Our focus is on operational PFI Contracts: How to get the most from partner changes. With most PFI contracts having an average lifespan of 20 to 30 years, it is inevitable that some of the parties will change during that period. And if you are not ready for such a change, the impact of a change to your partner will inevitably be far higher and more likely to be negative than if you are well prepared. Questions to consider include – How will this change affect you and will you be ready to react? Will you maximise the benefits this opportunity creates or suffer the negative consequences of poor preparation?
Recent examples of such change include Balfour Beatty, John Laing, DfE and Dexia selling off contracts, projects, divisions or their entire business for reasons as varied as profit, liquidity and security.
PFI Contracts: Three Impacts of Partner Change in Operational PFIs
This article is separated into the following three ‘Impacts of Change’ sections which relate to a variety of situations, where having the right prior knowledge could mean the difference between success and failure. Choose the one that best fits your situation or worries for the future, then see our advice for steering the recommended course through those particular stormy waters.
Please click on the links below to go straight to the relevant section(s):
Section One Impact of the building contractor selling its equity share and stepping down from the SPV board
Section Two Impact of a change of FM provider or FM contractor selling their equity share
Section Three Impact of changing senior funders (banks) or other equity providers (SPV management companies)
Section One: Impact of the building contractor selling its equity share and stepping down from the SPV board
This is undoubtedly the most common change to the PFI management structure of operational PFI contracts, and therefore one that requires serious consideration from the outset. Recent examples include Balfour Beatty’s sale of their PFI contracts and the imminent sale of John Laing.
The most common reasons for such a sale are:
- Profit: Construction companies can reap multi-million pound profits from the sale of their stake in completed projects because, once completed on time, on budget and without any major threat of snag/latent defect claims from the client, these assets are very attractive to equity investors.
- Cash flow: Construction companies often need cash flow to progress to their next project, and the sale of their stake in a completed structure can provide the necessary liquidity in abundance.
- Responsibility: Or rather an avoidance of responsibility, as by selling their share, they can effectively remove themselves from any inherent and ongoing issues with the buildings they built, unless a formal legal process is invoked.
To achieve the maximum possible benefit from their position, construction companies tend to sell off their equity share soon after completion of the bulk of the building works on a contract.
Pros of a construction contractor selling its equity share
1. Impartial approach to latent defects and building snags by the SPV: With the construction contractor no longer having a stake in the SPV, it is much easier for the management company to hold them to account, as there is no conflict of interest in getting the construction company to deliver or pay for any remedial works required.
2. Impartial control of FM provider: Where the FM contractor is a subsidiary of the construction company, such a relationship often results in both companies ‘having each other’s back’ when building defects or poor service performance are suggested. With the construction company out of the equation and deductions passed down to the FM contractor, the SPV can adopt a wholly impartial approach to the enforcement of availability and performance deductions, up to a certain level (i.e. up to a limit triggering contract default), as improved FM service saves them time and money on managing the contract.
Cons of a construction contractor selling its equity share and how to mitigate them
1. Lack of continuity: Diminished contractor-side knowledge on the ‘how, what and why’ associated with provided assets and implementation-stage changes can often lead to inefficient use of systems provided (such as Building Management Systems in utility usage control). At the same time, issues with building design and subsequent changes to it, which may have been agreed during construction, are likely to fester and escalate because the parties who made the agreement are no longer part of the PFI equation.
How to mitigate:
- Keep a detailed construction-stage change-control register, for the duration of the contract.
- Ensure that the provision of an operations manual for the assets is one of the conditions for works completion sign-off, and insist that you receive both hard and electronic copies.
- Insist that the SPV and its contractors produce and provide, in a timely manner, minutes of all client meetings, monthly reports, annual plans, change-control registers and so forth.
- Ensure that all client-side parties record all issues on the helpdesk system, not by personal approach to caretakers/contractors. This will provide an audit trail for any building defects, such as faulty doors/taps, and will make it easier to get the contractor back to replace/repair them at their expense.
