Tag: PF2

How does PPP work

Public / Private Partnerships originated in Australia as governments sought new way of dealing with public procurement of infrastructure in the 1980’s. In the intervening periods they have remained similar as a financial model but as governments like to change the name when there is a new administration in a misguided attempt to make it look like a new policy as opposed to a rehash of the old ones there have been various iterations in the United Kingdom.

The last Conservative Government of John Major started using these financial models and they were knows as a Public Private Partnership (PPP). While in opposition Gordon Brown called into question PPP’s and made it clear they would not be used if Labour won the next General Election. So were born the  Private Finance Initiative (PFI) which as the Labour government became tired and ran out of steam were ridiculed by Gideon Osbourne and would not form part of any incoming Conservative government procurement plans. Of course a little tweak here and there and now we have Private Finance 2 (PF2).

Yet in reality they are little changed, save for the minor tweaks.

What are Public Private Partnerships?

Public Private Partnerships are generally where public services or private business ventures are funded and operated through a partnership between the Government and one or more private sector companies.

They allow Government to contract out the design, building and operation of a facility for the benefit of the public to a private sector company usually for a period of 25 to 30 years usually based on a “value for money” test over traditional procurement. In effect government had two ways to procure:

  • A standard procurement structure, in which the Government specified what it wanted in terms of an asset and then paid a contractor to build that asset. The Government then took ownership of the asset, and took on the obligation to maintain it, after it was built; or
  • A PPP structure in which the Government specified what it wanted in terms of a service and either pay a service provider to make that service available, or allow the service provider to retain the resulting revenue or share it with the Government.

However the effective result of PPP is that everything is procured through the PPP model and has resulted in almost every aspect of what the government provided being effectively sub-contracted, through large service providers, such as Capita. There is some miss-guided notion that a private company can run the service for less money and still make a profit than government after factoring in inherent inefficiency. The actual result is usually poorer service. There is a scandal every so often, the culprit is given a token ban from securing government work, but this is soon dropped and they back on the gravy train.

A worked example

For the purposes of this example we will assume the highway authority want to provide traffic relief by building a new toll road (such as the M6 toll which by-passes Birmingham via Cannock in the West Midlands) and maintaining and managing the asset for a 25 year period.

There would clearly be key functions that would need to be considered and evaluated by the PPP operator, such as

  • The cost of building and operating the road would need to secured
  • The PPE contractor would have to engage a designer to determine the layout and specification of the road
  • A contractor would need to be appointed to construct the road
  • A service organisation would be required to clean the road, replace damaged infrastructure from crashes, provide and maintain lighting, institute a “smart” tolling system (Such as at the Dartford Crossing of the Thames River
  • Cyclical maintenance such as resurfacing would need to undertaken
  • A mechanism would need to be established of what the handover procedure is when the lifecycle of the PPP ends

As can be seen this is a multi-disciplinary activity and the government would in effect expect the cradle to grave cycle to be undertaken by the successful bidding organisation. This generally means that the bidders are Joint Ventures (JV) (incorporated or unincorporated) that allow the main Special Purpose Vehicle (SPV) that will hold the effective PPP contract to cover different competencies. In our example the SPV could be made up of a Finance House, Design Organisation, Main Contractor and Service Provider. However despite this make-up of the JV the actual works will still be sub-contracted even to a partner company. This is because the trend has been for these SPV’s to be sold off after a defined period. In effective the SPV is a shell because it owns no physical assets, employs few (if any staff) and exists to own the head contract for the PPP being contracted for.

Risk is obviously a major consideration in these projects because of their complexity and part of the PP process would be for government to transfer risk to the SPV and its agents. This could be done as follows:

