Starting handback the right way
In previous blog posts we talked about the fact that a 30-year period of expiring PFI contracts is now upon us and gave our view on the NAO findings that contracting authorities do not have up-to-date contracts, lack information on asset condition and annual maintenance, do not have asset registers and expect to use the Dispute Resolution Process (DRP). In this post we talk about the importance of contracting authorities and PFI Providers starting the process in the right way so that collaborative working relationships, integral to CURSHAW’s E3 (effective, efficient and equitable) handback, are not compromised at the outset of the process.
The importance of relationships and collaboration
CURSHAW’s approach is to help our clients work collaboratively and in partnership with their counterparties. Our award-winning experience of successfully managing the largest PFI expiry (£13.3bn, 1,000 properties, 20-year term) from programme inception through to post-PFI supply chain stabilisation is that PFI providers need contracting authorities, and vice versa, in order to deliver an expiry plan and hand back assets in the right way. The expiry and handback process can be fraught with complexity and may involve time pressure. But, even where the need for dispute arises, it is essential that good relationships are maintained. The operational, commercial and ultimately financial risks to both sides of not maintaining them are sizeable.
The expiry process starts with a contract review
It is widely acknowledged that the process starts with, or should be preceded by, a contract review; indeed the IPA have divided their PFI exit planning programme into 4 projects one of which is titled ‘Operational and Contract Reviews’. The IPA’s project will in their words, “assess the performance of a number or PFI contracts with more than 7 years to run and recommend ways to improve their operating performance and to make efficiencies”.
Of course, contracts should be managed throughout their life-term to ensure, inter alia, that SLAs, KPIs and compliance obligations are being met and the right operational performance and value for money is achieved. But this is especially important as expiry approaches and the assets are due to be handed back. It may be surprising to some that only now, with expiry approaching, is there a focus on contractual compliance. Nonetheless it’s a welcome focus area. A review at the outset of, or prior to, the expiry process is a great way of baselining and protecting service on mutually agreed terms before addressing the challenge of operational and commercial demobilisation. Both contracting authorities and PFI Providers should know what it takes to achieve the right performance and commit to one another to sustain that right up until the point of expiry before addressing the challenge of how to work through exit obligations and manage transition.
How to review contracts and why relationships must not fail
It is important that the contract reviews are done collaboratively between contracting authorities and PFI providers. It is accepted by everyone involved - equity investors, SPVs, OpCos, contracting authorities and public sector service users - that PFI providers should be on top of their contracts and complying with their obligations. A starting point to reviewing the PFI contract is to have an up-to-date version: a single version of the truth for all stakeholders. The NAO notes that the PFI contract is central to preparing for and managing the expiry process and that it can take a considerable amount of time to gather together the PFI contract and all its variations over time. Once the up-to-date version of the contract is available, it is important that demonstrating compliance is supported by evidence.
In undertaking the exercise of ensuring contractual compliance, the parties ideally should agree on the purpose of the exercise. Is the prime objective to:
Ensure that the assets are in the condition required by, and being managed in accordance with, the contract;; or
Achieve the maximum financial penalties that the Contracting Authority is able to claim.
The answer to this question, which will often be some years ahead of the expiry date, is likely to significantly impact the relationship. If the process is seen by either party as a means of catching the other out then a breakdown in relationships is inevitable. The exercise must not be seen by contracting authorities as an expedient means of obtaining cash savings on spurious claims relating to trivial operational non-compliance; however it is important that providers are held to account. Equally it should not be exploited by PFI providers to compromise service or maintenance for the sake of short-term profit. Where these things happen, relationships will fail before the really challenging aspects of expiry, which we at CURSHAW know can put more strain on the relationship, need to be faced. We know from the NAO review that a third of respondents expect to have to use the DRP. The proportion with the fatalistic view that DRP is necessary will only increase if the early onset of the expiry process is characterised by cynicism and mistrust and/or seen as a zero-sum game rather than pursuit of a win-win outcome.
Important considerations
See the bigger picture and acknowledge the importance of collaboration the whole way through - Expiry should be a long game - the IPA recommend preparing 5 to 7 years out - and must be led by people who understand and can communicate this. Breaking the relationship before the expiry process has begun would be very short sighted because expiry has the potential to be a great deal more complicated than BAU contract management. As the NAO pointed out and was mentioned at the PAC by Matthew Vickerstaff and Sean Hansen, the early contracts are likely to contain significant ambiguity around the roles and responsibilities of the parties at contract expiry. From my own experience the expiry provisions were vague with very little detail around transition and the practical aspects of handback. More importantly, there is an acute asymmetry of information. PFI providers have the data, systems and staff with operational knowledge that is highly valuable and the public sector needs to protect it and take it back at the point of transition, so as to have any hope of efficiently managing the assets going forward. Falling out at the start puts the transfer of this on mutually agreeable terms at risk. Break the relationship and expect contract-end financial liabilities and operational disruption for state-critical services.
Operational evidence and data must drive contract reviews - A contract review must be supported by data and be run as a commercial process, with a relentless focus on operations with service users in mind. Lawyers have a key supporting role to play but this is not a legal process and therefore should not be led by lawyers. These are contracts for state-critical services. The aim is to ensure services are being delivered adequately and the assets are being maintained and that service continuity is maintained.
An independent third party may add value - Given the impartial, evidence-based imperative, consideration should be given to engaging a third party to undertake the review on behalf of both PFI provider and Contracting Authority to exercise independent operational and commercial judgement.
If a third party is used, carefully consider how they are positioned and compensated - If one party pays, there will be doubt over impartiality. If they are paid by one party and on a risk/commission basis and therefore vested in a certain outcome, this may present long-term challenges and risks compromising effective working relationships.
Consider using a joint (PFI Provider and Contracting Authority) balanced scorecard for running the expiry process - Agree how the expiry process should run and what would characterise an E3 expiry. Agree this before embarking on Contractual Reviews to set direction and tone.