35.1.1 PFI Contracts are structured so that the private sector is responsible for the delivery of services on time, on budget and according to specification. Such structuring helps to insulate Authorities from the consequences of a Contractor's financial difficulties. The key elements of such structuring are:
- Fixed Price Contracts - the Unitary Charge is fixed at Financial Close and thereafter changes only for agreed indexation, value testing, Change of Law, Service Change or upon the occurrence of a Compensation Event. It does not increase for Contractor delay or failure or for Contractor under-estimation of the actual outturn cost of delivery of the Services.
- Multiple Stakeholders - both Shareholders and Senior Lenders are financially incentivised to manage and resolve difficulties, which may arise within projects, since their returns are dependent on the successful delivery of the Project (rather than the balance sheet of the Contractor).625
- Fixed Term Contracts - the length of the Contract is fixed, so that the private sector investors have a finite period over which to make a return on their investment (in the case of the Shareholders) and to achieve repayment of debt (in the case of Senior Lenders). The private sector is therefore incentivised to ensure that Services commence on time and remain available for the required period. Given this risk allocation the private sector will take responsibility for managing financial difficulties of the Contractor or its Sub-Contractors to the extent they impact on delivery of the project.
- No Service No Payment - this principle means that no payment of Unitary Charge is made until the Works have been constructed in accordance with the Authority's requirements and are available for use. The principle of "no service no payment" allocates to the private sector the risk of late delivery or non-completion, or delivery of an asset outside the pre-agreed contractual specification, and thus helps insulate the Authority from problems in the construction period. During the operational period, if full Services are not provided, the Authority will not make full payments (or potentially any payment) and is therefore not at risk of providing financial support to the Contractor.
- Senior Lenders' Due Diligence - Senior Lenders (assuming the funding is provided on a project finance basis) will undertake substantial due diligence in order to ensure, amongst other things, the financial robustness of the project structure, that the Contractor's obligations have been contractually passed to the Sub-Contractors or otherwise suitably insured, and that the Sub-Contractors are able to meet their obligations under the Sub-Contracts. Characteristically this would involve testing the financial model against various distress scenarios.
35.1.2 The structure of PFI contracts will help ensure that the risk of delays and increases in costs are allocated to the private sector. There are however a number of structuring and management measures that Authorities should implement to ensure that their PFI project operates effectively in circumstances of Contractor distress.
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625 This guidance assumes the Project is being financed on a project finance basis. If this is not the case, different principles may apply (see Section 37 (Corporate Finance)).