PFI EXPIRY Preparing for PFI expiry – Practical guidance for authorities

Georgia Lewis

Georgia is Senior Strategy Director at Local Partnerships. She joined Local Partnerships in July 2014, having trained and qualified into the Projects team at city law firm Nabarro LLP (now CMS). In private practice, Georgia specialised in advising local authorities and the private sector in a range of public private partnerships (including PFI) in the waste, education and housing/regeneration sectors.  Georgia recently set up and ran a PFI unit within central government and now oversees strategy for Local Partnerships’ PFI/PPP services and support to the public sector.

Georgia provides a comprehensive guide to dealing effectively with handback of PFI assets and stresses the need for early planning. “..as the number of expiring contracts continues to grow each year, it is vitally important that public authorities do not leave key decisions to the last minute.” 

Background and context 

As many readers will know, the ‘private finance initiative’ (PFI) programme was introduced in the 1990s as a means of delivering critical public infrastructure at pace and at scale. The programme covers wide-ranging sectors and was used to design, build and operate new (and/or refurbished) public assets such as hospitals, schools, prisons, waste facilities, libraries, courts and roads. Public sector organisations involved in procuring PFI contracts include the NHS, central government departments, waste authorities, and local councils. Key defining features of the PFI are the use of private sector debt and equity and the transfer of risk associated with asset design, build and operations to the private sector. 

In June 2020, the National Audit Office published a report “Managing PFI assets and services as contracts” (1) considering whether government is making appropriate preparations to manage the expiry of PFI contracts and including key recommendations. As at publication, there were over 700 operational PFI contracts in place in the UK with a capital value of £57bn. In the five years to 2024-25, an average of 10 contracts were set to expiry annually, increasing to an average of 31 contracts in each of the five years between 2025-26 and 2029-30. 

Key findings and risks highlighted in the report include: 

• where the public sector does not take a strategic or consistent approach to managing PFI contracts as they end, it risks failing to secure value for money during the expiry negotiations with the private sector 

• there is a risk of increased costs and service disruptions if authorities do not prepare for contract expiry adequately in advance 

• some authorities have insufficient knowledge about asset condition (increasing the risk that assets will be returned to the public sector in a worse quality than expected) 

• authorities recognise that contract expiry will be resource intensive and require unique skills and expect to fill gaps with consultants 

• a misalignment of investor and authority incentives at contract expiry creates potential for disputes 

• early PFI contracts are likely to contain significant ambiguity around the roles and responsibilities of the parties at contract expiry. 

Lessons have already been learned from expiries to date, including the need to prepare many years in advance of the expiry date. Best practice, as captured in guidance published in February 2022 by the Infrastructure and Projects Authority “Preparing for PFI contract expiry – Practical guidance for contracting authorities on managing expiry and service transition” (2), provides that PFI authorities should begin preparation for expiry at around seven years from expiry. Although this will vary (and longer and shorter timeframes may be appropriate taking into account the specifics of each project), this is not an unreasonable ball-park timeframe and as the number of expiring contracts continues to grow each year, it is vitally important that public authorities do not leave key decisions to the last minute [Ed – see previous article on CCS procurement, where the lotting structure reflects this PFI expiry challenge]. 

Contract expiry workstreams 

Dealing with contract expiry can be resource intensive and will certainly require more support than is currently being provided to the project. Even the best providers and authorities with excellent relationships will be confronted by myriad issues that will need to be addressed through the process. The resolution and timing of tackling these issues will require careful project planning. Contract expiry should be considered at an early stage – ideally well in advance of relevant contractual provisions – while maintaining a good level of control over current project delivery. Plans for an orderly handover should be developed, and a strategy put in place for what happens next, to ensure that contract expiry can be a success. To achieve this, PFI authorities should ensure three separate concurrent workstreams: 

1. managing the PFI contract on a day-to-day basis (to maximise efficiencies and achieve best value for money) 

2. preparing for expiry (to ensure a smooth handover of physical assets maintained to the contractually-stipulated standard, together with the orderly transfer of personnel involved in providing the services (where applicable), and other assets such as warranties and service records etc) 

3. considering the future of the assets after expiry (future service strategy). 

1. Managing the PFI contract on a day-to-day basis 

During the normal operation of the PFI contract, it is essential to ensure proper contract management. This requires a thorough understanding of the PFI contract including (for example) rights of audit and inspection and to information about the services. The contract will include a detailed payment and performance mechanism which allows for deductions from the annual charge to be made for specified failures. It is essential that terms are understood and appropriately enforced. 

PFI contracts are performed on a ‘self-reporting’ basis whereby the PFI contractor essentially monitors and reports its own performance to the authority. It is essential that authorities monitor closely all reporting activities, first to check that reporting itself is in accordance with contractual requirements and second, to ensure that the details reported are accurate and that any failures are being addressed in accordance with the contract (through deductions or otherwise). This requires that authorities have a thorough understanding of the rights and obligations of both parties and can resource all activities involved in proper oversight. Although there will necessarily be a focus on the payment and performance mechanism, authorities will also need to understand and ensure the proper implementation of provisions relating to lifecycle planning, scheduled maintenance, reactive repairs and value testing (benchmarking and/or market testing). 

