Olwen Dutton: Why you should be a demanding PFI client

PFI has been thrust back into the news and it doesn’t make for pleasant reading. Olwen Dutton asks whether PFI deals should be terminated or if there are alternative ways to manage these controversial contracts.

PFI is in the news again and not in a good way. In reality the situation has been rocky and getting rockier for some time.

The Carillion collapse brought some attention to PFI but hot on its heels came the National Audit Office report on PFI and PF2.

With the report came details of PFI deals struck in the past that are difficult to comprehend. For example, a privately financed hospital with a cost 70% higher than the public sector comparator; a group of schools financed under PF2 that has costs some 40% higher than the price of a project financed by government borrowing.

The question is what can be done about PFI contracts? Should they be terminated? Or, is there another way of managing what have, at times, been seen as highly controversial finance arrangements?

Costs

For many years, as far as councils were concerned, if you wanted a capital scheme then PFI literally was “the only game in town”.

And what a game. Whereas public bodies are generally dissuaded from using private borrowing — because public borrowing is so much cheaper — over the last twenty years capital investment using PFI and PF2 has averaged around £3bn per annum. And the most visible additional cost is the cost of finance at 2%, sometimes up to 5%, higher than the cost of government borrowing.

These are small percentages, perhaps, but it adds up.  The NAO says that paying off a £100m debt over 30 years at 2% interest costs £34m in interest; at 4% it’s £73m.

And that is all funding coming out of the public purse, leading not only to the repayments themselves but also reduced flexibility around budgeting after the repayments are taken into account; fettering your discretion, it used to be called, or reducing the sum of money at your disposal because it has to come out of the budget first.

This is acceptable (at a push) if the service, or assets, are still needed, but the inbuilt lack of flexibility in many of the PFI deals, can be difficult, especially given shrinking budgets across the public sector.

When councils, for example, face difficult decisions around service delivery — making workers redundant and, or, cutting services to the bone — having to pay millions of pounds a year for an empty asset, such as a no longer needed school, is not far short of a public scandal.

This is especially the case when the PFI deal means that the repayments — over the last ten years of the contract alone — can amount to not far short of double the cost of building it in the first place.

There is the lack of flexibility in other ways as well. Do I need to mention Sheffield’s trees and the Streets Ahead PFI deal with Amey? It can be “exorbitantly expensive” to change.

Benefits

It’s important to remember that it wasn’t all bad, not by any means.

Too sharp a focus on the financial issues masks the reality that in many case that without PFI many hospitals, schools, street lighting and prisons, would not have been built at all.

And at the time they were put in place, its probably true that many of the projects benefitted massively from the qualities that the private sector brought to the deals: projects were finished on time, delivery happened.

Was it worth it?  We don’t know. Somewhat surprisingly for such a huge programme, the overall performance of PFI has never been quantified.

It’s also true that the older deals are worse for the public sector than the later ones.

Public bodies, in many cases, did not have the capacity or expertise to negotiate sufficiently hard in those days, and the overwhelming number of schemes were negotiated more than 10, or even 15 years ago.

Most of those who were involved have moved on, or retired. Recent public sector budgets cuts means there are now fewer people around and a corresponding shortage of contract management skills.

Think differently

So what can be done?  Buy the deal out? It’s legally possible, but so are lots of things; it doesn’t mean they’re advisable.

Most PFI deals date back before 2008 to an era of more expensive interest rates. That has to be factored in, together with compensation payments to equity investors in the SPV (special purpose vehicle). But it can be done.

TfL have terminated three deals — enabled, in part, by break clauses in the contracts, an unusual inclusion for PFI deals. In 2014 Northumbria HealthCare NHS Foundation Trust also bought out a PFI hospital deal.

But the belief is that on the largest deals the cost to break them is likely an additional 23% — on top of the outstanding debt. And then there is all the advice that will be needed, the knock on effects of termination, picking up the service delivery, staff transfers etc.

Looking at all that, will it be worth it? Could you really argue that reductions in your PFI payments are part of a solution to tight budgets? Perhaps.

But think differently. Is the contract delivering what it should be? How do you know for sure? What evidence have you got? Those are the questions I would ask, and where I would start.

And that’s because where there are shortfalls in delivery a council, or other public body, can put itself in a much stronger bargaining position. Where PFI deals have been ended early, the contractor’s performance, or lack of, is usually at the bottom of things.

Options

Tempting as it might be to talk about termination and radical solutions, a better option is likely to be collecting some good advice about the contract. While most PFI deals follow a fairly standard form, this is the best place to start.

Examine what can be done within the contract, how it can be managed, what options there are to drive as much delivery and efficiency as possible out of what is there, and improve contract management within the public body, watching and evidencing, what is being done by the contract provider.

If you know the strengths and weaknesses of the contract you can use what is within it to your benefit; look at the optimum delivery that was promised and see if you are really getting that.

Put yourself in the strongest possible position as a demanding client. You do that best from a position of knowledge. And then, once you have that baseline of proper expectation, invest in top quality contract management to drive it through.

There are no magic solutions here. But the public sector can put itself in a much stronger position, either to drive out maximum benefits or, if the contractor isn’t up to scratch, putting in place the consequences.

Olwen Dutton is a partner at law firm Anthony Collins.