  1. Risks that Government want to pass to the PPP SPV would be set out in the contract between the parties, or assumed by the SPV as applicable at law to its activities, such as liability for contamination during the construction phase
  2. As the SPV is project specific and does not own anything physically these risks and obligations are allocated to the various members of the supply chain where applicable or where this cannot happen will be left as a risk the SPV holds with some form mitigation to cover the financial consequences of the risk crystallizing. In effect the cost of this type of risk would be a component of one of the costs of the service
  3. During the construction phase – for example, liability for environmental pollution during construction phase the risks would be passed down by the SPV to a Contractor (who could further pass down the risk to Sub-Contractors) through “back-to-back” provisions in their contracts. In effect this means the Contractor agrees to perform all the defined services the SPV has agreed to provide to the government. The Contractors programme would be of equal length of shorter than the SPV, to build a road to the same specification required by the government in the head contract and to ensure the SPV would not be in breach of contract and subject to Liquidated and Ascertained Damages. (LAD’s) However there would be a “back to back” provision that would make the Contractor liable to the SPV for LAD’s at the same level in the event he was in breach of contract. In effect mitigating this risk for the SPV. The effective purpose would be to leave the allow the SPV neutral and the Contractor managing the risks involved in the construction of the asset
  4. When the road was complete and able to operate as a toll road, the SPV would operate the road and, again, these obligations would sub-contracted to an Operating Company using a similar methodology as detailed in the previous point. However it is possible that not all operation and maintenance risk could be passed to the Operating Company, two examples would be:
  • “Day-to-day” operation and maintenance could be passed on but obligations to undertake periodic, major maintenance, such as resurfacing for wear and tear may not be subcontracted at the start but remain an SPV risk, and contracted for separately when required (where defined in the head contract) or as due when there are sufficient funds and resources
  • “Change in Law” provision are a risk that cannot be evaluated at the start and that the Operating Company could not take on because of the length of the service contract. These risks are to a large extent under the control of government as the legislator. It is likely this would be a shared risk between government and the SPV and be dealt with as and when the risk crystallises following a change in law.
  1. The SPV has to finance the construction and initial operational activities, in effect the construction costs of the road would need to be paid for, and the money for this would need to be repaid from revenue generated by the road when it opened for traffic. The financial model would see the funding requirements should exactly match the SPV’s liabilities to pay its subcontractors. In effect a lean organisation

 Nature of risks with this PPP project

At the simple level the risks would be:

  • Can the road be built on time and to the required specification
  • Can the road be operated as the government requires
  • Will revenue generation be as expected as the financial model will be based on revenue assumptions

We could now expand these sub heading and detail some of the specific further risk that could be associated with each.

Built on time and to the required specification

  • Does the SPV have the necessary access to the site
  • What happens if ground conditions are different from expected
  • What happens if the law relating to road construction changes during the construction period
  • What happens if resources that the contractor is expecting to use are not available or in short supply
  • Who takes the risk that the road costs more to build than expected
  • What happens if a natural disaster occurs

Operated as the government requires

  • Does the SPV have the required access to the site
  • What happens if the law relating to road operation changes during the operating period
  • What happens if resources that the operator is expecting to use are not available or in short supply
  • Who takes the risk that the road costs more to operate than expected
  • What happens if a natural disaster occurs

Revenue generation expectations

  • Has the road been built to specification
  • Is the road being operated according to the Government’s requirements
  • Demand risk: will cars, lorries etc want to use the road
  • Payment risk: will cars, lorries etc want to pay to use the road
  • Are the operating costs, including finance cost fixed or variable

 These risks are typical but not exhaustive and each would require a provision in the contract to deal with. Some we have already looked at in other blog posts such as access (frustration) or natural disasters (Force Majeure). However Demand Risk could be dealt with where government makes up for any shortfall in notional demand. Of course this really means the taxpayer is obligated to pay the shortfall.

However in the alternative these risks would exists under traditional procurement where the accepted norm is to contract out the running.

As the Local Democracy, Economic Development and Construction Act [2009] outlawed Conditional Payment clauses, although this is the standard in PPP contracts where the SPV is created for the sole purpose of procuring the project has no assets and is not intended to have any liability unless it is first paid. Therefore PPP contracts have an Exclusion Order where Conditional Payment provisions will exist, although in the longer term this may need to be subject to further legislation. However because of the nature of the contracts and that they are bespoke, heavily negotiated forms this is a risk known to all parties at the outset.

The Exclusion Order means that provisions in first tier PPP sub-contracts which make payments in such contracts conditional upon obligations being performed in other contracts (such as providing certificates and ‘pay when paid’ clauses) will be effective.  However, ‘pay when paid’ clauses will, generally speaking, continue to be ineffective in accordance with the Local Democracy, Economic Development and Construction Act [2009]


PPP as a procurement model has been with us for over 20 years. It’s a simple and legal way for government to not have to declare obligations as government debt. In an overwhelming majority of cases where a dual analysis of PPP and traditional procurement has been evaluated, the assumptions are skewered to assist in ensuring the PPP option is the governments preferred procurement route. However when costs are well known and become public knowledge PPP proves itself to be poor value for money.

But the reality is it’s here to stay, even if when the current Conservative government runs out of steam and the electorate give another party the opportunity to govern, probably Labour once again once they have dispensed with their insane trip back to 1920’s state control under Jeremy Corbyn and his “brothers” and “sisters”. One thing is sure PPP will continue, it will just be called something else.

Maybe they could call it Stakeholder Hybrid Infrastructure Term Schemes.

Termination & Suspension clauses in construction contracts

Legally speaking in a contract there is very small differences between Termination clauses and Suspension clauses. Although there is now a Statutory Right to suspend works in construction contracts for non-payment.

It is therefore imperative when agreeing a contract, particularly for the supply of goods and services a termination and suspension clause should be included, if for nothing else to ensure the reasons for suspension cannot be regarded as termination. As this would usually come about when there is some dispute and / or claim between the parties, this only seeks to reinforce the requirement for clearly defined suspension clauses, that may lead to termination, but not when first triggered.

