2.13 It is usual on other PFI deals to have a direct agreement between the private sector party's lenders and the public sector client procuring the service. A direct agreement is the term given to an agreement between the public sector body letting the PFI contract and the senior lender to the project which is put in place when the original PFI agreement is signed. It deals with their relationship following the early termination or threatened early termination of the contract for a number of reasons, including default by the private sector party.
2.14 PFI guidance makes it clear that in certain circumstances direct agreements can benefit the senior lender in the event of possible termination of the contract. These circumstances include projects where the lender has no right to sell the project assets, and therefore security for their financing is limited to rights against sub-contractors and amounts in the bank accounts of contractors. Exercise of these rights by the banks is consequently unlikely to lead to full repayment of the outstanding debt. The National Audit Office considers that, on this deal, the bank's rights over the museum were not as strong as was thought because of the restrictive covenants in RAI's sub-lease. The Department disagrees with this assessment. The Department's view, based on advice from the Armouries' legal advisers, was that the payment required by the Receiver, on the Bank's behalf, could have been substantial as the provisions for a moratorium period of at least two years would have given the Receiver a strong hand in negotiating the terms and the level of this payment (paragraphs 1.67 to 1.71).
2.15 Guidance also considers that direct agreements can be advantageous to the public sector as they give senior lenders an opportunity to "step in", if they so choose, to save a project in difficulty before a contract is terminated, and so avoid the need for direct involvement by a department, and the disruption to the service following a termination. During the step-in the lender is given the opportunity to rectify performance failures or breaches of the contract.
2.16 In the case of the Armouries, there was no direct agreement providing the senior lender with step-in rights following a termination or threatened termination of the contract. The existence of such an agreement is no guarantee that a bank will choose to step in. Similarly, if RAI's bankers had truly wanted to step in to save this deal, they could still have asked the Armouries whether they could step in to attempt to save the museum even without such an agreement.
2.17 However the existence of a direct agreement on this deal would have benefited the Armouries. It would have created a direct relationship between the Bank of Scotland, RAI's lenders, and the Armouries and thus have strengthened the Armouries' position when asking for meetings with the Bank to discuss RAI's financial problems without RAI being present (paragraph 1.66). Under a direct agreement the private sector partner's banks would also have to tell the public sector body if the partner was having difficulties meeting its loans. The Armouries would therefore have got to know immediately of RAI's difficulties in meeting its debts.