Bringing PFI contracts ‘back in-house’

The shadow chancellor recently pledged that Labour would bring existing private finance initiative (PFI) contracts ‘back in-house’ if they are elected. Philip Vernon, partner at Ashurst, explains the proposals and their potential implications.

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What are Labour’s proposals in relation to PFI contracts?

The shadow chancellor, John McDonnell, announced in a speech at the Labour Party conference in Brighton on 25 September 2017 that ‘the scandal of the PFI, launched by John Major, has resulted in huge long-term costs for taxpayers while handing out enormous profits to some companies’. He promised that Labour would ‘rip up’ PFI and, in addition to Jeremy Corbyn’s previous pledge not to sign any new PFI deals, Labour would ‘bring existing PFI contracts back in-house’. Mr McDonnell also said that if Labour came to power ‘the government would intervene immediately to ensure that companies in tax havens can’t invest in PFI projects and their profits can’t be hidden from HMRC’.

This initial soundbite was tempered somewhat by the Labour Party press release which followed Mr McDonnell’s speech and which appeared to be somewhat less radical, stating ‘Labour will review all PFI contracts and, if necessary, take over outstanding contracts and bring them back in-house, while ensuring NHS trusts, local councils and others do not lose out and there is no detriment to services or staff’.

A Labour spokesman said that shareholders in PFI companies would be compensated by swapping their shares for government bonds and ‘Parliament will assess the appropriate level of compensation at the point at which contracts are brought back in-house’.

In reality, it might be that only a relatively small proportion of PFI contracts would be brought back into public ownership under a Labour government. In an interview with the BBC on the day after Mr McDonnell’s speech, the shadow health secretary, Jon Ashworth, addressed PFI contracts in the healthcare sector, saying ‘NHS experts generally accept that it’s only a handful which are causing hospital trusts across the country a significant problem, but let’s look at every single one in detail’.

Are they achievable?

Whether Labour’s proposals are achievable would depend on where across the spectrum of possible outcomes outlined above Labour ultimately land.

If Labour’s proposals turned out to involve a review of all existing PFI contracts based on their then current terms, in order to assess whether termination of any of them presented better value of money than continuation, then that would look relatively simple to achieve.

Indeed, the current government has been reviewing the value for money of PFI, looking at ways in which savings could be made and, if appropriate, considering terminating PFI projects where it makes sense to do so. HM Treasury issued a policy note in June 2015 which set out the budgeting, accounting and fiscal implications of a voluntary termination of a PFI contract by the procuring authority. It expected ‘the incidence of voluntary terminations of PFI arrangements to be low, due to affordability challenges and the requirement to be able to demonstrate value for money for the public sector as a whole’.

On the other hand, if Labour’s proposals turned out to involve the introduction of new legislation to change the terms of PFI contracts by statute, providing for termination with reduced compensation, then this would be more complicated. For example, the suggestion by a Labour Party spokesperson that ‘Parliament will assess the appropriate level of compensation’ raises the possibility that something other than full contractual compensation may be contemplated.

This would require primary legislation to be passed and it is likely that any new legislation which sought to adjust the compensation payable under current PFI contracts would face a number of challenges. In the first instance, the standard terms of PFI contracts provide both for a clear level of compensation to be payable for public sector ‘voluntary termination’ and for compensation to be paid by the public authority if legislation is introduced which discriminates against PFI. While new legislation might seek to sidestep or override these provisions, this in itself is likely to give rise to wider potential areas of challenge.

For example, legislation that has the effect of cancelling contractual and other legal rights under PFI structures would likely give rise to claims being advanced before UK courts based not only on breach of contract/legitimate expectation grounds, but also potentially under the Human Rights Act 1998 (in relation to the right to protection of property contained within the European Convention on Human Rights).