2. Any disputes regarding provided assets are likely to be more formal and protracted: After the sale the construction contractor no longer has any incentive to deal with remaining snags and latent defects. As the client no longer has a direct contractual relationship with the construction company, they have to rely on the SPV to manage such issues. The SPV will have little incentive to address these issues, unless they have a real impact on the value of the asset (i.e. massive crack in external wall à escalation guaranteed; offices overheat in the summer and freezing in winter à can wait).
How to mitigate:
- Escalate any major issues quickly and formally with the SPV.
- Enforce availability and performance penalties for any snags/ latent defects which haven’t been picked up as part of sign‑off.
In summary
Although destabilising and stressful for both clients and local contractor staff, changes to PFI partners can also be seen as an opportunity for service improvement and as a driver for positive change.
By gaining a good understanding of the reasons for the sale and their impact on every area of the PFI contract, client teams are much more likely to reduce the negative impact of such changes and to be able to harness their potential for service improvement.
To discover more about how change to other PFI parties could affect your contract, click either of the following links Section Two or Section Three
To arrange for an informal meeting, free of charge and without obligation, to discuss how you can leverage any of the above recommendations, please do not hesitate to contact one of our specialist advisors.
Section Two: Impact of a change of FM provider or FM contractor selling their equity share
Such a change to the FM provider can occur in a number of scenarios:
- If the FM provider is part of the construction consortium, they may decide to pull out of FM provision at the same time as selling their equity share.
- The construction partner may decide to offload their FM subsidiary to another company, as exemplified recently by Balfour Beatty selling its UK FM arm.
- If the FM company is a standalone provider and/or equity partner in the SPV, they may decide to sell their equity share, or to sell all or part of their PFI portfolio, to raise capital or reduce exposure to PFI-related risks (availability and performance deductions).
The pros and cons described below apply to all of these scenarios, unless specifically indicated otherwise.
Pros of changing FM contractor
1. Good time to resolve long-outstanding performance issues/variations related work: The new contractor is likely to bring in their own managers, which would remove the security net of existing relationships from the remaining staff, and any personal animosity which may have led to stand-offs on ‘in principle’ issues. This makes the timing right for the client to put on the table any long-outstanding disputes, ‘stuck’ variations and staff performance concerns. The new provider is likely to be keen to make a good impression at this early stage, in order to establish a productive working relationship with the client from the outset, as well as to limit the risk of performance and availability deductions going forward.
2. FM provider that once sat on the PFI board becoming a sub-contractor, allows the SPV to be far more impartial in enforcement of deductions, which will now be fully passed to the FM provider without risk to the funders: They will also be more likely to enforce such penalties up to a certain level (i.e. up to a limit triggering contract default), as the likely improvement in FM service, following increase in deductions, will save them time and money on managing the contract.
Cons of changing FM contractor and how to mitigate them
1. Lack of continuity: As with the departure of a construction partner, replacing a FM contractor may lead to loss of knowledge relating to local issues, particularly if the FM managers involved are not transferred to the new provider.
How to mitigate:
- Insist that all sites keep full maintenance and life-cycle records, as well as records of local meetings and change-control forms.
- Ensure that all client-side parties record all issues on the helpdesk system, not by personal approach to caretakers/contractors. This will enable the new contractor to be prepared for the workload and type of issues they are likely to face and to ‘hit the ground running’ on handover.
2. Destabilising for local FM staff: A change of employer, and in some cases, management structure, often leads to good staff leaving or being poached by the original provider, particularly if the new provider decides to embark on a wholesale restructuring programme.
How to mitigate:
- Establish a good working relationship with the local contractor team and provide regular support for, and positive feedback on, the best performing staff to incentivise them to stay.
- Arrange a meeting between the new provider and SPV directors, as soon as possible after the handover and emphasise the importance of retaining the named best-performing staff to ensure efficient service provision, client satisfaction and low penalty payments.
3. Formalisation of established informal arrangements: If the FM contractor changes some years into the operational period, it is likely that the contractor staff will have developed a whole raft of local practices and workarounds as part of their service delivery. This is often over and above the requirements of original contract, either as a favour to clients or to make the management and operation of services easier/more efficient. It is very likely that with a change of FM provider, at least initially, these will be curtailed, with the FM staff instructed to ‘stick to the contract’, while the new provider seeks to reduce penalty risk and optimise profits from the newly acquired contract.
