Fighting time: why PFI claims are on the rise


Is a looming legal time limit behind a rise in defect claims relating to long-completed schemes built under private finance intiatives? 

In autumn 2021, North Kent Police Station’s geothermal heating system broke down. Almost three years later, the administrators of the company holding the station’s private finance initiative (PFI) brought a claim against contractor Kier for million of pounds. The dispute is just one of a raft of PFI contract issues to hit well-known construction industry names recently. So what’s causing this trend, more than a decade after PFIs were scrapped?

The PFI funding mechanism was spearheaded in the final years of John Major’s 1990s Conservative Government, before becoming a key plank of the subsequent New Labour administration’s public sector building programme. Hospitals, police stations, schools and other assets were built using private money and then leased to public sector organisations, usually for terms of around 30 years. Clients remain liable for maintenance service charges and interest as well as repayment of the building costs. Each project had its own PFI company, known as a special purpose vehicles (SPV), set up to deliver and maintain the asset. SPVs were, initially at least, usually consortiums made up of the contractors that built the assets and institutional investors that provided capital.

“At the time there wasn’t really an expectation that there would be an ability to sell on the equity”

Patrick Waterhouse, Bowdon Consulting

In theory, PFIs offered low-risk building contracts with no upfront payments for the public sector, and the SPVs could rely on long-term returns. However, the original PFI model was scrapped by the Coalition Government in 2012 following criticism that it lacked transparency. Critics also said that PFI terms were weighted in favour of the private sector over public clients.

According to the Infrastructure and Projects Authority (IPA), more than 550 PFI contracts were still operational in summer 2021. Analysis by the Whitehall body found that those projects represent an initial capital expenditure of £46bn and are set to generate £244bn in total payments from the public sector to SPVs over their lifetimes.

Austerity

The schemes were taken up with enthusiasm by the public sector to get assets like new hospitals and roads delivered at scale without paying for them upfront, recalls Patrick Waterhouse, who worked on PFIs in the mid-1990s while at Wimpey and then Tarmac Contracting. The government successfully aimed to create a private sector asset maintenance business that could take “intelligent, strategic decisions rather than just be responsive”, he says. “The organisations who do facilities maintenance of roads, schools and hospitals today, just didn’t exist in the early 1990s.”

Waterhouse, who is now an adjudicator and director at Bowdon Consulting, has witnessed the rise of PFI disputes. He says one of the big causes is the decline in cash available to public sector bodies, compared with the era in which the contracts were drawn up. “I remember being in a workshop in a local authority with a highways PFI project. They said ‘we’re having to take 25 per cent out of our highways budget but we cannot touch this bit of the budget at all because it’s PFI and we’re locked in long term, so we’re having to take more than 25 per cent of everything else,’” he says.

“Investors are looking at the UK and going, it’s not great, we don’t have a pipeline to build”

Alison Fagan, DLA Piper

In many cases, astute SPVs negotiated reductions in service or expenditure with their clients, but in some instances, the parties were less flexible, Waterhouse says. He adds that there is “a very healthy market in PFI claims consultancy”, with specialist firms set up to advise clients on how to withhold payments over apparent defects. This practice, known as deductions, often prompts disputes, and can put SPVs out of business.

Around a month after the heating failed at North Kent Police Station, the company holding the station’s PFI, Justice Support Services North Kent (JSS), installed an oil-powered replacement in the station’s car park. JSS filed for administration in December 2022, nine months after Kent Police began withholding payments to the company on the basis that its car park had been put out of use.

Kent’s police and crime commissioner terminated the PFI contract in August 2023. This prompted JSS’s administrators at AlixPartners to issue legal claims against the client for “engineering” the collapse of JSS, and against Kier over alleged defects in the building. Legal papers seen by Construction News show AlixPartners is pursuing the police and crime commissioner for £38.8m.

Meanwhile, the administrators want at least £18.3m from Kier to cover the costs of the alleged defects, including the heating failure. If the claim that the police pushed JSS into administration is unsuccessful, it will be brought against Kier instead, the papers show.

This is not the only case involving a contractor that has delivered PFI work. In its accounts for the year to 31 December 2022, Vinci Construction UK cited its facilities management work for the Coventry and Rugby Hospital Company at the Coventry and Rugby University Hospital as being
a cause of its overall loss.

The hospital had stopped paying the SPV before terminating its contract over alleged performance issues, and the Coventry and Rugby Hospital Company SPV went into administration in May 2023.

Lendlease’s 2023 profit was also hit after it was ordered to pay £5m to a PFI company for fire-safety defects found in St James’s Oncology Centre in Leeds. Lendlease then tried to win back £3m of those costs from consultancy Aecom for 18 of the 25 defects, but it was unsuccessful as the claim was outside the 12-year limitation period.

