Recommendations referring to Termination Liabilities

Recommendation 

Report Source

Treasury response on the extent to which action has been undertaken in order to meet the recommendation1

1  Where departments are likely to be exposed to increased termination liabilities as a result of a refinancing, in the absence of reaching 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 placing a cap on the level of termination liabilities they are prepared to accept, or by requiring the private sector to underwrite the risk themselves or through a third party.

1 
NAO

Specific guidance for an Authority on value for money in refinancing has now been introduced. The Application Note - Value for Money in Refinancing clarifies interpretation of value for money.

2  There may be a good case for the public sector to make payments to the external financiers on termination of a PFI contract. It is, however, unacceptable that a department should accept without full compensation any risk of having to meet higher termination liabilities as a result of a refinancing which would greatly benefit the private sector shareholders.

2 
PAC

The Treasury accepts the Committees' recommendation. All qualifying refinancings are now subject to gain sharing arrangements as required by either the voluntary code of conduct on refinancing or the standardisation of PFI contracts.

3  Departments should take early legal advice when developing PFI contracts to limit their exposure to increases in termination liabilities during the contract period. They should develop contracts which unambiguously give them the right to approve any arrangements which might increase those liabilities.

2 
PAC

This requirement has been present in the standardisation of PFI contracts since July 2002.

4  No department in a PFI deal can afford to relax its guard against perverse incentives which might tempt the private sector side, in adverse circumstances, to cut and run. In this case, such a risk might theoretically arise because the Prison Service's greatest exposure to additional termination liabilities would occur at a time when the private sector shareholders would have received most of the benefits of the refinancing and their company would be facing additional costs. In such a situation, the shareholders might become less concerned about their company's performance at a time when the costs to the Service of terminating the contract would be at their highest.

2 
PAC

We note the theoretical concern expressed here but take comfort from the fact that the lenders to the project, who generally provide in excess of 90 per cent of the risk capital, have a substantial ongoing interest in the project and would therefore facilitate that the project finance is sensibly structured and risks borne in such a way as to minimise the impact on the equity investor's attempts to cut-and-run.

5  Departments should assess the risk of contract termination, taking account of changes to a consortium's cashflows which are likely to occur during the contract period. This risk assessment should then be used by departments to devise a pattern of rewards and penalties which continue to incentivise the consortium throughout the period of a PFI contract.

2 
PAC

The risk of additional liabilities for the Authority from contractor default following refinancing has been mitigated by the arrangements put in place in the standardisation of PFI contracts first implemented in July 2002.