How to mitigate:
- Ensure that key informal arrangements are documented, with sign‑off from the SPV, making it easier to insist on keeping them.
- Arrange a meeting with the FM manager as soon as possible after the transition to new provider, to review any such arrangements, emphasising the benefit to them of maintaining these informal practices. Time and cost savings associated with such arrangements are likely to keep clients happy and more inclined to overlook other less critical contractual responsibilities. At the same time, keeping them informal makes it possible to adapt them to changing circumstances without incurring hefty legal fees for formalising and amending them in the contract.
- If all else fails and the process is critical/important to client, instigate a change notice to include such provision formally in the contract.
In summary
Although destabilising and stressful for both clients and local contractor staff, changes to PFI partners can also be seen as an opportunity for service improvement and as a driver for positive change.
By gaining a good understanding of the reasons for the sale and their impact on every area of the PFI contract, client teams are much more likely to reduce the negative impact of such changes and to be able to harness their potential for service improvement.
To discover more about how change to other PFI parties could affect your contract, click the final link to read Section Three or go back to Section One
To arrange for an informal meeting, free of charge and without obligation, to discuss how you can leverage any of the above recommendations, please do not hesitate to contact one of our specialist advisors.
Section Three: Impact of changing senior funders (banks) or other equity providers (SPV management companies)
Although less frequent, external political and economic factors can result in either the lead equity partners of the senior funders selling their share in the PFI project (recent examples include the cancellation of the Building Schools for the Future (BSF) programme leading to DfE selling their stake in delivered projects (BSFI) to private equity firms, and Dexia (a major senior funder investor in PFIs) seeking to sell their PFI shares due to their financial woes following the 2008 credit crunch). Although less noticeable from the outset than the other two scenarios described above, such change can have a major impact on operational PFI contracts, as detailed below.
Pros of a change to the senior lender/equity partner
1. This offers a good opportunity to get the SPV to re-negotiate the senior funders’ role in variation approvals: i.e. approval only for variations above a set threshold; funder-appointed technical/legal consultancy required only for major variations, etc.
2. Sale of equity shares to a majority equity shareholder or new investors (e.g. the sale of BSF Partnership for Schools investment arm’s shares to investment firms such as Amber Investments): This may lead to a more proactive approach to the management of the PFI contract from previously ‘silent’ partners.
Cons of a change to the senior lender/equity partner and how to mitigate them
Note: These will apply to the period between the funder announcing its intention to sell its share and the actual sale taking place, although, depending on the new provider, these can continue after the sale.
1. Any major variation approvals are likely to get stuck: The selling organisation would want to reduce the level of passed-on risk, inherent in any construction work, to make the assets more attractive for potential buyers.
How to mitigate:
- Have robust change-control governance in place to ensure that any delays are quickly identified and escalated.
- If there are consistent delays on a multitude of variations, invoke the ‘persistent breach’ provision in the contract.
2. Funder PFI staff likely to be destabilised and cut to the core: As the seller strives to reduce its PFI-related operational costs, this is likely to further increase response times and reduce the rate of approvals for major variations.
How to mitigate: see previous section.
3. Funder-related costs for variations are likely to increase: The funder will wish to maximise its income from the contract at this stage, while no longer being overly concerned about reputational damage as a result of unreasonable charges.
How to mitigate:
- Ask for a breakdown of the variation fee, as well as the rationale and assumptions behind them.
- If the client side have in-house resources to deal with the variation-related work (legal drafting, etc.) suggest the advantages of taking over such tasks.
- Do a search on any existing/pending public sector projects the funder is involved in and get in touch with them, or threaten to do so, to form a client group that can jointly resist unreasonable charges more effectively.
In summary
Although destabilising and stressful for both clients and local contractor staff, changes to PFI partners can also be seen as an opportunity for service improvement and as a driver for positive change.
By gaining a good understanding of the reasons for the sale and their impact on every area of the PFI contract, client teams are much more likely to reduce the negative impact of such changes and to be able to harness their potential for service improvement.
To arrange for an informal meeting, free of charge and without obligation, to discuss how you can leverage any of the above recommendations, please do not hesitate to contact one of our specialist advisors.
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