To expiry and beyond: The IPA's 'Preparing for PFI contract expiry'

Anticipation has been building since the IPA announced that it would issue practical guidance to contracting authorities (CAs) on managing PFI expiry and service transition. CAs have been understandably anxious to understand how they should best approach the handback challenge. At the same time, the private sector has been keen to understand the proposed approach and how best to respond.

There is a lot to commend in the guidance. Whilst it majors on the risks to CAs of not managing the expiry process effectively, it also highlights where opportunities may lie to drive greater value for the public purse. There is also a real focus on the need to plan for life after PFI and how this fits into expiry discussions - something which often gets lost in the current debate. It also provides practical advice based on experiences to date and concrete actions that CAs should undertake in order to best manage the process. Importantly, there seems to be some latitude for CAs to avoid slavish contractual adherence where this better serves their commercial objectives.  There is a lot of detail in the 74 pages of the guidance - some of the key take-aways are discussed below

Risks

The guidance is a call to arms, highlighting the risks to the public sector of a failure to manage the expiry of PFI contracts - operational disruption, lack of service continuity, financial loss and reputational damage. The clear message is that effective management of the expiry process is essential to protect value for money and ensure service continuity.And if you're not paying attention at the back, there is a stark message to 'Senior Leaders' to allocate 'more and different senior management support' to the expiry process. There is also a requirement to appoint a Senior Responsible Owner (SRO) to manage expiry and transition (again noting the focus on life after PFI). Both the NAO and the Public Accounts Committee highlighted the current lack of resource deployed to manage PFI expiry and the IPA seems determined to drive this message home.

Opportunities

But it's not all doom and gloom. The guidance is clear that the overarching objective must be to ensure that the PFI project company (PFI Co) meets its contractual obligations, so that full value for money is obtained. However, at the same time CAs need to ensure that the expiry process takes into account future plans for assets and services following PFI contract expiry. Here is an opportunity to 'rethink the future', in particular in relation to:

• technology, digitalisation and standards which have evolved from service commencement
• the focus on Carbon net zero
• changes to underlying service needs
• the market for services and risk allocation

How to approach expiry

The guidance makes a really valid point -  PFI expiry is not a distant future event, rather it's the end destination of the PFI rollercoaster and day-to-day contract management feeds directly into the success of expiry process.The guidance acknowledges that PFI expiry is complex and that the precise terms will vary from project to project, depending on the drafting of the contract. There is also a recognition that in most cases that handback provisions might lack sufficient detail and that this will need be fleshed out though discussions with the private sector.  The guidance does not shy away from the resourcing issue.  CA's need to treat the day job of contract management, handback and the procurement of alternative service provision as separate (albeit necessarily linked) activities and ensure that there is sufficient resource in order to manage all three work streams effectively.Early preparation is also recommended, with the guidance echoing the NAO's suggestion that CAs start planning for expiry 7 years out.  The rationale is as follows:

• to ensure good contract management is in place for remaining term
• major maintenance lifecycle is such that significant works are likely to be scheduled 5-7 years before expiry
• the length of time required to conduct surveys for buildings (eg. major acutes) and time required to carry out remedial works (the SoPC process may not allow sufficient time)
• early engagement with PFI Co should ensure that funding is available through project reserves and future payments and that investors are incentivised to seek 'mutually beneficial outcomes'
• addressing handback issues whilst there is senior debt outstanding should ensure that lenders will exert positive influence over PFI Co

Implementation

The guidance outlines five key pillars to the implementation of expiry:

• Contract awareness and management
• Relationship Management
• Assets
• Commercial Approach
• Future Services

Contract awareness and management Music to the ears of any lawyer, the guidance notes that 'knowing your contract is the necessary starting point for PFI contract expiry and transition planning'. Key contract elements to understand are:

• expiry date
• rights to future use of land, assets and information
• handover process
• required condition at handover
• provisions relating to transfer of information needed to support future service provision

Fundamental to this, CAs will need to complete an information gathering exercise to obtain all relevant information - the project 'bible', variations, financial model, latest information on stakeholders and project level reporting (eg.  monthly performance reports, management accounts lifecycle Plans and reports). A clause by clause review of the project agreement will be required to understand all expiry related terms and conditions. CAs should also assess the adequacy of handback provisions and understand risks and uncertainties:

• Is asset ownership clear? Do the assets automatically transfer to the CA?
• Are the handover provisions workable in practice?
• Is the time window for conducting surveys appropriate and workable?
• Is the handover condition clearly defined and how can this be assessed?