Termination clauses in construction contracts

Standard form of contract will contain express provisions on the rights of either party to terminate the contract in defined circumstances. By way of an example, if the contract is in effect a Sub Contract and therefore a further party is the employer, an insolvency event of the employer would allow the contractor to terminate the contract with the sub contract.

Non-contractual rights to terminate

The contract is entered into and usually implies that the parties will diligently carry out the works being contracted for within prescribed timeframes and then the obligation on the other party would be to make regular payment on a fair and reasonable basis. Usually under the services being contracted for the party providing the services would be required to “carry out and complete” the services, The definition of complete will usually even be defined in its own right, so there is no ambiguity in this that can lead to dispute.

Even with these terms there can still be reasons why the contract would end up being terminated, such as the following:

Frustration

Frustration can occur when neither party has defaulted on the contract but circumstances have intervened to prevent the contract from being performed as originally intended making further performance of the contract is impossible, illegal or significantly different to the circumstances and understanding when the parties entered into the contract.

Where frustration occurs the contract automatically terminates and the parties are excused from their future obligations, although any accrued liabilities remain.

It is therefore vitally important to ensure (and in effect for both parties to agree) that frustration has occurred, justifying the termination. This would be to avoid by consequence of terminating for frustration to being in breach of contract, where frustration has not actually occurred.

By way of examples, where a contract becomes more expensive to perform through any number of issues which should have been considered as part of the negotiation of the value of the contract, this will not be a frustration event or where an event is set out as being possible and how it is dealt with is set out as an effective potential variation (change) to the contract this will not be a frustration event.   Case law gives some examples of events that are not frustrating events. The parties need to be wary of Force Majeure clauses and their potential overlap. This will be investigated further in a later post.

An event that could be regarded as frustration would be where an employer instructs an architect to design a house to be built by a Contractor on a piece of land that the employer is in the process of purchasing. If the sale of the land falls through, the contract would be frustrated as the design for will no longer be required.

Repudiation

Repudiation occurs when a party commits a breach of contract sufficiently serious that it entitles the injured party to treat the contract as terminated with immediate effect and to sue for damages for breach of contract. If this is a material or anticipatory breach will depend upon the severity and effect of the breach, and whether it goes to the root of the contract.

Certain extreme types of breach will amount to a clear repudiation of a construction contract, such as:

  • Refusal to carry out work;
  • Abandonment of the site
  • Removal of plant by the contractor;
  • Employing other contractors to carry out the same work;
  • Failure by an employer to give access to the site.

These examples above are clear and unambiguous and grounds for repudiation. However other breaches may not be clear-cut and like frustration need to be clearly grounds to ensure that where the injured party treats the contract as repudiated as a consequence of the breach, which is not repudiatory; this will be wrongful termination and be a breach in its own right.

Whilst damages for repudiation may be higher than for other for other breaches, the parties should ensure they have that all important right to terminate for repudiation before doing so and where possible should try to utilise a more clear cut contractual right to terminate if available.

Further repudiation by one party will not by itself bring an end to further contractual obligations, the repudiation has to be accepted by the injured party. While there is no prescribed form of acceptance, it must be unequivocal acceptance by both parties. Where both parties accept the contract is repudiated, each side is released from performance of their respective unperformed obligations and damages are assessed under the normal rules and payable by the party at fault. The principle of these damages is to put the injured party in the same position they would have been in had the contract been properly completed.

However if the injured party does not accept the repudiation it “affirms” the contract is to continue, it is still entitled to claim damages for the breach but the contract will continue.

A further difficulty can be where the injured party instead of accepting repudiation, inadvertently “affirms” by their actions that contradicts acceptance or is equivocal in some way. This in itself could lead to the injured party being in breach of contract if it stops performing its obligations in the mistaken belief repudiatory breach has been accepted.

Just to confuse matters in this complex and complicated area of contract law, in some cases a breach may give the injured party the right to terminate for repudiation and a defined right under the contract.

In these circumstances the injured party does not necessarily have to elect to use one right or the other. However where exercising the contractual right is inconsistent with acceptance of repudiation, where the consequences of terminating under the contractual right are different or the response to the breach is less than unequivocal the injured party will be taken to have “affirmed” the contract and will have to rely on the contractual right rather than repudiation. As stated previously this could have consequences in relation to the level of damages for the breach.

Contractual rights to terminate

Termination clauses in contracts give parties right to terminate in certain circumstances and usually are in relation to breaches of specified contractual obligations as well as Force Majeure events which will be investigated separately.

Termination for convenience

Termination “at will” or “for convenience” wording can be inserted into a contract allowing one party to terminate without having to establish that some event has occurred or breach has been committed by the other party.

