PFI Contracts – Should poor value/performance allow you to terminate early?

By Allan Watton on

Poor Customer Service Evaluation FormTwo weeks before the 2015 general election, David Cameron visited Halifax to assure residents that the A&E department of the embattled Calderdale Royal Hospital would not face closure. “After the election we want to do what we’ve done with other hospitals, which is sort out the PFI mess and financial mess that they’re in,” he pledged.

Calderdale Royal Hospital is one of the UK’s first PFI hospitals, a distinction that at first glance seems to have proven costly for the Calderdale and Huddersfield NHS Foundation Trust (CHFT). The figures being reported are to the tune of £773.2m for a building that cost £64.6m to construct, plus its maintenance and running costs over the term.

The consequent ‘casualty’ it seems is its A&E department, as the Trust looks to make savings where it can. Cameron opted out of specifying exactly how he’d help the hospital salvage what he perceived to be its low value PFI contract, mirroring most of his opponents’ vagueness on PFIs. UKIP was an exception – in its manifesto it called for PFIs to be abolished while local authorities would be encouraged to buy out their PFI contracts early, if it’s affordable to do so.

That last caveat is the sticking point. Is early termination of your PFI contract really a viable option? What if you are receiving poor value? Is there a way to legitimately get better value or if not, to extract yourself as a result of poor value – but minimising or eliminating excessive costs in the process?

Calderdale Royal Hospital’s PFI contract is for 60 years, with repayment due by 2031/32 (30 years after it opened its doors to patients), at which point a break clause – and the associated early termination fees due – can be exercised. CHFT is by no means alone, but the situation highlights why PFI contracts require extra deftness in handling.

Always thoroughly review whether your poor relationship can be repaired

As we have mentioned in numerous articles, the early termination of an outsourcing/PFI relationship may carry with it significant costs, both monetarily and in terms of the time and effort needed to see it through, not to mention potential blows to one or both parties’ reputations. In a PFI partnership, these factors can be intensified, and an exit should be considered only after all other alternatives have been explored.

Effective communication, through both the good times and the bad times, is what drives a healthy strategic partnership. It’s what keeps both sides focused on their mutual goal, and gives each a clear view of the other’s desired outcomes and perspectives. If vendor performance or value is poor, getting objective evidence of the cause and then addressing how that evidence points you on the road to driving better value can help you avoid more drastic and potentially unnecessary measures. Similarly, if your organisational objectives have been reprioritised, realignment with your service provider may still be possible.

A well-resourced ICF (Intelligent Client Function) team are your front line here. Ensure that you have the right people in the right jobs with the right skills and authority to do what it takes for the good of the relationship and you are on the right road to success. Don’t, and you may find yourself flying blind. The skills you need to balance in your ICF team to drive maximum value in these complex relationships were the subject of a recent blog that you can read about here .

Evaluating an early exit? Address the financial challenges…

Due to the perceived costs involved in exiting PFI contracts, specific due diligence needs to be addressed as to whether the exit is for ‘convenience’ or for persistent default (breach of contract) or poor value.

In the case of exiting for convenience, the Government would no doubt need to support any such move at a local level because of the termination costs involved. Though whether the long-term benefits achievable from such an investment will win out over the expense in austerity-led Britain is yet to be seen. Theoretically, with adequate funds in place, one could opt for a buyout, though the actual costs will be down to a combination of what you are committed to in your PFI contract and what you can negotiate with your strategic partner.

Few written contracts are free from ambiguity in their ‘early termination’ clauses, and this is a fact that both clients and suppliers sometimes look to exploit to their own advantage. Realistically, not only will the price tag attached to an early exit be high, but a drawn-out negotiation is likely in ‘convenience’ terminations, as it is often the case that both sides will wish to be seen to have discharged their responsibilities during the course of the relationship.

Terminating for poor performance? How the process differs…

If you are terminating early because of quantifiable poor performance and/or poor value – especially if you’ve made every reasonable effort to set things straight and clear instructions had initially been communicated and documented – you will often have a much clearer route to exit, providing your evidence has been evaluated in the right manner. This has also be the subject of another article we’ve written that you can find here .

