4.3.1 While certain elements of the contract will always remain to be negotiated in the period between appointment of the preferred bidder and financial close, it is important that a potential preferred bidder accepts, and the price reflects, the key contractual terms that form the basis of the agreement between the parties. In practice this means that it is content with the extent of the risks being transferred.
4.3.2 Experience to date suggests that the areas in the contractual terms with the potential to delay deals the most have included:
• the allocation of general and specific legislative risk and the boundary between them;
• the compensation arrangements for termination and the trigger events for default;
• the payment mechanism - particularly the balance between availability, demand and performance and the triggers for defaults;
• indexation - relating both to the base costs eligible for indexing and the appropriate indices;
"step-in" rights; and
• changes in client requirements.
4.3.3 The standardisation of contract terms should help resolve these issues more easily. Nevertheless, the procurer needs to be satisfied that agreement on the contract terms has been reached, and that they are consistent with the price proposed, before appointing a preferred bidder. Otherwise, it risks having them reopened at a later stage when there are no other bidders remaining, and mounting pressures to meet the project timetable.
4.3.4 The procurer can be exposed to a number of risks:
• inexperienced bidders may choose apparently attractive financing packages which ultimately prove not to be deliverable;
• bidders may not anticipate the requirements of debt/equity providers, or be over optimistic about the amount of risk they can pass on to sub contractors; and
• because funders' technical due diligence procedures often only begin after competition has ceased following the appointment of a preferred bidder, they may be conducted with less of the disciplines of the competitive process and the procuring authority may have little control over how long they take (see paragraphs 4.4.4 to 4.4.10 below on due diligence).
4.3.5 With the increased standardisation of contract terms and more detailed specifications of the ITN, funders should accept the commercial allocation of risk and reward agreed between the procurer and the bidders before selection of a preferred bidder. In doing this, changes to the commercial deal which alter the agreed balance of risk may not be sought when competitive pressure has been relaxed (see Section 5).
4.3.6 To a certain extent, these risks arise in all PFI deals. The use of suitable expert advisers can help to reduce them, but many of the difficulties are attributable to a failure to tie down contractual documentation in a realistic manner at sufficiently early a stage in the bidding process. Too often in the past ITNs have been issued with no, or incomplete, contract documentation. Output specifications have been, at one extreme, unnecessarily detailed or, at the other, too vague, and proposed payment mechanisms have reflected an uncommercial risk allocation. Procurers must be clear about their real requirements from the outset and should introduce mechanisms to measure how a preferred bidder will deliver the services required.
4.3.7 Procurers may come under pressure from their own time constraints and from the cost concerns of bidders to leave significant elements of the contract to be negotiated after the appointment of the preferred bidder. Experience has shown this to be very counter-productive. Negotiating complex and commercially sensitive terms and conditions with a single bidder has proved a long, costly and sometimes inconclusive process. It is important that the procurer and shortlisted bidders agree the contractual terms/principles that form the agreement between the parties to inform the evaluation of their proposals and contribute to the selection of a preferred bidder. In practice, this means that the preferred bidder is content with the extent of the risks being transferred, has had the opportunity to discuss those risks, price them, and reach an accord with the proposed lenders as to how the risks are to be allocated within the consortium structure.
4.3.8 In order to minimise these potential difficulties, the Treasury Taskforce recommends that all the key commercial terms in the contract documentation and output specification, including the terms of any parent company guarantees that may be deemed necessary, should be negotiated fully before the appointment of a preferred bidder. In this way the activities post-preferred bidder appointment are more likely to be limited to the detail of the financing arrangements and service specifications/descriptions of the asset to be provided, whilst the basic commercial agreement remains intact.
4.3.9 The procurer should provide the fullest possible documentation in the ITN, including full drafts of the contract, performance standards, payment mechanisms, draft term sheets, with clauses on compensation on termination, default trigger events and step-in rights. There should also be a clear and realistic statement of the required degree of risk transfer and the degree of agreement to be achieved on all key aspects of the project. Unrealistic expectations of risk transfer or changes to any key aspects of the project after the issue of tender documents are likely to involve abortive costs for bidders and should be avoided.