United Kingdom | Publication | April 2020
On April 2, the Infrastructure and Projects Authority (IPA) issued guidance supporting vital service provision in PFI and PF2 projects during the COVID-19 outbreak (the IPA Guidance Note).
In this article, we consider the measures that PFI contractors are being asked to adopt, give our view on the practical steps PFI contractors (and their private sector counterparties) should take in response and consider the legal effect of the IPA Guidance Note and any steps taken by the parties as a consequence of it.
In summary, our recommendation is that PFI contractors should be seeking to conclude with contracting authorities a simple agreement (such as a counter-signed letter or agreed memorandum) that captures the nature of any interim arrangements to PFI contracts, has a schedule of changes and reservations being made, and which is a living document which is added to as the situation changes.
The IPA Guidance Note follows procurement policy note (PPN 02/20) that was issued last month by the Cabinet Office which requires authorities to act in a pragmatic way with all of their suppliers to ensure business continuity during this period. PPN 02/20 does not, however address PFI/PF2 projects specifically; it is still applicable and public authorities will have to read the IPA Guidance Note and PPN 02/20 together. For further analysis on the implications of PPN 02/20 please see our briefing here.
The overall message of the IPA Guidance Note is clear:
Putting the legal analysis aside, which we consider later in this note, the intention of the IPA Guidance Note is that the parties should act pragmatically to continue to deliver essential services, and from a private sector perspective the overall message is a positive one: PFI contractors should continue to be given (mostly) full payment, should be given adequate relief to reflect the circumstances and the contracting authorities should vary the contract terms pragmatically to achieve the right outcomes.
In the circumstances, it seems that a pragmatic response is called for from PFI contractors, and by extension, from their funders and supply chains. Although there is indeed legal uncertainty, an over-legal response by PFI contractors may not be the most effective approach.
Our view is that the logical response is for PFI contractors to follow the spirit of the IPA Guidance Note and the PPN 02/20 and confirm that they will work with the contracting authorities to do what is necessary, but, importantly, reserving their rights at the outset on all contractual matters.
We would recommend that PFI contractors use the issuance of the IPA Guidance Note as an opportunity to have a discussion with the contracting authority and to clarify its position towards the PFI contract over the coming weeks and months. This could be captured through a simple agreement (such as a counter-signed letter or an agreed memorandum) that captures the nature of any interim arrangements to the PFI contract, has a schedule of changes and reservations being made, and which is a living document which is added to as the situation changes.
A view might be taken that as long as full cash flow continues (including timely coverage of any additional costs incurred to address management of COVID-19 risks), it would be appropriate for PFI contractors to agree with the contracting authorities that they would not pursue certain matters contractually for the time being, and in return the authorities would not hold the failure of contractual notices against them. This would be on the basis that the parties should keep each other fully apprised at all times and work with full transparency on service impacts and costs. This is consistent with the existing PPN 02/20 guidance which suggested that suppliers in receipt of public funds should operate on an ‘open book’ basis during this period.
The IPA Guidance Note and PPN 02/20 both suggest that for performance-based contracts, the contracting authority should continue to pay based on the level of recent performance, recommending as the basis for this, the level of payment over the previous three months. While this may be fair for some projects, it may not be fair for projects which have recently had localised or unusual issues that are not reflective of their performance generally, particularly if the PFI contractor is now unable to take practical steps to remedy that performance, and any disruption in the most recent period due to COVID-19 should also be disregarded. We trust that contracting authorities will use common sense in applying this recommendation but PFI contractors may need to be prepared to argue the point if it would lead to an unjust outcome for them.
There could also be an express or tacit understanding that should be a reconciliation when the situation returns to normal, but since the focus of PPN 02/20 was on business continuity, it may not be appropriate for the contracting authority to seek to recover ‘overpayments’ at a later stage if this would cause hardship to the PFI contractor or the supply chain at that point. There may also be a question as to whether the parties should apply the IPA Guidance Note retrospectively to cover any adverse impacts felt to date; the IPA Guidance Note itself is not clear on this, but it would be consistent with PPN 02/20 to address this as part of any discussions.
