14.8  GENERAL CHANGE IN LAW AS A SHARED RISK

14.8.1  General Change in Law may affect the Project in a variety of ways. For example:

•  the change may require alterations to the structure of a building or its fixtures (with an impact both on Capital Expenditure and, potentially, timetable); and

•  the change may necessitate a change in the way a Service is delivered (e.g. the number of people required to deliver it or the rights of employees may change).

14.8.2  Costs arising from General Changes in Law should generally be for the account of the Contractor, as the Contractor is protected through the combined effects of benchmarking, market testing and indexation.201

14.8.3  This alternative approach recognises, however, that it may be more equitable for the Authority to share costs which are difficult for the Contractor to manage. An exception is therefore made of General Changes in Law which:

•  require Capital Expenditure; and

•  take effect during the Service Period (i.e. after construction is completed (but see Section 14.8.8)); and

•  were not reasonably foreseeable at Contract signature.

Under this approach the costs of a General Change in Law falling within this exception are shared between the Contractor and the Authority. If the change was foreseeable during the construction period although not yet in effect, the Contractor's obligation to mitigate (see Section 14.5 (Mitigation)) would require it to have taken all reasonable action to minimise the eventual cost of implementing such change (e.g. by altering construction works prior to completion). This approach promotes a shared incentive to keep the costs of a change in law to a minimum without exposing the Contractor to excessive risk.

14.8.4  An appropriate approach to sharing the risk of the type of change in law described in Section 14.8.3 is to share such risk on a progressive scale so that, for example, the Contractor takes 100% of the first £x of Capital Expenditure, 75% of the next £y, 50% of the next £z and so on (see the table set out in Section 14.8.10). Once a certain amount is reached, the Authority takes 100% of any amounts above that amount.202 The threshold figures agreed and the number of graduated steps will take into account the size of the Project and the impact of other factors such as the likelihood of environmental and health and safety legislation. The levels of Cumulative Capital Expenditure (see Section 14.8.10) are not indexed (as the totals are cumulative, indexation can lead to unnecessary complication). The Contractor's total liability should generally be between 2% to 5% of the initial capital cost of the Project.203 A cap by reference to time is not recommended.

14.8.5  The advantage of sharing the risk in the way described (as opposed to the Contractor simply being liable for the first £x of Capital Expenditure) is that it both incentivises the Contractor to minimise the cost of implementing the change (as opposed to the Contractor simply invoicing the Authority for whatever it costs) and reduces any concern the Contractor has that the Authority can take advantage of the situation.

14.8.6  Although it is the responsibility of the Contractor to manage the way in which it will fund any increases in capital costs which occur as a result of a General Change in Law occurring during the Service Period, if it is clear to the Authority from the winning bidder's Base Case that it has priced the risk at 100 percent,204 the Authority may wish to retain the risk on value for money grounds. For example, if the Base Case shows amounts being drawn from Senior Debt to fund a so called "Change in Law Reserve Account", the Authority is paying for this account to be placed in-funds as if it were an expected cost of the Contractor.205 Experience has shown however, that the competitive bidding process incentivises bidders to price the risk at less than 100 percent and Senior Lenders are typically comfortable that General Changes in Law can be managed either by: (i) standby finance (from Shareholders or Senior Lenders); (ii) undrawn revolving working capital facilities; or (iii) building up sums over time from free cashflow without the need for a pre-funded Change in Law Reserve Account because:

•  changes in law are usually consulted well in advance;

•  there is normally a grace period for implementation; and

•  such changes rarely apply retrospectively.

14.8.7  The Authority should generally pay such Capital Expenditure in accordance with the principles set out in Section 13,3,7 (Funding and Payment). Any consequent operating cost increases are borne by the Contractor although these costs will be mitigated by the effects of market testing, benchmarking and/or indexation206 (see Section 15 (Price Variations)). The points made in Section 5.2.3 (Calculation of Compensation) are similarly relevant here.

14.8.8  All other General Changes in Law requiring Capital Expenditure (e.g. those which take effect during a typical construction period) should, with this approach, be at the risk of the Contractor in terms of time and money.

14.8.9  For projects which have unusually long construction periods, transferring the risk of General Changes in Law for the entire construction period (rather than adopting a sharing approach) may in fact be poor value for money and is likely to be difficult to achieve in practice (see in particular Department for Environment, Food and Rural Affairs' guidance for Waste PFI projects).207

14.8.10  Changes arising in operational costs as a result of a General Change in Law should also be borne by the Contractor (subject to Section 15 (Price Variations)). If a General Change of Law requires changes to the Service then either party should be entitled to require a variation to the project specifications to comply with a Change in Law and no breach of contract should arise while this is being done.208

Required drafting is as follows:209

"Contractor's Share"

means the percentage figure corresponding to that part of the Cumulative Capital Expenditure at the relevant time shown in the first column of the table set out below.

"Cumulative Capital Expenditure"

means the aggregate of:

(a)  all Capital Expenditure that has been incurred as a result of each General Change in Law that has come into effect during the Service Period; and

(b)  the amount of Capital Expenditure that is agreed, or determined to be required, as a result of a General Change in Law under Clause 14.8 (Qualifying Change in Law).