By way of an example, where an employer reconsiders the use to which land where they cannot secure financing for the whole of the project or cannot secure anchor tenants’ the contractor finds the project will be unprofitable or too risky, or the project has been suspended for a significant period with no prospect of it being recommenced could be grounds to terminate “at will” or “for convenience”. This could in effect reduce the possibility of dispute or claim later and the termination would be in the long term interests of the parties.

Traditionally this form of provision has been less common than those permitting termination for default in some of the un-amended standard forms. Employers in New Engineering Contract (NEC) 3 and the majority of Public / Private Partnerships (Private Finance Initiative and Private Finance Initiative 2) (PFI & PFI2) do have these rights usually. However, contractors and consultants are rarely given the right to terminate for convenience.

 Precedent and Compensation with terminate “at will” clauses

In these matters the only way to fully determine if the termination was legal and lawful is by having it determined by the courts. The matter could be subject to Adjudication, however the losing party would in all likelihood not accept the finding if they were to suffer financial loss.

As Public / Private Partnerships are a concept that originated in Australia, historically the English courts have looked to the Australia system for guidance around  termination “at will” or “for convenience.” It has been established through case law that in the absence of sufficient wording, it will be a breach of contract to exercise a termination for convenience clause simply for the employer to obtain a better price to complete the works from another contractor. This would be consistent as in effect it’s a higher form of “subby bashing” if we take the view the Employer and Contractor as effective in a Sub Contract arrangement. Further it has been established that a contract may provide no express limitation on when, or in what circumstances, a termination for convenience clause can be operated.

To be effective, termination for convenience clauses need to provide for contractor compensation. Standard forms do contain these clauses and there is a precedent that where compensation is provided for in the contract in clear, unambiguous terms it will usually be enforceable.

The key phrase there is “clear wording” as this will be required before a termination for convenience clause can be fully effective. Unreasonable provisions, such as allowing the employer to pass work on to a third party, must be stated in clear, unambiguous terms otherwise they will be unenforceable.

The courts have also determined that the use of omissions clauses to tackle bad bargains cannot be used as an omissions clause to get out of what it now considers to be a bad bargain. It is further doubtful (although not tested) if this type of clause could be relied on exclusively by an employer to switch contractors in the event of dissatisfaction with the current contractor’s work.

Case law precedent warns us that even if the contract does contain an express provision dealing with termination for convenience trivial breaches may preclude termination and harsh objectives need clear wording otherwise termination will be seen as an intrusion on the contractor’s right to finish the work. It has further established that work transferred between contractors is questionable and an employer cannot use an omissions provision to get out of a bad bargain, and it is also doubtful it can be used if the employer is dissatisfied with a contractor’s performance a termination clause should provide for compensation to avoid being treated as unenforceable because it is unfair.

Suspension clauses

As stated at the outset there is a very close relationship between suspension and termination. Dependent on how the clause is drafted the end result of a suspension clause may be much the same as a termination clause in that either party will have the right to terminate the contract at the end of the agreed suspension period where the reason for suspension has not been removed

The issue is that when negotiating terms and conditions of a contract in an effect to ensure the termination clauses are consistent and adequately protect both parties, defined suspension terms tend to be overlooked.

Just as with termination clauses, suspension can take many forms and the onus is on what is agreed between the parties. It should be stated that the terms and mechanism for suspension should be well defined to ensure that this in itself does not result in a dispute.

One of the key reasons to suspend previously was for non-payment; this is now a statutory right with the changes in the Local Democracy, Economic Development and Construction Act [2009].

Broadly speaking the justification for suspension clauses will be similar to termination. Suspension could be a sensible mechanism for example to be used by one party where the scope and proposed outcome of a project has changed significantly but without the constraint to allow it to be developed. A suspension here for a mutually agreed timeframe would benefit both parties, if kept within certain boundaries. There could for example be agreement on a demobilisation and remobilisation cost during the suspension. This would be on the basis all parties have the desire to complete what was started, but just to a different scope. An example would be where historical artefacts are discovered that mean a proposed development has to have a significant re-design to allow for this. It would be far more sensible to suspend the works while the optioneering takes place that to let design to continue where it may only be subject to further re-design.

However it must be considered that conventional wisdom is that in the absence of an express contractual term it is difficult to argue that a general right to suspend exists in law as the courts have consistently refused to recognise such a right, save for the statutory provisions. This makes a defined suspension clause a sensible inclusion to benefit both parties.

When this clause is drafted however care needs to be taken to ensure that lifting the suspension is dealt with as well as the practical consequences of suspension and how long a contract can be suspended for before termination may occur

 

In conclusion as this is a complex and subjective area on contract law, where using these clauses you must proceed with caution. Where these clauses are going to be invoked you need to be absolutely clear that you strictly follow the contract’s notice and procedural requirements.