In July 1998, the Department of Trade and Industry (DTI) signed a contract with Laser, a Special Purpose Vehicle (SPV) owned by Serco Group plc and John Laing plc, for a 25 year PFI deal to build and manage new facilities at one of the world's leading measurement laboratories, the National Physical Laboratory (NPL). The planned cost was £96m, funded mainly through loans from Bank of America and Abbey National Treasury Services plc.
Initially the fixed price design and build contract with John Laing Construction Limited (JLC) protected Laser from increases in construction costs. However, when in November 2001 John Laing plc sold JLC, and took on responsibility for the contract with Laser, it lost this protection. A supplemental deed meant that the contract was now to complete an agreed list of work, rather than to construct facilities that met DTI's specification. The DTI was not party to this deed and registered its objections. The deed exposed Laser to the full financial impact of any further construction problems and delays.
Problems materialised during construction and by 2004, Laser had paid JLC £76 million of a £82 million fixed price for construction, although only nine of the 16 modules were completed and an estimated £45 million worth of work was outstanding. Laser acknowledged that it could not complete the project in July 2004 and, after negotiations, the DTI and Laser signed a termination agreement worth £75million (which was at the low end of the range of estimates of Laser's contractual entitlement) in December 2004.
The private sector reported considerable losses. While the equity investment in this PFI was small, it certainly took pain when the project failed, as the equity holders lost all of their £4 million investment. Debt also suffered as senior lenders wrote off debt to the sum of £18 million. However, the largest losses were incurred by the construction contractors, JLC, who reported losses of £67 million, and their subcontractors, who reported losses of £12 million.
The DTI, having invested £122million (including the termination compensation, cost of procurement process, upfront payments and unitary payments), was left with assets valued at £85million. This indicates that while significant financial losses were incurred by the DTI, these were mitigated by the risk transferred to the private sector.
What equity was not successful in doing, in this case, was ensuring that the design was deliverable. However, unlike many infrastructure projects, the design of the NPL was complicated by its highly technical scientific requirements. It was in achieving these that the budget overruns occurred. The DTI had concerns that the design of the NPL would not meet with specifications as early as the procurement stage. However, it was expected that Laser would overcome these design problems, recognising that it was in their interest to resolve such concerns. The DTI did not seek to impose its own design on Laser or request changes to the design as it wanted to ensure that responsibility for delivering satisfactory performance remained unambiguously with the private sector.
While Lenders gave early warning of problems within Laser and took an increasingly active role in overseeing its actions, they did not step in to sort out the problems. It is arguable that this was because there was no alternative solution to the problems that Laser was encountering that would enable it to remain within budget.
Ultimately, much of the financial risk was successfully transferred to the private sector through the use of PFI, and the financial downside for the DTI was mitigated by this. However, not all risk was transferred and the DTI was left with unfinished assets which it has to find an alternative contractor to complete.