Over a third of public bodies expect formal disputes with the private sector when PFI contracts end

Over a third of public bodies expect formal disputes with the private sector when PFI contracts end

By Simon Reason, director of the treasury, National Audit Office

Over a third of public bodies expect formal disputes with the private sector when PFI contracts end

From 2025 onwards, the bulk of private finance initiatives (PFI) will expire, resulting in infrastructure assets with a total capital value of £3.9bn returning to public sector ownership. The NAO’s latest report on managing the expiry of PFI finds that public authorities risk these assets being returned in an unsatisfactory condition and facing additional costs for repair and maintenance.

The government announced in 2018 that it would no longer be using the PFI model for new infrastructure investment, but for decades these contracts have been used to set out a long-term agreement between the private and public sector to deliver infrastructure such as roads, hospitals and schools – there are currently over 700 PFI contracts in the UK.

Our report drew on our survey of the public authorities managing PFI contracts, who are largely local bodies such as NHS trusts and local authorities. The results show that authorities face challenges understanding the condition of assets and more than a third expect formal disputes when contracts end.

Although it is the responsibility of special purpose vehicles (SPV) – private finance companies set up to finance, build and operate PFI assets over the contract term – to maintain the assets and report to the authority, the authority still needs to monitor assets during the contract.

Typically, an authority will have access to a financial model outlining all the forecast maintenance expenditure across the life of the contract. In addition, an SPV will usually provide the authority with an annual maintenance plan, which is the case in 70% of the contracts in our survey.

However, these maintenance plans are not always supported with detailed expenditure data. Instead, authorities must rely on information contained in the SPV’s financial statements, which do not always provide enough detail on maintenance expenditure. Around 55 percent of survey respondents recognise they need more knowledge of assets’ condition.

In addition, many PFI contracts contain limitations over what information authorities can request from the SPV. Around 35 percent of survey respondents said they had insufficient access rights to monitor asset maintenance, and there is evidence that PFI investors and sub-contractors are not cooperating with authorities to provide information – a fifth of authorities that asked for information said requests were ignored or denied.

The SPV will usually build-up a dedicated fund, known as a sinking or lifecycle fund, to ensure there is enough money to fund planned maintenance. Each time an authority makes a usage payment, a proportion is set aside specifically to fund future maintenance. The SPV bears the risk of the lifecycle fund being insufficient to meet any replacement obligations, however, the SPV can keep any surpluses with the intention that this encourages efficiency.

This gives SPVs an incentive to make sure assets are well maintained; if fewer unplanned replacements are required, there will be a larger surplus in the lifecycle fund at expiry which can be paid out to investors. However, there is also a perverse incentive for SPVs to underinvest in assets – some authorities raised concerns that SPVs are ‘sweating’ the assets and making them last longer than originally planned, in order to increase investor returns.

Once a contract has expired the SPV company will be closed. This means it may be difficult for the public sector to recover any payments from the SPV post-expiry, making it more important for authorities to resolve any disputes or recover any money owed before contracts expire.

There is still time for government departments and authorities to address these challenges and avoid the cost of formal disputes, and additional repairs and maintenance when contracts end. Early preparations, and a collaborative approach between public and private stakeholders, can help to ensure a successful exit from PFI agreements.

We recommend that government departments should encourage authorities to prepare for expiry as early as possible and develop a contract expiry plan that identifies all the critical tasks and obstacles. Departments and the Infrastructure and Projects Authority (IPA) should help build sector specific expertise, and a range of tools, including specialist advice and guidance documents for authorities to use.

In addition, the IPA should assess the value to taxpayers of providing authorities with access to a centralised pool of internal resources, such as lawyers and surveyors, during negotiations. It should also develop a consistent approach to resolving legal disputes, and an investor strategy which manages the relationship with private sector stakeholders across all PFI contracts. Where necessary, departments should provide direct financial support to authorities to help fund dispute resolutions and hire additional staff.

Simon Reason is the Director for the Treasury at the National Audit Office. He oversaw the NAO’s report on managing PFI services and assets as contracts end

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