Lendlease and maintenance company Equans, owned by Bouygues UK, are also being pursued by an SPV over alleged defects at five schools in Burnley, Lancashire, built from 2007.

Why now?

A major reason for the recent increase in PFI disputes is the contractual time limitation for when claims can be made – usually 12 years. This has led to clients carrying out surveys of their assets just before the expiry period so they can issue claims if defects are identified. For many PFI projects this point has recently passed, so disputes resulting from this are working their way through the courts. “I don’t think that there are necessarily more problems on projects but the majority of PFI projects completed 10-15 years ago,” says Alison Fagan, a partner at law firm DLA Piper. “Because of statutory and contractual limitation, proceedings have to be issued to protect rights to claim.”

When the PFI policy was being established, one of the claimed benefits was that the ongoing contractual relationship between the client and SPV would improve quality, as builders would still be involved in maintaining their asset for decades. In reality, what followed was a wave of contractors selling their stakes in SPVs to financial institutions.

Some still hold shares in SPVs, but many sold theirs years ago. “Wimpey and Tarmac went into PFI to keep winning the big projects they’d always built,” Waterhouse recalls. “At the time there wasn’t really an expectation that there would be an ability to sell on the equity. I remember when it started happening there was surprise in a number of companies as to the value of the investments they held, but I guess the moment you set up any type of market with a long-term income stream, there is an asset that can be traded.”

Another result of those sales is that contractors can face legal claims from companies that they previously owned a part of. For example, Kier owned 42.5 per cent of JSS, before it sold its stake in 2013. And until 2016, Lendlease owned 50 per cent of the Lancashire schools PFI company that is now suing it.

So would there be fewer  PFI disputes now if more contractors had continued to own shares of the SPVs? “From a legal perspective, where there’s a contractor-equity split, they are run as quite separate businesses and always have been,” says DLA Piper’s Fagan. “In that sense, even if building contractors were still involved in the SPVs, they would have a duty as directors to act in the best interests of that SPV and wouldn’t be able to tell the PLC what was going on or vote in decisions. In reality, if they were still there, would someone at PLC group level go, ‘I’m not going into court with you on that side and you on that side’? Maybe heads would be knocked together and resolutions would be reached.”

Fagan, who does not refer to any specific company in her answers, adds that she does not think equity retention would have had a major impact on the number of disputes now taking place.

More to come

Data from the National Audit Office states that in the five years to 2024/25 an average of 10 PFI contracts will expire annually. This number is set to rise to more than 20 in 2026 and more than 30 a year in the late 2030s. An analysis of the PFI sector commissioned by the IPA in 2023, which involved interviewing more than 160 people working with the contracts, found the “prevailing view” was that more disputes are expected to take place during the process of handing assets back to the public sector. This is because of a widespread lack of contractual clarity about the condition assets should be in at the end of their terms. The analysis, known as the White Fraiser Report, called for all parties to the schemes to try to act cooperatively before issues become disputes.

Melanie Pears, head of public sector and a partner at law firm Ward Hadaway, points out that there may be an upside for contractors in the number of assets due to be handed back. In cases where there is no longer any liability for fixing the problems found, there is likely to be a rise in remediation work going to tender, she says.

Fagan, meanwhile, warns that PFI issues are not separate from the rest of the building “ecosystem”. She calls for a clear future building pipeline from the government and warns that public sector client behaviour on current contracts could have a direct bearing on the future investment picture. “Investors are looking at the UK and going, it’s not great: we don’t have a pipeline to build, there’s quite a lot of political risk because the public sector is applying quite aggressive deductions, actually why don’t we go elsewhere and build great infrastructure and make solid returns?

“We’re losing people, we’re losing skills, we’re losing engagement in UK infrastructure,” she
says. “What is happening now is really relevant to what the industry will look like over the next 10-20 years.”

What steps can contractors take to avoid becoming involved in litigation?

Ward Hadaway partner and head of public sector Melanie Pears says sale agreements need to be thoroughly examined. “A number of contractors were originally the major or the sole shareholder in the PFI provider. What they’ll need to do is carefully check that when they sold their shares, normally to an investment company, they didn’t create an extended liability period,” she says.

“I’ve experienced a situation where a contractor did agree that it would be responsible for any defects or issues for the whole 25-year term of the PFI contract [in its sale agreement].”

DLA Piper partner Alison Fagan adds that proactively checking assets can help reduce the costs of disputes – even if doing so turns up problems.

“I think if contractors find something on one project they should move proactively be getting in front of the problem, bring it to the attention of the stakeholders on other projects with a plan to investigate and resolve it proactively,” she says.
“And try to do so before someone else finds it and presents it and it essentially becomes a bigger and more contentious issue to unlock.”



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