Usually, there will be a provision in the contract outlining how to calculate early exit fees if the partnership’s dissolution can be attributed to consistently poor service from the provider. Meanwhile, having evaluated the evidence you have, if it proves poor value/poor performance from your partner, then this will provide significant leverage to negotiate an exit at little or no cost due to the performance/value issues being experienced.

10 key questions to consider before deciding whether an early exit from your PFI contract is the best solution

For all our best intentions, not all contracts are destined to live out their anticipated lifetime, as there are many times when both sides are simply unable to realign project objectives, or when, despite one’s best efforts, consistently poor service delivery threatens the ultimate point of a strong PFI partnership – to provide public value for money.

In these circumstances, when all attempts at value and performance improvement have not been able to get enough traction, then the best path forward is to evaluate the business case for an early termination. The steps you take during this evaluation in preparing and negotiating your exit will determine whether taxpayers benefit or lose out from the process.

These 10 questions will help you examine whether you should be considering an early exit, as well as whether you have assessed key aspects of the appropriate evidence to determine whether you’re ready to proceed with the next steps:

  1. Are we terminating because of poor vendor performance or because our organisational objectives have changed?Have we exhausted all other options?
  2. Will the termination fees be affordable and how can they be minimised?
  3. What evidence do we have to support our case – from a supplier’s expert representations, to their fulfilment of them and their contractual obligations alongside all clear documentation presenting outcome expectations?
  4. Will exiting the relationship improve public value for money?
  5. Do we have the resources and capability to provide the same service post-termination?
  6. If not, are we able to transfer the service to another supplier, and do we have the resources to manage the transition – particularly through any EU-regulated procurement process?
  7. Do we have the resources and capability to successfully negotiate a public value for money outcome?
  8. How will this affect our reputation and future relationships with the present and other vendors?
  9. Are we aiming to sever all ties with the supplier or just exit certain services, and if the latter, will we still be able to maintain a strong and innovative working relationship with our partner?
  10. Having explored these questions, the final and inevitable thing to ask is: can the Government help? In order for trusts and local authorities to be able to make the best of misaligned PFI contracts, they need to be given the right tools and resources, from access to expert advice and easily accessible information to funding in the event of an early exit for convenience.

With more of the same in Parliament, where does that leave the future of PFI contracts?

At present, there is no real central support mechanism for local authorities and trusts who find termination to be the best, or even only solution to remedying a low value PFI contract. And in spite of the Prime Minister’s assurances while on the campaign trail, PFI cases like that of Calderdale Royal Hospital do need to be resolved sooner rather than later, lest more than its A&E be at risk due to funding reductions.

Hexham General Hospital, another one of the PFI firsts, has shown that it’s possible to turn around a crippling situation with a carefully negotiated buyout. During a debate in the House of Commons on 21st October 2014, Daniel Poulter, the Parliamentary Under Secretary of State for Health, acknowledged as much, stating: “[Hexham General Hospital] has seen that the way forward is to buyout the PFI and free up more money for front-line patient care. We will support as many more hospitals in doing that as can be achieved, because this is about making sure that we deliver more money for NHS patients.”

Ensuring that such a promise holds true will be the task of the Conservative majority when Parliament starts this month. Otherwise, one option put forward is the introduction of a social investment fund in the same vein as the Enterprise Investment Scheme, which would enable the public to invest directly in a PFI project for a fixed return.

Such a fund could also be used to support early contract terminations in the right circumstances, refinance projects, and serve to replace private sector debt, allowing clients more flexibility to change project objectives or service levels, make cost reductions, or find new ways of increasing value. We at BPG are keen to progress looking at these more innovative options providing they can increase public value for money.

With David Cameron returning to 10 Downing Street, we are unsure how much change to expect when it comes to public policy on PFI contracts. But one way or another, we believe that the effect of PFIs on the public purse will wiggle its way onto the agenda. We hope that with the right leadership and guidance, the Government will endeavour to foster PFI relationships that can benefit vendors and communities alike, even if that means having to completely re-evaluate the structure of the relationship for some.

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