PFI/PPP Disputes - Part 1

Foreword

It is now over 13 years since the first public finance

initiative/public private partnership ("PFI/PPP")

projects were completed in the UK and there were, as at the end of

2008, some 935 PFI/PPP projects worth over £66 billion. The

number of projects and the time over which they have been operating

enable some assessment to be made of where problems are emerging or

are likely to emerge and what the nature of those problems is

likely to be.

The market has changed between 2008 and 2009 as the UK and

global economies have declined. The "credit crunch",

i.e. the sharp reduction in bank lending as a result of

banks' substantial losses, has had the obvious effect on PFI

projects of a decline in bank lending to the private sector. This

has led to the government in the UK providing funding for projects

for which private finance is no longer available, so that,

paradoxically, "private finance initiative" projects may

proceed without or with reduced private finance. There has also

been a reduction in new PFI/PPP projects. Nevertheless, there still

exists a substantial PFI/PPP market in the UK.

In a typical PFI/PPP project, the head contract is an agreement

between an organ of government ("the Authority") and a

consortium whose task it is to design, build and operate the

project. This consortium will typically consist of a funder, a

construction company and a facilities management company, often in

the form of a limited company special purpose vehicle formed solely

for the purpose of the project ("SPV"). The SPV will

itself have a contract regulating the relationship between its

members (a shareholders' agreement). The SPV will enter into

various sub-contracts for the performance of the project, usually

including a sub-contract with its contractor member for the

construction of the project (and often also for the design of it)

and its facilities management ("FM") provider member for

provision of management services for the duration of the project,

often 25-35 years. These SPV member subcontractors will in turn

enter into sub-sub-contracts for various aspects of the performance

of the project.

Outside this vertical structure, there will be commercial

bankers providing funding of the project to the SPV. The SPV

absorbs the costs of bidding for and winning the project and

designing and constructing it. The SPV then receives fixed payments

(the "Unitary Charge", which is subject to some

adjustment in some circumstances) for the duration of the project

(say 30 years). These payments cover all the bidding costs, capital

costs, operating costs, financing costs and the profits of the SPV

members.

The typical structure described in Figure 1 is not always

applicable and different structures will give rise to different

relationships between the parties to the project. Figure 1 shows

the typical model as described above and also by way of comparison

Figure 2 shows the model for the M6 toll road, a UK project

discussed further below.

All of these contractual relationships, like any other, may give

rise to disputes. That is not to say that PFI/PPP projects are

particularly prone to disputes nor that other methods of

procurement are immune from disputes. To date, PFI/PPP projects

have not been dispute-ridden, nor is it anticipated that they will

be in the future. However, disputes can and do arise and the

entities involved will require a contractual framework best suited

to the management and avoidance of those disputes.

General introductory matters

Different types of dispute, possible future trends, the normal

contractual provisions for dealing with them and means of avoiding

or managing these disputes are considered below.

It has been convenient to use acronyms, abbreviations and words

with a defined meaning (identifiable by the use of a capital

letter), a list of which appears at the end.

Space has not permitted a detailed discussion of the

shareholders' agreement, regulating the relationship between

members of the SPV. Careful consideration should be given here to

clear risk allocation and, when it comes to dispute resolution, a

tiered system such as is discussed below in relation to the head

contract may also be considered. The issue of conflict of interest

where the same individuals are board members of the SPV and another

company involved in the project, e.g. the contractor or FM

provider, is considered below. General market factors tending

against disputes and factors which may lead to disputes are

considered below.

By way of background to the more detailed discussion which

follows, some introductory explanation of common types of dispute

resolution in PFI/PPP-related contracts, covering their main

features is then set out. There is then a consideration of the

normal dispute resolution provisions in PFI/PPP head contracts, by

reference to the current Treasury standard form, SOPC4, and also to

the Centre for Effective Dispute Resolution ("CEDR")

dispute resolution procedure for PFI and long-term contracts.

