NAO recommendations arising from the Fazakerley prison refinancing (June 2000)
1 Departments should give careful consideration to refinancing issues when preparing an Invitation to Tender and when developing a PFI contract. They should address whether they should establish within the PFI contract the right for them to share in refinancing benefits.
The OGC's revised guidance on refinancing, published in final form in July 2002, requires refinancing to be addressed in the standard contract terms that are set out as part of the procurement. These require departments to have the contractual right to share, in most situations, 50/50 in the benefits arising from refinancings as defined in the guidance.
2 Departments should set out unambiguously in their PFI contracts the circumstances in which they would be required to consent to part, or all, of a proposed refinancing. These should include any situation which may have adverse consequences for departments, for example by increasing their termination liabilities.
The OGC's revised guidance requires departments to have the contractual right to approve any refinancing as defined in the guidance. It also states that, where a proposed refinancing involves an increase in termination liabilities, contractors will generally need to secure the authority's consent both to the refinancing itself and to the change in termination liabilities, as these rights are separate and distinct.
3 When faced with a refinancing, departments should enlist the help of experienced legal and financial advisers. This can assist departments in understanding the full implications of the refinancing proposal and in establishing the best way to approach any negotiations.
The OGC's revised guidance says that it is very likely that authorities will need to seek the assistance of appropriate legal and financial advisers.
4 Where departments are likely to be exposed to increased termination liabilities as a result of a refinancing, in the absence of an acceptable agreement on the sharing of refinancing benefits, they should consider whether to limit their risk. They may be able to achieve this by capping the liabilities they are prepared to accept or by requiring the private sector to underwrite the risk themselves or through a third party.
OGC guidance requires departments to have the contractual right to approve any increase in termination liabilities (whether arising from refinancing or any other circumstances). In practice, this gives departments the right to decide whether to accept all, some or none of the proposed increase in termination liabilities. Although the revised OGC guidance does not specifically deal in any further detail with limiting increases in termination liabilities, the guidance also states that departments will be unlikely to agree to a refinancing that increases termination liabilities unless the additional refinancing gain available to be shared is judged to represent better value for money than a refinancing that does not involve such an increase in termination liabilities. The OGC and PUK consider that, as a result of this requirement, it is unlikely that departments will approve increases to termination liabilities arising from a refinancing.
5 Where a department has the flexibility to negotiate over refinancing benefits, it should prepare a robust but reasonable negotiating strategy taking account of the alternatives if a negotiated agreement cannot be reached.
The revised OGC guidance for new contracts sets out the sharing arrangements, normally 50/50, for refinancing benefits expected in new contracts. There should therefore be no need for departments to enter into negotiation over the sharing of refinancing benefits. In respect of existing contracts, the OGC is seeking agreement from the private sector that departments will generally receive 30 per cent of future refinancing gains (on contracts other than those that already provide for the public sector to receive a specific share). If this strategy comes into operation, this will also remove the need for negotiations on each refinancing of an existing contract. Previously, since November 2000, the OGC's advice in respect to refinancings of existing contracts was that departments should seek an equitable outcome that would protect taxpayers' interests and be defensible publicly, and to seek 50/50 sharing if the department's approval for the refinancing was sought.
6 Departments should consider linking at least part of their advisers' remuneration to the outcome of any negotiations to which the advisers contribute.
This is not specifically dealt with in the revised OGC guidance but, for the reasons noted in paragraph 5 above, contract-by-contract negotiations over the sharing of refinancing benefits should not normally be necessary.