PFI: Opportunity still knocks

Earlier this year, as reported in Building (22 February), Hills, a family-owned mechanical and electrical company, was sold for £1. The company blamed its losses on a number of “disastrous” school PFI projects and difficulties in meeting performance criteria on Building Schools for the Future contracts.

Salutary tales such as this have not, however, dissuaded specialist subcontractors, or even main contractors, from wanting to get involved in the world of PFI. And this is not surprising. The latest official Treasury document on PFI, Infrastructure procurement: delivering long-term value – March 2008, points to a number of strong projects in the pipeline. Despite the credit crunch, some £23bn-worth of deals are projected to be closed in the next five years, representing only a small decline from the 2005/06 peaks.

The opportunities are particularly interesting for medium-size contractors. Over the past 10 years, the big firms have got bigger. Their main interest in PFI has moved away from pure construction to the more lucrative area of investment in the project company. This has left something of a gap in the market. So if the opportunities exist, what are the catches?

First, PFI building contracts are a world away from JCT. The usual extension of time events do not apply, although the effects of some of these may be partly mitigated by insurance. Completion criteria are more onerous. Indemnities are widespread, and the lenders financing the project will reserve the right to boot off the contractor if the project falls too far behind. The losses payable if the contract is terminated for delay do not bear thinking about.

Second, the entitlement of contractors to extensions of time, money, variations and other relief will usually depend on the project company’s corresponding entitlement to that same relief, as against the public authority. This sounds like pay-when-paid by another name, and in Midland Expressway vs Carillion (2005), the High Court confirmed that it was. The judge struck down a standard “equivalent project relief” clause as being unenforceable.

Nevertheless, these clauses are still being used, often with ever more crafty legal drafting to avoid the effect of the Midland Expressway case. Their effectiveness remains dubious, but few contractors want to test such clauses in court. They are understandably wary of damaging their relationship with the project company or the authority, and of never being invited to the PFI party again.

Ever more crafty legal drafting is being used to avoid the effect of the Midland Expressway case. Their effectiveness remains dubious, but few contractors want to test them in court.

Third, the building contractor will enter into a direct relationship (an interface or co-operation agreement) with the facilities management (FM) contractor. This covers such matters as design development during the construction phase, which the FM contractor will want to comment on, access for the FM contractor before completion, and what happens during the defects correction period, particularly if there is a problem that might result in the authority withholding payment.

These agreements have now become quite complex, especially where they involve numerous parties, such as hard and soft service contractors, the IT provider and so on. For the building contractor, the main point is that it may face claims direct from one or more of these people, something it does not have to contend with under standard JCT contracting.

How does all this affect the specialist trade subcontractor, such as the M&E subcontractor I mentioned earlier?

If the construction phase overruns, the losses can be substantial. The building contractor will not want to put a cap on any losses it may have to pay up the chain. But the trade subcontractors will not accept liquidated damages figures that are out of all proportion to their contract sums. Some trade subcontractors will be in a strong enough commercial position to stand firm.

If there are no corresponding incentives, and a limited market for their specialism, they will be able to reject complex “pass-down” subcontracts as a matter of principle. If the building contractor is then left holding the baby, it needs to factor that into its initial price.

The risks for contractors and subcontractors in PFI are not to be underestimated. The trick is to understand what these risks are, and to be bold about pricing for them. But despite some negative publicity, PFI is likely to prove attractive to contractors for some while yet.