"Qualifying Change in Law" 212

means:

(a)  a Discriminatory Change in Law;

(b)  a Specific Change in Law; and/or

(c)  [a General Change in Law which comes into effect during the Service Period and which involves Capital Expenditure.213]

which was not foreseeable at the date of this Contract214

14.8  Qualifying Change in Law

(a)  If a Qualifying Change in Law occurs or is shortly to occur, then either party may write to the other to express an opinion on its likely effects, giving details of its opinion of:

(i)  any necessary change in Service;215

(ii)  whether any changes are required to the terms of this Contract to deal with the Qualifying Change in Law;

(iii) whether relief from compliance with obligations is required, including the obligation of the Contractor to achieve the Planned Service Commencement Date and/or meet the [performance regime] during the implementation of any relevant Qualifying Change in Law;

(iv) any loss of revenue that will result from the relevant Qualifying Change in Law;

(v) any Estimated Change in Project Costs that directly result from the Qualifying Change in Law; and

(vi) any Capital Expenditure that is required or no longer required as a result of a Qualifying Change in Law taking effect during the Service Period,

in each case giving in full detail the procedure for implementing the change in Service. Responsibility for the costs of implementation (and any resulting variation to the Unitary Charge) shall be dealt with in accordance with paragraphs (b) to (f) below.

(b)  As soon as practicable after receipt of any notice from either party under paragraph (a) above, the parties shall discuss and agree the issues referred to in paragraph (a) above and any ways in which the Contractor can mitigate the effect of the Qualifying Change of Law, including:

(i)  providing evidence that the Contractor has used reasonable endeavours (including (where practicable) the use of competitive quotes) to oblige its Sub-Contractors to minimise any increase in costs and maximise any reduction in costs;

(ii)  demonstrating how any Capital Expenditure to be incurred or avoided is being measured in a cost effective manner, including showing that when such expenditure is incurred or would have been incurred, foreseeable Changes in Law at that time have been taken into account by the Contractor;

(iii)  giving evidence as to how the Qualifying Change in Law has affected prices charged by any similar businesses to the Project, including similar businesses in which the Shareholders or their Affiliates carry on business; and

(iv)  demonstrating that any expenditure that has been avoided, which was anticipated to be incurred to replace or maintain assets that have been affected by the Qualifying Change in Law concerned, has been taken into account in the amount which in its opinion has resulted or is required under paragraph (a) (v) and/or (vi) above.

(c)  If the parties agree or it is determined under Clause 28 (Dispute Resolution) that the Contractor is required to incur additional Capital Expenditure due to a Qualifying Change in Law (excluding the Contractor's Share of any Capital Expenditure agreed or determined to be required as a result of a General Change in Law under this paragraph), then the Contractor shall use its reasonable endeavours to obtain funding for such Capital Expenditure on terms reasonably satisfactory to it and the Senior Lenders.

(d)  The Contractor's Share shall be solely for the account of the Contractor.

(e)  If the Contractor has used reasonable endeavours to obtain funding for Capital Expenditure referred to in paragraph (c), but has been unable to do so within [60] days of the date that the agreement or determination in paragraph (c) occurred, then the Authority shall pay to the Contractor an amount equal to that Capital Expenditure on or before the date falling 30 days after the Capital Expenditure has been incurred.

(f)  Any compensation payable under this Clause by means of an adjustment to or reduction in the Unitary Charge216 shall be [see Section 5.2.3 (Calculation of Compensation) above].217

____________________________________________________________________________________

201  The Contractor should also receive the benefits of any cost savings resulting from General Changes in Law. Benchmarking, market testing and indexation should act to restrict the overall benefits received by the Contractor.

202  This will enable the Contractor and its financiers to quantify the Contractor's maximum exposure.

203  Bidders will price into their bid submissions any General Change in Law risk they are required to take. Both the Authority and bidders should seek to ensure that cost and adequate risk transfer are balanced as far as possible to achieve the best value for money.

204  i.e. 100 pence in the pound.

205  The cost of funding such an account is not likely to offer good value for money to the Authority.

206  Indexation is much less likely to have an effect here than market testing and benchmarking.

207   See Department for Environment, Food and Rural Affairs website at  www.detra.gov.uk. Although this is based on English Projects, its advice is largely of generic applicability.

208  The required drafting that follows may be incorporated into a Change Protocol as described in section 13 (Change in Service).

209  This will have to be adapted to the extent the approach in Section 14.7 (General Change in Law at Contractor's Risk) is taken. The "sharing" approach is set out as it includes both approaches.

210  These figures are to be bid as part of the bid submission. In each case they are not to be indexed.

211  These figures are illustrative only and it is open for the Authority or bidders to set the Contractor's Authority's Share at zero or one hundred per cent with no incremental changes, or have only one or two stages in the graduation. This approach will help the Authority find the appropriate level.

212  It may of course be that if there is a particular uncertainty attaching to a particular change in law (even if foreseeable), such as where, for example, its effects can vary by a significant factor. If this is so, then risk sharing can be agreed where the value for money impact is extremely difficult to assess. One example of such an issue are projects for refuse incinerators, given the Valuation (Electricity) Order (Northern Ireland) 1997 SR1997 No. 118.

213  This will depend on which option in Section 14.7 (General Change in Law at Contractor's Risk) is adopted and the extent to which Capital Expenditure is at the risk of the Contractor (i.e. the extent to which such amounts have been included in the bid).

214  If any greater clarity can apply to this in a particular project (such as concerns over particular envisaged changes in law) then this should expanded upon.

215  For example, the contractual, financial, operational and/or construction implications of the change in Service. Any change in Service should be agreed and implemented in accordance with the Change Protocol described in Section 13 (Change in Service), with the costs of the change being shared as recommended in this Section 14.

216  There will only be an adjustment to the Unitary Charge in respect of increased capital costs if the Contractor's Share is less than 100% and the Authority does not make a lump sum payment to the Contractor (see Clause 14.8(e) above). Increased operational costs resulting from any General Change in Law are borne by the Contractor and will not result in an adjustment to or reduction to the Unitary Charge (see Section 14.8.7 above).

217  See also Sections 14.6.3 and 14.8.2.