After considering these agreements, the writer proceeds to

consider disputerelated issues concerning sub-contracts entered

into by the SPV, including equivalent project relief

("EPR") provisions. The following topics, which are

identified as potential areas for PFI/PPP disputes, are also

discussed below: SPV or contractor/FM provider sub-contracts with

consultants; conflict of interest for directors of the SPV and its

sub-contractors; "interface" agreements (defined below);

bid costs; public procurement issues; and benchmarking and market

testing. The writers conclude with some guidance on areas of

caution and dispute avoidance for the various participants in

PFI/PPP projects.

Features tending against disputes

Disputes between the Authority and the SPV are unusual; the

March 2006 Treasury report recorded that the dispute resolution

procedure has been invoked on few projects, attributing this to

"the fact that relations are strong enough to be able to

resolve issues without normally needing to resort to dispute

resolution." With a typical duration of 30 years, a PFI/PPP

project promotes long-term relationships. Similarly, the SPV

participants have a long-term commonality of interest and are

unlikely to have disputes between themselves.

Because the SPV's funding is provided by bankers who have a

close interest in the proper planning of the project and its

contractual documentation, PFI/PPP projects are typically the

subject of a high degree of design work prior to the construction

phase, high quality budgeting, careful analysis and costing of risk

and detailed and thoroughly considered contractual obligations.

These are factors tending against disputes at the construction

phase, which on traditional procurement has been a fertile area for

contractors' and subcontractors' claims.

Broadly speaking, PFI/PPP projects can be broken down into three

phases: the procurement phase, the construction phase and the

operation and maintenance phase. The construction phase is

traditionally in particular a likely source of disputes. Time and

cost over-runs are some of the most common sources of dispute in

conventionally procured construction projects.

In 2003, a UK National Audit Office ("NAO") Report

found that the percentage of projects where the cost to the public

sector exceeded the price agreed at contract had reduced from 73

per cent (under traditional methods of procurement) down to 22 per

cent under PFI/PPP project procurement. Similarly, the number of

construction projects delivered late to the public sector had

reduced from 70% (pre PFI/PPP) to 24% under PFI/PPP. Whilst no

official statistics have been produced since 2003, unofficial

statistics published on the Building Magazine website indicate that

as at the end of 2008, the number of projects delivered late has

decreased further to 20%.

This does not mean that PFI/PPP projects are delivered at a

lower cost or more quickly than traditionally procured projects,

but it indicates more accurate pricing and programming at the

outset and, therefore, less likelihood of disputes.

Disputes over contractor final accounts, for example, are

uncommon with PFI projects. This is partly as a result of

provisions in PFI/PPP construction contracts which typically

restrict building contractor delay compensation and time relief to

what are described as "compensation events", "relief

events" or "force majeure". These events are

normally much more narrowly defined (and may exclude time and money

and/or relief from liquidated damages) than traditional

"relevant events" and "loss and expense" claims

under the common standard form construction contracts.

One of the reasons for this is the commercial pressure applied

to contractors and the SPV by the banks and lenders through the

security package. PFI/PPP projects also call for construction

requirements to be specified at an early stage in the project which

minimises the prospect of a work scope change during the

construction period - an event that often creates disputes with

conventional procurement. Furthermore, the influence of private

finance (the banks and investors) results in a more rigorous

specification and costing of the construction phase, pre-contract.

Additionally, the construction contractor will frequently be a

shareholder in the SPV and will thus have a direct interest in

ensuring that the construction phase is completed on time and to

budget.

It should be borne in mind that profit margins have been

considerably higher for the construction phase with PFI/PPP

projects than with traditional procurement. Two per cent is a

normal profit margin with traditional procurement, whereas six to

eight per cent has been normal for PFI/PPP projects. The thin

margins in traditional procurement have led to a claimsorientated

industry whereas conversely dispute avoidance is easier where

profit margins are more generous.

The fact that long-term relationships are established by PFI/PPP

projects (typically for 25-35 years) and that the...