Contract Flexibility

Furthermore, in carrying out this cost-benefit analysis, proper account must be taken of the reduction in Contract flexibility which arises as a result of increased termination liabilities. HM Treasury: "PFI-Meeting the Investment Challenge" (July 2003, §8.45-8.47) emphasised the importance which the Government places on PFI Contracts maintaining adequate flexibility. Loss of flexibility derives from at least two sources:

- Policy flexibility

It is important for Government to maintain the flexibility to allow for future changes in policy affecting the services provided under the Contract. Accordingly, at the time it entered the Contract, the Authority will have placed a distinct value not only on having the option to terminate the Contract voluntarily but also on the exercise price of this option (i.e. the compensation it would have to pay to the Contractor in such circumstances). An increase in termination liabilities and hence exercise price will reduce the value of this option.

- Operational flexibility

If the environment within which the services are provided are subject to rapid or continuous change, then it is likely that the Authority will need to make extensive use of the change control provisions of the Contract or, indeed, have a need to negotiate substantial changes to the contract itself. This may place stresses on the Contractor which were unforeseen by both the Authority and the Contractor at the time of entering the Contract. Even if such circumstances do not give rise to instances of Contractor default, they may nonetheless take the partnership working between Contractor and Authority beyond limits with which the Contractor is comfortable. In such circumstances, the cost of voluntary termination by the Authority (as an alternative to negotiating difficult changes) becomes important. The greater the termination liabilities the less flexibility there may be in the Contract.

The VfM assessment of loss of Contract flexibility is not straightforward, since it may not be possible to predict how policy or operational needs could change in the long term. Nonetheless even if such an analysis cannot be carried out quantitatively it must still be carried out qualitatively by the Authority. Moreover, even if an Authority believes there is a low probability of future changes being necessary, it does not diminish the need for an Authority to give due weight to these important scenarios in its VfM assessment.