It is suggested that any concerns around workability or lack of clarity can be fed into commercial discussions with PFI Co. Inherent within this is a recognition that the SoPC approach to handback may not be workable in practice. CAs are encouraged to place renewed emphasis operational contract management to meet additional challenges of expiry. In particular, CAs should focus on contract management to ensure that the condition of assets will meet contractual requirements, that they have all information needed for future operations and that they have the project based information that will support commercial negotiation of the CA's expiry objectives. Relationship Management It is heartening that the IPA has put so much value on the role of constructive relationships. The accent is very much on collaboration to avoid disputes - noting that the expiry phase will require a 'similar intensity of relationship interaction' to that required in the original procurement phase. We have long been advocates of a collaborative approach and welcome the official seal of approval. The guidance also cites that starting the expiry process early will also provide the necessary space to reset the relationship, to explore the CA's objectives with the PFI Co and to address any areas of potential dispute (eg. contractual interpretation). In particular CAs should set out their objectives and expectations and look to agree these with PFI Co. A contractual dispute resolution procedure or another mutually agreed mechanism such as a dispute avoidance board, should be used where appropriate. Again, early collaboration and preparation is the order of the day - the parties need to agree a practical approach to expiry. Assets The IPA is advocating an early survey at least five years before expiry to ensure that asset condition is on track for handover. Ideally this survey would be commissioned on a joint basis. The guidance acknowledges that the SoPC approach of conducting condition surveys 24 months prior to expiry might not leave enough time for remedial works to be completed. Whilst this approach is not consistent with SoPC, the IPA's view is that early surveys will benefit both parties in that early surveys allow time for remedial works to be completed before the final condition survey, reducing the risk of significant rectification works being required at the end of the contract.  We share this view - the time pressure created by leaving matters to the final years of the contract is only likely to increase the risk of disputes. Commercial approach The guidance recommends that that CAs develop an overarching commercial strategy, which takes into account the PFI contract, the priorities of the various stakeholders and the CA's future plans for the assets.  As part of that exercise, CAs are encouraged to identify the negotiating levers that might be available to them. Examples cited include:

• contractual rights to make deductions and understanding how the quantum compares to the cost of rectification works
• whether early condition surveys can be employed
• pro-active contract management and the application of the payment mechanism
• follow-on contract opportunities
• wider corporate relationships

Consideration should also be given to the CA's termination options - if appropriate this should be discounted as a strategic option in order to focus management activity.  Our view is that it is not inconceivable that early termination might be a strategic option, but CAs will need to weigh in the balance termination costs, the current condition of the facilities and ongoing service provision. The output of this exercise should be a commercial strategy document summarising:

• the commercial objectives for expiry
• the commercial decisions in the expiry process
• the proposals for addressing gaps/lack of clarity in the contract
• the principal expiry risks
• alternate routes to resolve disputes that can't be resolved through negotiation

Future Services CAs are facing something of a 'cliff-edge' and need to ensure that their replacement service solutions are ready to start on or before the expiry date.  This will require CAs to start future planning alongside their handback preparedness activities. Successful expiry also requires understanding the future services strategy and the requirements for the future use of assets and services, which may differ from those provided under the PFI. In order to ensure continuity of service, CAs will also need to understand the procurement timeline and associated activities. In addition, a transition plan will needs to be negotiated with PFI Co for to facilitate a seamless transition to the incoming service provider. The need to focus on planning for life after PFI cannot be highlighted enough. There is a lot of strategic thinking to be done here and it is crucial that CAs turn their minds to this at an early stage, not least given the length of the procurement process.

Conclusions

 If CAs were in any doubt that they need to start planning for PFI expiry and replacement survey, the guidance should be something of a wake-up call. Whilst handback presents a number of risks to CAs, a proactive and collaborative approach should enable CAs to drive greater value from their PFI contracts. If CAs take this guidance in board, then we are likely to see a real increase in handback related activity in the coming months. If not, CAs should at least be aware of the risks they are facing.

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If you would like any further information in relation to the above, please do not hesitate to contact James Larmour, Banking & Finance Partner.