1.61 The Armouries was aware that RAI was in financial difficulties. It knew that visitor numbers were lower than expected and that RAI had made staff redundant in 1997. The Armouries also learned of the refinancing by RAI in 1997 soon after it occurred. However the Armouries had difficulty getting information on the exact extent of RAI's financial difficulties. Although the Armouries did receive information on daily visitor numbers and spend per head and copies of RAI's annual accounts when published, it had no rights of access to RAI's underlying financial records and no rights under the contract to be informed of financial difficulties. The Armouries only became aware of the actual extent of RAI's financial difficulties in September 1997 when RAI's annual accounts for 1996 were made available to them. Access to the annual accounts was of limited use as these only gave the historical position. The Armouries had no access to RAI's business plans with its forecast of RAI's future performance and RAI's strategy for dealing with its financial problems. Nor did the Armouries have access to RAI's management accounts which showed RAI's financial performance across the whole of its business. Consequently, when attempting to identify RAI's likely future performance in 1998 and 1999, the Armouries and the Department had to rely to a great extent on their own estimates.
1.62 In view of RAI's financial difficulties in December 1997 the National Audit Office, as the Armouries' external auditors, suggested strongly to the Armouries, amongst other things, that the Armouries should consider a clear risk assessment of all available options, with the benefit of robust, critical input from advisers with appropriate project finance skills and experience, to help safeguard its position. In particular this assessment should consider whether the proceeds from the Clarence Dock redevelopment would be sufficient to solve these difficulties and, if not, what risks the Armouries faced in the medium term.
1.63 In response, the Armouries commissioned in early 1998 a review from Schroders of the risks associated with the joint venture, with and without the potential development agreement for Clarence Dock. Using information supplied by RAI, this review examined the future financial viability of RAI and the consequences if RAI failed. Schroders reported in July 1998 that, if the Armouries did not support the Dock development, there was a significant risk that RAI's financial position would deteriorate, possibly leading to insolvency. However, if the Armouries did support the redevelopment, it was likely that RAI would eventually become profitable, although, in the medium term, the construction work arising from the redevelopment was likely to have an adverse effect on the visitor numbers.
1.64 Schroders considered that RAI would eventually become profitable for two reasons. Firstly, RAI would use its share of the proceeds arising from the Dock development to pay off some of its debts and so reduce its borrowing costs. Secondly, the completed development would boost visitor numbers through increased passing trade. However the Armouries disagreed with these two assumptions. As a result of external factors and increases in the costs of site preparation, the level of development proceeds, and therefore RAI's share, had been reduced. In the Armouries' view all of this reduced RAI share would have to be used by RAI to meet the increased losses arising from decreased visitor numbers during the development construction work. None would therefore be left to reduce RAI's borrowing costs. The Armouries also felt that the underlying assumptions about visitor numbers used by Schroders were too optimistic.
1.65 Thus, by the end of 1998 the Armouries considered that the development gain was unlikely to be at a level to solve RAI's financial problems and that RAI would continue to make losses. Also, RAI's total loans had further increased to £15.8 million. RAI had expressed to the Armouries and Department in October 1998 its willingness to work on joint proposals with a view to ensuring the museum's long-term viability. The Armouries therefore met with the Department in November 1998 to discuss how it should work with RAI to solve these problems. The Armouries decided to seek an increase in its own grant-in-aid funding in order to meet the new museum's deficit and to persuade RAI's bank to continue to support the project.