Terminating PFI contracts: What it really costs

Author: Kim Fowler

The rise of Corbynomics and the fall of Carillion have put PFIs in the spotlight. What would terminating such contracts actually involve?

At the Labour Party Conference last year, John McDonnell raised the idea that public sector bodies could provide better value for money in certain service areas if the government was to terminate long-term projects with the private sector.

The shadow chancellor called PFI deals a “waste of taxpayer money” and said they would be brought back in-house under a Labour government.

It wasn’t long, however, before he changed his position to a commitment to “review” all PFI deals, reflecting the reality that terminating PFI deals is not straightforward. Nor is it cheap.

From a contractual perspective, many of the older PFI projects do not contain provisions allowing the public sector body (the authority) to terminate on a voluntary basis.

For those projects, termination only applies as a result of specified default events on the part of the contracting parties. Unless the contractor is in default, the authority cannot terminate. Even if the contractor is in default, there is often a process by which it can attempt to rectify the default before the project is terminated.

In circumstances where the project agreement contains a right for the authority to terminate by giving written notice, there are many points that need to be considered and agreed before termination can take place.

Terminating PFIs means compensation

The most substantial is agreement between the parties of the termination payment payable by the authority.

Standard SOPC3 drafting (on which a considerable number of PFIs are based) states that on voluntary termination, the authority is required to pay compensation to the contractor, which includes the following:

  • Any outstanding debt still to be paid to the funders of the project.
  • Any amounts payable to employees as a result of termination and any amounts payable to any subcontractors as a result of termination.
  • An amount which is taken together with a) dividends (or other distributions) paid by the contractor on its share capital, on or before the termination date, and b) interest paid and principal repaid by the contractor under the subordinated financing agreements on or before the termination date.
  • Taking account of the actual timing of all such payments, gives a real internal rate of return on the share capital subscribed and amounts advanced under the subordinated financing agreements equal to the base case equity internal rate of return.
A domino of clauses

The compensation for voluntary termination in SOPC3 is calculated in line with the compensation on termination provisions relating to authority default, which state that the contractor should be no worse off because of the authority default than if the contract had proceeded as expected.

This position was repeated in SOPC3 guidance published by the Treasury in June 2015, which stated that the contractor should, on voluntary termination by the authority, receive a termination amount which leaves it in the position than it would have been in, if the contract had run its full course.

This raises the question of adviser fees and any additional costs incurred by the contractor as a result of voluntary termination.

Terminating a project agreement has a knock-on effect on the remaining project documents, the rest of which ought to terminate automatically. There may not be any formal handback requirements on voluntary termination and, depending on the notice period, a very limited timeframe in which to rectify any historic issues on the site, leaving the authority to take over a site that is in a different state than if the project had run its course.

Leaving the contractual implications aside, the financial cost of terminating a PFI project can be substantial. There are currently 700 PFI projects in the UK with a capital value of roughly £59bn.

In November, The Telegraph, using a calculation put together by John Laing Infrastructure Fund, estimated that the cost of terminating all of these projects could be as high as £51bn.

This is a substantial amount of money, particularly if it was to be paid out in respect of projects that are running smoothly and providing value for money. Bringing all of these projects back in-house does not seem like a realistic proposal.

Kim Fowler, Senior Associate, Fladgate LLP (kfowler@fladgate.com)

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