Private Finance Initiatives can be lucrative for lawyers and even the publlic purse but they remain controversial, reports Cameron TimmisP
Last month, the government gave the green light to six NHS hospital private finance initiative (PFI) developments, worth nearly £1.5 billion in capital investment. This followed approval in March for the huge £1 billion Barts and the London NHS Trust PFI project – the biggest ever NHS PFI scheme – transforming Barts in Smithfield and the Royal London in Whitechapel.
So far a total of 76 hospital PFI schemes have been completed, with a capital value of more than £10 billion. Indeed, a great swathe of public sector investment – in schools, roads, railways, bridges, prisons, military barracks, libraries, courts, museums and leisure centres – is now PFI-funded. That looks set to continue: according to the Treasury’s PFI report in March, around 200 PFI projects have been earmarked for completion in the next five years, representing a capital investment of £26 billion – between 10% and 15% of its total investment in public services.
First conceived by Tory Chancellor Norman Lamont in 1992, PFI funding remains controversial. A method of public procurement in which capital projects – generally buildings – are designed, built, operated and financed by the private sector and then leased back to the public sector, usually for a 25-year term, PFI provided a means to boost public sector funding without increasing current borrowing.
In the past nine years under the Labour government, PFI has escalated rapidly. The concept of risk transfer is central to PFI – and to the lawyers’ role. In exchange for the opportunity to make a profit, the private sector assumes the risk of failure and ultimately not recouping its investment.
According to the Treasury, PFI is delivering. In a 2003 report, it cited that 88% of PFI projects were constructed on time, in contrast with 30% of projects under conventional procurement. Similarly, its research on 105 operational projects this year found that 89% were meeting service levels ‘always’ or ‘almost always’.
PFI’s detractors, notably UNISON, the UK’s largest union, see things differently. The union claims PFI ultimately costs the public sector more, because the private sector borrows at higher rates than the public sector and because of its high set-up costs – in part ‘due to expensive negotiations involving City lawyers’. In addition, UNISON claims that PFI schemes often go wrong.
Not all PFI schemes have been successful. A notable example was the Libra IT project for UK magistrates’ courts, in which costs rose from £146 million to £319 million – and which was described by Edward Leigh, chairman of the House of Commons’ public accounts committee, as ‘one of the worst IT projects I have ever seen’ and possibly the ‘shoddiest PFI project ever’. Even the Treasury acknowledges that IT projects have been a thorn in the side of PFI: in 2003, it said IT projects were not suitable for PFI funding, citing difficulty in establishing long-term requirements because of the pace of technological change.
Law firms involved in PFI are among its most ardent proponents. South-west firm Bevan Brittan boasts a team of 40 PFI specialists and was the first firm to close a PFI project under the Building Schools for the Future (BSF) programme (for Bristol City Council in July), for which it drafted the standard documentation. It has also advised on 23 out of 40 NHS local improvement finance trust (LIFT) PFI schemes, aimed at improving primary health care.
‘All of this is about delivering improved infrastructure to the public sector,’ says Chris Jarman, head of the firm’s PFI practice. ‘It is not a cynical means to take power away from unions or pay public sector workers less.’
One benefit of PFI cited by many lawyers is that unlike conventional public procurement, where contractors’ obligations end with construction of a building, assets such as buildings or equipment will be properly maintained for the duration of the contract under PFI schemes. ‘The big theory behind PFI is that it will bring down whole-life costs because the public sector will have a product with low maintenance costs,’ says Patrick Finch, PFI head at national firm Pinsent Masons. However, as Mr Finch observes, most PFI contracts still have another 20 years to run, making it ‘too early’ to fully assess their true benefits.
Others argue that PFI imposes greater discipline on public procurement. According to Andrew Petry, a PFI specialist at magic circle firm Freshfields Bruckhaus Deringer, PFI funding ‘forces the public sector to live by the decisions it makes, because it puts a price on them changing their minds later’.
Public sector lawyers are more guarded about the benefits of PFI. ‘Whether a deal is struck will depend on value for money at the end of the day,’ says Birmingham City Council chief legal officer Mirza Ahmad. The council has completed one PFI schools project – a ‘great success’ according to Mr Ahmad – and is evaluating a second PFI project, for highways. He adds: ‘It’s wrong to say that just because a union has a negative view it will not be successful… we will look at the whole package.’
Whatever its merits, few would deny PFI has been a bonanza for law firms. To date, says Mr Jarman, Bevan Brittan has closed around 200 PFI deals and has another 200 on its books. At Pinsent Masons, PFI work, including related overseas work, now accounts for 6% of the firm’s turnover, according to Mr Finch.
It is lucrative work too: to take one example, for its work advising London Underground Limited on the London Underground PFI, which completed in 2003, Freshfields netted £29.3 million in fees.
Whether the PFI pay-outs will continue is less clear. A key trend in the past few years has been the use of standard contracts. In June 2004, the Treasury published a third version of its ‘Standardisation of PFI Contracts’ or SoPC 3, which is mandatory for all PFI projects. Other government departments, notably the Department for Health, have launched sector-specific PFI contracts. ‘That has brought the costs down, and certainly brought advisory costs down,’ says Mr Jarman. Eight or nine years ago, almost everything was being negotiated, with particular sticking points, including issues such as insurance liability, force majeure clauses and ultra vires. Today, says Mr Jarman, most of these issues have been ‘put to bed’.
‘There is not the same level of in-depth negotiation that there used to be,’ admits David Fennell, a PFI partner at Birmingham’s Wragge & Co, ‘but these are multi-million projects and therefore there are still sector and project-specific issues that arise.’ In practice, he says PFI work remains ‘very lawyer intensive’, with contracts ranging from 200 to 1,000 pages in length. In one of his recent projects, as many as 500 lawyers were involved in the deal, although 50 is more typical.
Law firms have also been quick to exploit other opportunities in the PFI market. One burgeoning area is in the PFI secondary market, where investors in PFI projects, like contractors, sell their investments to specialist PFI funds. For example, Innisfree, the country’s largest PFI investor, has a stake in around 50 PFI schemes, including the Barts and London NHS Trust PFI. ‘A lot of contractors need to sell to raise money to invest in a new project,’ explains Mark Berry, a senior associate at City firm Norton Rose, one of the leading firms in this niche market. ‘The secondary market started two or three years ago and has really come into its own. There are secondary market players involved in around 100 schools PFIs.’
Another opportunity for law firms has been in refinancing of PFI schemes, where PFI companies refinance their borrowing to take advantage of cheaper debt. Following a National Audit Office report earlier this year, which strongly criticised the refinancing of the Norfolk and Norwich University Hospital after the PFI consortium achieved a £95 million profit, such deals have been stuck on the ground.
This month, however, THG, the consortium running the Swindon NHS hospital PFI, did successfully complete a refinancing, indicating perhaps that more schemes will go ahead. Mr Petry, who advised the lenders in this refinancing, notes the considerable ‘upside’ for the public sector in PFI refinancing: since 2001, profits from all refinancing of PFI schemes must be shared 50/50 between the public and private sector. He says that has netted the public purse more than £200 million so far.
Whatever the criticisms of PFI, it seems that it is here to stay. With the public benefiting from new facilities and not thinking about what may happen 25 years down the line, it is not just the lawyers who will be pleased about that.
Cameron Timmis is a freelance journalist
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