Where investors in PFI structures are non-UK entities or individuals, claims could be brought against the UK under the 100-plus investment treaties which the UK has entered into with foreign states. Foreign investors with the benefit of investment treaty coverage could sue on the basis of expropriation under public international law, with such claims being heard before arbitral tribunals and with any resulting awards being directly enforceable against the UK under international law, with no appeal process available to the UK. We note that Jeremy Corbyn described this process as ‘supranational and unaccountable’ in the context of EU transatlantic trade agreement discussions in 2015.

Consideration would also need to be given to the impact of Brexit. The current status of Brexit negotiations means that we can only guess at the potential impact.

What would they mean in practice for those in the construction industry?

There are many large UK (and international) construction companies with interests in PFI projects, both through having signed construction contracts with the project companies which are established to enter into PFI contracts with public authorities and through direct investment in those project companies. We focus here on their interest as construction contractor, rather than as investor (see question below for the impact on investors).

The immediate impact of wholesale termination of PFI contracts on construction contractors would be more limited than for investors. There would be a relatively small proportion of PFI contracts on which construction works had not yet completed and, in any case, construction contractors are generally paid for works on a monthly basis (using the private finance provided by senior debt providers and investors).

Upon voluntary termination by the public sector during the construction phase, a construction contractor would generally have a claim for breakage costs (including some compensation for lost profits), but the public sector might well take the view that it would make sense to use its collateral agreement with the construction contractor to continue to use the construction contractor to complete the works outside the PFI structure (unless there were problems with the current construction process).

Looking further forward, the wider impact on the construction industry of curtailing PFI arrangements depends upon the ability of the government to finance the continuing and substantial need for infrastructure investment in the UK, which itself depends upon the state of the public finances.

What it would mean for investment in national infrastructure more generally?

There are wider commercial, financial and political implications if Labour’s proposals were to result in the wholesale termination of PFI contracts (with reduced compensation), including:

  • the impact on the government’s public accounts of financing the settlement of compensation claims by senior debt providers and investors in PFI contracts
  • the transfer of PFI workforces from the private sector to the public sector, including employment and pensions implications
  • the takeover by the public sector of operational and financial responsibility for continued maintenance and lifecycle across the existing PFI estate
  • the costs and resourcing of multiple claims from participants in the PFI structures
  • the impact on pension funds and corporate investors (including construction companies) with investments in the PFI estate
  • the impact of the consequent state of public finances on the ability of government to finance further spending on UK infrastructure.

The Labour Party proposal on PFI contracts forms part of a wider set of proposed nationalisations by Labour, which have raised questions over the impact they could have on the confidence of international investors in the UK. John McDonnell himself has stated that he plans to carry out scenario planning for crises which could follow an election victory. One of the scenarios to consider is a flight of capital from the UK with a run on sterling. As Mark Carney, Governor of the Bank of England, said in his recent (June 2017) Mansion House speech, ‘the UK relies on the kindness of strangers’ to fund its current account deficit.

How have the proposals been received?

They were well received by many of those attending the Labour Party conference but less well received by many of Britain’s business groups, as well as those active in the PFI market.

The Confederation of British Industry’s director general, Carolyn Fairbairn, said the policy could send investors ‘running for the hills’ and that ‘the shadow chancellor’s vision of massive state intervention is the wrong plan at the wrong time. It raises a warning flag over the British economy at a critical time for our country’s future.’

The director general of the British Chamber of Commerce, Adam Marshall, echoed these views, adding ‘with the UK’s departure from the EU on the horizon, businesses will be concerned by the shadow chancellor’s proposals for widespread and deep intervention across the economy. Proposals to nationalise key industries would put business investment in the deep freeze at precisely the time that it is needed most’.

However, given the clarifications that followed John McDonnell’s initial comments, it may well be that Labour’s policy to ‘review all PFI contracts and, if necessary, take over outstanding contracts and bring them back in-house’ will not actually result in a step change from current government policy. Only time will tell.

Interviewed by Alex Heshmaty. The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

For more information on PFI contracts, see LexisPSL Construction subtopic: PFI/PF2.

Filed Under: Construction

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