Dispute Resolution Procedure (DRP).

Asset condition surveys

• The contract should stipulate how many years before expiry the survey should be carried out.
• Some PFI contracts allow the authority to conduct surveys throughout the life of the contract, not just in the lead–up to expiry. This allows an authority to better monitor whether the SPV is meeting its maintenance obligations, which is important in cases where the authority has limited access to performance data.
• Measuring the condition of an asset can be a subjective process, which means appointing an independent surveyor, agreed by both the authority and SPV, is important. The contract should include arrangements for appointing a surveyor. The terms may vary in regard to who appoints the surveyor (SPV, authority or jointly) and who pays for it.

Engagement with the SPV

• Around 20% of respondents noted a lack of cooperation from SPVs in providing information on the assets’ condition. In one school PFI contract, the authority attempted to carry out an independent survey to confirm whether maintenance work was being completed as planned, but the SPV denied access to key areas of the school as it did not perceive it as being part of the contract. In one prison PFI contract the authority had the right to receive cost information relating to the performance of the service, but the SPV did not provide it.