A money back guarantee

According to recent news reports (14 May, page 10), schemes that are part way through a PFI procurement process may be frozen or even axed as a result of the need for cuts in public spending. So far, it appears the government’s focus may only be on those projects that have not yet reached preferred bidder stage, but it is not inconceivable that cuts will extend to projects where a preferred bidder has been appointed but financial close has not been reached.

When PFI projects are axed for economic reasons, what comeback do bidders have in terms of the payment of their bid costs?

The appointment of a preferred bidder is a milestone in the PFI procurement process. Before the appointment, there is a competition between bidders for selection as preferred bidder, which is a decision made by the appointing authority based on final tender submissions. In ordinary circumstances, bid costs incurred up until then will not be recoverable (unless the bidder can show a breach of process and make a claim under public procurement rules). This is the case because the invitation to tender will generally exclude recovery - and if it does not, custom (and legal precedent) usually will.

The preferred bidder will probably be able to recover bid costs incurred to the date of appointment, as it will be included within the financial model that governs the payments to be made to it over the life of the project.

It is very unusual (although not unheard of) for PFI projects to be cancelled after the appointment of a preferred bidder but before financial close. If and when such a cancellation occurs, different rules come into play.

If PFI schemes are cancelled with no compensation, it may damage the trust between client and bidder

First and foremost, if a cancellation occurs after preferred bidder stage, the terms of the agreement between the preferred bidder and the authority must be scrutinised to see what they say about bid costs. Furthermore, there may be the possibility of claims in restitution or, depending on the particular facts, enforceable contractual obligations.

The other route to recovery is through government policy: that is, the last government’s adoption of the recommendations of the Bates Review in relation to PFI, including the treatment of bid costs. Malcolm Bates conducted his review in 1997 at the request of the Labour government, and in it he said: “When a decision is made not to proceed with a project and that decision is not related to the viability of tenders received, bid costs should be refunded.”

Since 1997, some government departments have clarified how the Bates recommendations will be implemented. For example, in February 2007, the Department of Health issued a “framework for the identification and validation of heads of claim arising from cancelled or re-scoped PFI schemes”. This identifies which type of costs might be recoverable and which would not. It also emphasises that any decision to contribute towards bid costs is discretionary.

The review is helpful in any claim to recover costs incurred after preferred bidder stage, although of course it has not yet been ratified as current policy by the coalition government. That said, it is sometimes difficult to know whether the policy will apply. For example, what factors should be used to test whether cancellation is due to the “viability of tenders received”? If the project is not viable, because its scope has increased and it becomes unaffordable, does this make the tender non-viable? If cancellation is directly related to public spending cuts, the policy should surely bite.

The risk of incurring wasted costs has always been the downside of private sector participation in PFI procurement. The risk arises because of the competitive process and also because of the possibility of a scheme failing at an early stage.

Nevertheless, as we know, there is a market for PFI, not only because of the returns to be made if a project reaches financial close, but also because of the trust and reliance that has been built up between the government and private sector, which is necessary in view of high bid costs.

If significant numbers of PFI schemes are cancelled without compensation, that relationship of trust and reliance may be damaged in the long term. This is one of the risks the government should consider when deciding its policy in relation to the payment of wasted bid costs in the event of PFI schemes being cancelled.

Caroline Cummins is a partner in CMS Cameron McKenna