What rights and remedies do you have when PFI contractors fail to perform? David Hunter explains.
The recent closure due to safety fears of 17 schools in Edinburgh, all built under a public private partnership, has once more shone an unflattering spotlight on privately financed projects.
Putting to one side the critically important matters of the safety and education of children, this may prove a useful test of what was heralded as one of the big selling points of PFI: risk transfer. The contractor, it would appear, has failed to design and build the schools to the required standard so will it (and its investors and funders) bear the cost of rectifying the problem?
We do not have sight of the actual contract Edinburgh Council signed up to, but the majority of PFI contracts, certainly in England and more broadly in the UK, generally adopted standard terms. Under these terms, rights that one would expect to be available to the public sector in a situation akin to that in Edinburgh would include:
- A claim against the PFI contractor to make good defects in the works at its expense.
- Collateral warranties from the builder and the professional team, giving a right to claim against those organisations, where their work was responsible for the issues that have emerged. (This will usually last for 12 years from completion of the works and may only apply where the council is unable to sue the PFI contractor).
- A right, possibly, against the party who signed off the works as satisfactorily completed.
- A right to withhold contract payments to the PFI contractor where parts of schools are in a condition which means they cannot be used.
- Possibly, a right to terminate the agreement if the council can establish a specific default on the part of the contractor giving a right to terminate has arisen.
Compared to a traditional design and build arrangement, a council might expect to have equivalent rights to the first three outlined above. The fourth is potentially a benefit of PFI, in that there is a right to costs relating to the impact of the issues with the defective construction work. There is likely to be a question mark as to whether the deductions the council can make are sufficient to compensate adequately for costs it incurs in being unable to use the facilities. Further, the fact this is a “sole remedy” – in other words, the council cannot claim separately for additional losses it suffers – may limit that benefit.
The final remedy would also not be applicable to a traditional D&B contract, but may take on a particular importance to the council if it is interested in extricating itself from the contract as a whole.
In relation to this right, this is most likely either to relate to extended unavailability of the school, or a failure to make good the defects in the building. If the council establishes that such a default has arisen and successfully terminates the agreement, it will have to make a compensation payment. There is a notoriously complicated process, which was the product of years of negotiation and hundreds of thousands of pounds of advisors’ fees, that may be invoked to establish how that compensation is established and what it amounts to. The intention behind it was to give the banks putting up the majority of the money for PFI confidence they would get most if not all of their money back, so it is quite possible at the end of all this, the council may need to find several million pounds to pay off the banks. This may sound unpalatable in the circumstances, but is likely to be materially cheaper than other ways of terminating the PFI contract – and cheaper than paying for the remaining years of the contractual term.
As the equity investors in the PFI contractor are unlikely to get their investment back in the event of a termination for contractor default, and the banks don’t like the risk of not getting all their money back, the theory is they will all be doing all they can to remedy the defaults so that termination does not arise.
When the dust settles – and assuming there is public disclosure of how the matter is resolved – it will be interesting to see whether it offers any vindication of the PFI model, or an affirmation for PFI’s opponents of its iniquities.
In the meantime, whilst Edinburgh is a very public example of one authority crying foul over a PFI, we are aware of a trend lately whereby other commissioners are proactively seeking to shift the balance of power in their PFI arrangements. They are identifying non compliance with regulations by PFI contractors and are then arguing that the facilities have been unavailable for a long time. They are claiming recompense for overpayments and arguing that this is pushing the contract into event of default territory. This has created the opportunity for the authority to renegotiate the contract terms. It has tended to be the larger government departments, who have the resources available to go looking for potential defaults, rather than say schools, local authorities or NHS trusts who have utilised this approach to date, but it may be a technique worthy of wider adoption by the public sector.