To avoid disputes, an early understanding of the true condition of the asset needs to be established well before it is due to be handed back. This is particularly important if the handback processes are not clearly defined or are ambiguous. 

Ensuring an effective ‘business as usual’ workstream will therefore likely require that authorities consider any number of the following: 

• bespoke training on effective contract management (including proper oversight and monitoring of the contractor’s self-reporting activities) 

• bespoke training on key contractual provisions (and where necessary development of a user-friendly contract guide for use by the contract management team) 

• opportunities for cost savings including regular benchmarking and market-testing (in accordance with the contract) 

• early resolution of performance issues 

• any opportunities for refinancing gain 

• discussion, agreement and implementation of contract variations to ensure the contract remains current and effective (in particular with expiry and future service provision in mind). 

2. Preparing for expiry 

The first exercise that the public authority will have to undertake is to review contractual provisions relating to expiry, including handback. The detail and quality of relevant provisions will vary from contract to contract and in some cases, detail will be sparce, absent and/or buried in neglected contract schedules. All relevant information will need to be drawn together and analysed (including identifying gaps) and a clear guidance document should be developed. Where gaps or ambiguities are identified, authorities may need to consider specialist support and advice in order to develop a robust and fair strategy for addressing this with the PFI counterparty to agree suitable terms at an early stage. Questions will include: 

• does the asset automatically revert to the authority after expiry or are there contractual steps that must be followed? 

• is the expiry date clear and are there any permitted extensions (and if so, how will the authority decide if/when it would trigger any such extension and ensure the PFI contractor does not gain any tactical advantage in related discussions)? 

• are there requirements for the PFI contractor to develop an asset list or exit plan (with associated timeframes)? 

• what is required by way of final surveys (including parties’ respective roles and responsibilities) and how are deficiencies in asset condition rectified and paid for? 

• how and when to engage with authority-related parties (some of whom may not have been involved at contract commencement, eg academy trusts where schools have converted during the contract term)? 

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It is important to recognise the leverage that the authority has in terms of negotiating with the PFI contractor. Authorities will be in a much stronger position when they still have recourse to the project lenders. It is also important to establish when the debt is likely to be repaid and the processes for contacting lenders directly which, in some cases, may be contractually restricted. This will be important if, for example, the authority wants to access lifecycle funds. 

PFI authorities will therefore need to consider: 

• preparation of bespoke contract guidance clarifying the expiry process and contractual rights 

• preparation of a detailed timeline of actions up to expiry including clear apportionment of roles and responsibilities between the parties 

• an understanding of lessons learned on similar projects 

• the need for any specific asset valuation(s) 

• contractual rights and practical steps in relation to asset condition surveys (including as to the appointment of suitable surveyors) 

• implementation of the expiry processes 

• preparation of a handback protocol and deed of expiry 

• preparation for staff transfers including any necessary consideration of TUPE (3) and pensions-related issues 

• development of an expiry project plan and associated risk register. 

In order to make a success of the preparation period and get ready for decisions around project expiry, the authority must ensure proper governance and resourcing is in place. It will also need to establish budgetary consequences for handback, acquisition or residual payments, and the costs of maintaining and operating the asset. Authorities will also need to begin the process of commissioning options appraisals for future service requirements post expiry (see further below). 

3. Considering the future of the assets after expiry 

One of the most important decisions that needs to be taken is whether the public authority intends to continue to use and operate the assets, or otherwise to vacate and dispose of them. If the former, the authority will need to consider whether it wants to carry out a wholesale re-procurement of the project (largely unaltered or with necessary changes to reflect its future service requirements) or to disaggregate or otherwise reorganise the services going forwards (through outsourcing or insourcing or a combination of the two). Within this decision-making process, it will be necessary to consider the benefits or otherwise of any permissible extension of existing arrangements. 

Where the authority has decided to cease provision of the services, consideration of the future for the assets will require a full appraisal of all options available. If the ownership of the assets does not revert automatically to the public authority, it is important to understand the options available under the contract and the financial implications, including the cost of terminating leases or acquisition of the assets. Options may also include alternative uses of the assets which may create different revenue and expenditure opportunities and risks. 

The authority will therefore need to undertake: 

• early preparation of options’ appraisals and comprehensive future service strategy 

• preparation of business cases and internal reports 

• procurement of new project or replacement contracts (as applicable) 

• planning for any ongoing services to be carried out in house (as applicable) 

• assurance reviews and health checks to make sure the future service strategy is on track and will deliver successfully on time and to budget. 

Again, suitable governance and resourcing for this workstream is essential to ensure senior buy-in and robust risk management and decision-making. This will include the identification of, and early engagement with, all necessary stakeholders from across the organisation to ensure a coherent approach which is fully aligned with the authority’s wider strategic objectives and priorities. 

References 

1. https://www.nao.org.uk/reports/managing-pfi-assets-and-services-as-contracts-end/?nab=2 

2. https://www.gov.uk/government/publications/preparing-for-pfi-contract-expiry 

3. Transfer of Undertakings (Protection of Employment) Regulations 2006.