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Commercial Question

Projecting into the Future

updated on 23 May 2006

Question

Project finance and PFI; what is it and does it have a long-term future?

Answer

Project finance law involves commercial transactions relating to infrastructure projects, ranging from hospitals, power plants and dams, to oil and gas installations. A 'private finance initiative' (PFI) is a subset of project finance, which involves the public sector's procurement of infrastructure by means of private sector investment. PFI is the term used in the United Kingdom for a structure more commonly known internationally as a 'public private partnership' (PPP). PFI, similar to other PPPs, is a means by which private sector finance and expertise is used to procure public sector facilities.

This method of procurement of public infrastructure was introduced in the United Kingdom by the Conservative government in 1992. Infrastructure traditionally provided by the public sector, such as hospitals, health centres, schools, roads, prisons and waste management facilities, is procured using the private sector.

The basic structure of a PFI transaction is that the public authority will offer by tender a long-term contract (usually, a term of 25-30 years) for the construction, maintenance and operation of the infrastructure facility. The successful private sector supplier takes responsibility for obtaining the funding for, and building and operating the facility.

The overall business risk of delivering the service lies with the private sector, which in return, receives an agreed level of payment from the public authority (the 'unitary charge'). The unitary charge is subject to deduction if the services are not provided to an agreed level or areas of the facilities do not satisfy agreed benchmark criteria (eg, lighting or heat).

The aim of PFI is that a competitive procurement combined with private sector efficiencies and innovation, and risk sharing between the public and private sectors (using the mantra "the person best placed to manage the risk should bear the risk") will result in better value-for-money for the public sector.

What does the work involve?

Projects work is predominantly transactional with an emphasis on practical skills such as negotiation, drafting and project management. Projects lawyers need to have a firm grasp of commercial contracts, corporate and banking law and an understanding of construction, property and procurement law. The primary role of the projects lawyer is to negotiate and draft the contracts between the parties and to project manage the transaction to a successful completion. This will involve drafting and negotiating the project or concession agreement that deals with the design, construction and operational phases, the construction contract, facilities management contract and the banking documents.

It will also involve coordinating a varied cast of lawyers, accountants and technical contractors towards completion of the deal. Due to the complexity of the deals, the number of parties involved and the impact of varied areas of law, the work is varied and the projects lawyer is required to be something of a renaissance man. But, for lawyers who enjoy transactional work, this area of law is exciting, fast-moving and challenging.

The role changes dependent on the party the PFI lawyer is acting for. If the client is the public sector entity that wishes to procure the facilities, the role is long term, advising the client on the procurement stages and assisting to scope the project, drafting the tender and initial project documents, evaluating the responses and helping to select the private sector partner. On the other hand if the client is a private sector bidder, the role is to review the documentation provided by the procuring authority and negotiate (i) funding documents to secure finance for the scheme, and (ii) construction and service contracts to ensure the bidder can build the scheme and operate the facility.

Here to stay?

PFI projects are topical and some projects have been the subject of adverse media attention. Critics consider PFI as a means of privatising the public sector through the back door. In addition, some private sector investors have profited immensely from PFI contracts while (arguably) the public have not received the expected standard of service from the relevant contract. Furthermore, sceptics have predicted the possibility of a future government reining in the PFI project pipeline.

However, the evidence suggests that this scepticism in respect of PFI is misplaced. On the whole, compared to non-PFI projects, PFI projects are delivered on time and to budget, and over time offer the public improved services. Over 400 projects have been delivered to date in the United Kingdom - 80% of these within budget and 90% on time. The consensus of those in the industry (which is supported by National Audit Office and other reports) is that PFI/PPP has delivered real, tangible benefits to the UK infrastructure, as well as quantifiable value for money (predominantly off-balance-sheet) for the UK public sector, making it a means of public procurement that is here to stay.

Future developments?

As a result of the perceived success of PFI/PPP in the United Kingdom, the model is now the focus of real interest for governments across Europe, as they seek to move their own infrastructure programmes forward. This will undoubtedly be a major new frontier for projects lawyers.

In the United Kingdom the PFI market has matured. The public sector is now more experienced and the next wave of projects will inevitably be both more complex and more challenging. The PFI sector is continually evolving - for example, the government recently rolled out a billion pound 10-year PFI programme for refurbishing the secondary schools in the country. The projects lawyer of today will need to adapt and innovate in order to face the challenge of the less commonplace transaction.

Luke Menzies is a trainee solicitor in Mills & Reeve's Real Estate Team. Ike Nwafor is a solicitor in the firm's Projects Team.