In the wake of Midland Expressway

The decision in Midland Expressway has been variously described as "groundbreaking" and one that will "cause shock waves in the world of PFI". The facts of the case have been well reported (see the Building archive) but less has been written about the impact Mr Justice Jackson's judgment will have on traditional PFI subcontracting and the alternatives that may be available to ensure the bankability of projects.

In Midland Expressway, a restrictions of the subcontractor's rights to claim for payment and extensions of time, known as equivalent project relief provisions, or EPR, were held to be in breach of section 113 of the Construction Act because:

• The subcontractor would not be paid until the project company itself was paid
• The subcontractor was not entitled to any greater recovery than that which the project company achieved under the project agreement.

So are EPR provisions now unenforceable? No. The scope of the judgment only extends to those circumstances in which the EPR provisions would breach section 113, meaning payment claims. The judgment does not have any application to the funding of the initial works, which will be paid out of the project company's loan facilities.

But what the judgment does mean is that EPR provisions can be challenged when:

• The awarding authority has assumed subcontractor compensation claims for risks under the project agreement
• There are disputes with the awarding authority over payments during the operating period
• The subcontractor claims for payments in respect of variations where the works are to be funded by the awarding authority.

On the face of it this judgment has increased project companies' risk, but there are steps they can take to mitigate that risk. In Midland Expressway the payment claim was made by a subcontractor that had no equity or other interest in the project company. This is not typical; under most PFI arrangements, subcontractors have an equity stake in the project company. Funders may, therefore, want to look more closely at share transfer restrictions in order to preserve this commonality of interest between sponsors and subcontractors.

Funders should also include appropriate subordination of claims provisions in any direct agreement entered into with a subcontractor to ensure funders will continue to receive debt repayments in priority to payment of any subcontractor claim. Although the direct agreement might constitute a contract, it should not restrict the effectiveness of subordination provisions. Nevertheless, subcontractors should be required to covenant that they will not take any steps to dissolve the project company. The relationship between subordination and the right to suspend works for non-payment under section 113 will also need to be considered.

Another option is to include a longstop final date for payment of any monetary EPR claims, as permitted by section 110 which will give the project company time to pursue its claim against the awarding authority.

An alternative is the use of so-called "parallel loans" where a subcontractor, or its parent, loans the project company an amount equivalent to the amount successfully claimed. However, this commercially problematic for the relevant parent.

Finally, there are two considerations which are not currently accepted by the public sector. The first is the joining of the awarding authority as a party to any EPR dispute between the project company and its subcontractors, which would allow a multiparty settlement of the dispute. Historically, authorities have resisted attempts to involve them in subcontract disputes, but sponsors might now wish to consider this option in light of the Midland Expressway decision.

The second is the inclusion of a "pay now, dispute later" clause in the project agreement. Although not usually acceptable to the awarding authority, such a provision is not without merit; the consequence of a spurious claim for payment by the project company would lead (after resolution of the dispute) to the repayment of amounts overpaid by the authority, together with an appropriate rate of interest. The project company is therefore discouraged from over-claiming from the awarding authority.