7.2.1 The key features of a payment mechanism are:
• no payments should be made until the Service is available;
• there should be a single Unitary Charge for the Service which is not made up of separate independent elements relating to availability or performance;
• the level of payment should be linked to the level of Service. For a payment mechanism based on availability with an overlay of performance deductions, this will mean linking payment to both the availability and the quality of the Service;
• the Unitary Charge should never be paid in advance of the period to which it relates;117
• the payment mechanism should adjust for sub-standard performance, and deductions should reflect the severity of failure. Thus no Service should lead to no payment, but proportionality is important and therefore a minor failure should cause a minor deduction (except in the case of persistent failure where ratchet mechanisms may increase the level of deduction);
• the mechanism should not only incentivise the Contractor to remedy service failures but should also take into account the importance of that failing Service to the Authority;
• a balance should be struck amongst the variables in the payment mechanism, such as the initial "weighting" of deductions for failures, response / rectification periods, and the "ratcheting up" of deductions for repeated failures over time;
• the performance and payment regime should not be made up of sub-elements which relate to delivery of inputs (e.g. completion of stages of construction, cost of materials or labour) but should be based on outputs (e.g. the availability of facilities or standard of Services); and
• the payment mechanism should never contain a fixed element which the Contractor always receives irrespective of performance (e.g. which covers the Contractor's debt service obligations).
7.2.2 It is not generally appropriate to "sculpt" the Unitary Charge (i.e. through an uneven or irregular payment profile) other than for relevant general price changes118 or to ensure consistency with any ramp-up in services in an initial period or project phasing. The reason for this is that sculpting the Unitary Charge is contrary to the principle of paying for Services rather than inputs; moreover it is orientated towards affordability rather than value for money concerns and can undermine the effectiveness of the risk transfer to the private sector.119 "Ramp-up" can happen, for example, where a project involves a mixture of new construction and refurbishment of existing facilities, with the latter becoming available before completion of construction.
7.2.3 The Authority should pay for Services on time and payment should not be unreasonably withheld. The Authority should comply with Government policy on late payment (e.g. agreeing payment of interest if payment is late), so Contracts should take into account the relevant provisions of the Late Payments of Commercial Debts (Interest) Act 1998. The Authority should also take steps to ensure that the Contractor complies with best practice in this area. In accordance with Government policy the Contractor should pay its Sub-Contractors ordinarily within 30 days, unless a different period is specified in the relevant Sub-Contract.
7.2.4 The choice of payment mechanism should be a positive decision by Authorities, informed by advice from their advisers. The Authority should also involve relevant stakeholders (e.g. end-users) as appropriate.
7.2.5 The payment mechanism must be properly applied in practice. There have been occasions where Authorities have been wary of imposing deductions for fear of threatening their relationship with the Contractor, or because they are concerned that deductions will damage the ability of Sub-Contractors to rectify problems. Authorities should regard the payment mechanism as an important part of their Contract and should enforce it.
7.2.6 The Authority's requirements and payment mechanism are designed to deliver the required Services identified in the business case and accordingly out-performance (i.e. performance to a higher standard) by the Contractor should not ordinarily warrant further payment. However, for some projects (for example, where the performance by the Contractor can affect the financial position of the Authority, such as rent collection in some housing projects) Authorities may consider that there is value for money in including scope for additional payments. In such cases Authorities may wish to cap payments for out-performance (e.g. at the level of previous deductions or by awarding 'bonus points' which can only serve to offset 'negative' points for poor performance). Such payments will, however, only offer value for money if they are valued by bidders and Senior Lenders in their pricing for the Project.
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117 Projects may appear more affordable if payments are made in advance (on the first day of a monthly, or other, period rather than after the end of the period). This is bad practice and not to be adopted.
118 The payment mechanism will often include provisions relating to changes in the general price level (i.e. as a result of inflation) during the Contract (see Section 15.2 (Inflation Indexation)). Benchmarking and market testing can also lead to changes in the Unitary Charge (see Section 15 (Price Variations)).
119 The May 2006 HMT Application Note "Interest-Rate and Inflation Risks in PFI Contracts" (see section 3.2 in particular) discusses this issue and addresses the related question of 'over-indexing' the Unitary Charge.