35.3.1 In addition to the structural protection as set out in Section 35.1 above afforded by PFI contracts, a number of key contractual provisions provide Authorities with protection in circumstances of Contractor distress. Such key Contract provisions are:
- Change of Ownership provisions - These provisions would usually provide, subject to certain exceptions, that the ownership of the Contractor (and Holdco, if relevant) is fixed throughout the Construction Period and the defects liability period (usually one year post-construction completion). By fixing the ownership of the Sub-Contractor, the Authority ensures that the bidding consortium which it selects to deliver the Project is maintained, and that key shareholders (one of whom may be the Construction Sub-Contractor) are incentivised to ensure that the Project is delivered in accordance with requirements of the Contract. Section 18 provides further details on Change of Ownership together with drafting for such provisions.
- Additional Permitted Borrowings - the Additional Permitted Borrowing regime affords Senior Lenders the ability to provide limited additional funding to the Contractor where the Project is in difficulty (whether in the construction or operational period) without the consent of the Authority. Such additional loans do not affect the Unitary Charge but are taken into account as part of the Authority's liabilities if the Project is terminated for Authority Default, Voluntary Termination, Force Majeure or Corrupt Gifts or at an Authority Break Point Date.
- Defaults and Termination - On termination, the Contractor will commonly, broadly, be paid the market value of the Contract. There is no guarantee that this will be sufficient to pay out the Senior Lenders, therefore they are incentivised to also ensure that the project does not fail and that its market value is maintained. Authorities should ensure that the payment mechanism is calibrated so that the accumulation of points, deductions and default triggers appropriately incentivise performance.
- Construction Period - During the construction period, where, in projects without any early service provision, the payment mechanism may not be relevant, the Authority's contractual remedies are its termination rights under the Contract. They may arise following failure to start Works by a certain date, abandonment of the Contract or failure to meet the acceptance criteria applicable to the Works by the long-stop date, among other circumstances. Contracts do not generally include termination triggers relating to Sub-Contractors, since the Contractor assumes the risk of managing Sub-Contractor performance. However the Authority may insert provisions requiring the Contractor to replace a defaulting building Sub-Contractor (breach of which could lead to a Contractor Default).
- Information Rights - Section 26 (Information and Confidentiality) contains information rights for the Authority, including rights to receive:
• the annual reports and accounts of the Contractor;
• a notification requirement where a Financing Default has occurred under the Senior Financing Agreements and, following such default, a right to request the production of an Interim Project Report and meetings with the Contractor and the Senior Lenders to discuss such report; and
• other information relating to the Project which it may reasonably request.
This information may provide early warning of Contractor distress to the Authority.
- Step-in Rights - Contracts allow Senior Lenders to step-in (giving them the opportunity to resolve difficulties in order to preserve the value of their investment) and replace the Contractor with a new Contractor. The Authority also has step-in rights which allow it, in certain circumstances, to substitute performance of the Contractor's obligations under the Contract or (subject to prior rights of the Senior Lenders) to take over management of key Sub-Contractors.629
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629 See Section 29 (Authority Step-in) and Section 31 (Direct Agreement and Senior Lenders) for further details on Authority step-in rights.