From a funder perspective, the message in the IPA Guidance Note should be seen as positive news from a cashflow and default perspective. We assume that funders would want to be kept fully informed of the ongoing dialogue between their PFI contractor borrowers and the contracting authorities, in particular as to how the contracting authorities are planning to apply the Guidance Notice during the emergency period and what interim agreements are reached, so that funders will have clear comfort in terms of revenue certainty and that the projects will not be at risk of default. If they receive this comfort, funders will then have to consider whether they are happy to let project cashflows continue as previously expected, in particular to allow distributions to occur on operational projects, or to allow drawdowns to continue on projects in construction.
From a sub-contractor and supply chain perspective, typically on drop-down terms (through equivalent project relief mechanisms), they will need to be fully involved in all discussions on payment and service levels and should equally be encouraged to act in a pragmatic way so that the contracting authority will be confident that it is complying with the transparency expectations in PPN 02/20 when varying any aspects of the contractual outputs.
The IPA Guidance Note is expressly addressed at PFI/PF2 projects, the vast majority of which in the UK are now in the operational period, and the specific guidance is geared toward operational service outcomes and adjustment of current payment streams. It does not directly apply to PPP projects which were not funded through the PFI or PF2 programmes but which were structured on a similar basis without central government support, such as certain waste management, health sector and university accommodation sector projects.
In relation to non-PFI/PF2 projects, our view is that a similar approach should apply, and that PPP contractors under those projects should reach out to their contracting authority counterparts with the IPA Guidance Note in mind, and encourage them to reach similar accommodations which would give interim certainty to their funders and supply chains. The broader messages in PPN 02/20 should still be applicable, and it would be logical for the procuring entities on PPP projects to take a consistent approach to the IPA Guidance Note even if it is not directly applicable.
In terms of PPP projects which are still in the construction phase – of which there are anecdotally estimated to be about £6bn by value at this time – the impact of the IPA Guidance Note is less clear. The private sector typically retains full funding risk prior to services commencement, so the guidance as to maintaining cashflow is not directly applicable. There is significant uncertainty in the market as to whether ongoing construction projects are ‘essential service’ workplaces which should continue or not, and there are health and moral implications involved in how and whether to continue operations, particularly where this would involve people working in close contact, and different contractors are taking different views on this.
A high level of disruption is inevitable, and this disruption is invariably uninsured. There is likely to be a need for projects to be materially restructured when the emergency subsides, and there will be a difficult question for funders as to whether they should continue to allow drawdowns for projects which are being materially affected, particularly where it is not clear how long the disruption may last for and what economic position the project may be in at the end of the emergency. In many cases the legal allocation of risk will not be sufficiently clear at this point to guarantee what, if any, contribution may be available from the procuring authority to re-balance the project.
This is a difficult situation, and although the IPA Guidance Note does not directly address the point, we would suggest that contractors could seek to engage contracting authorities to take a similar approach, and invite an open discussion between contracting authority, contractor, supply chain and funder as to the stark choices that may apply if the government party does not take steps now to ensure business continuity. For example it may be appropriate that the parties reach an agreement that the contracting authority should cover standstill costs and debt interest costs during any construction downtime where this cannot be recovered in any other way. Notably, this is the standard-form approach taken on Force Majeure and Relief Events under the form of SOPC contract that was adapted by Infrastructure Ontario for their projects in Canada.
It is not immediately clear where the IPA Guidance Note stands from a legal perspective. In contrast to PPN 02/20, which was addressed to contracting authorities only, the IPA Guidance Note addresses itself both to PFI contractors and contracting authorities, and explicitly states what PFI contractors “should” do and “must” do. Moreover, it also explicitly states that “as a matter of contract, the Government does not regard COVID-19 as an event of force majeure”.
Given the very restrictive definition of Force Majeure in UK PFI/PF2 contracts, this interpretation may well be correct, but it should be noted that a guidance note does not affect the true legal interpretation of any individual contract, which is a matter between the PFI contractor and the contracting authority in question. For example, some contracts might well have an argument that the existence of COVID-19 (at the site, or generally) might amount to “biological contamination”. Some contracts (particularly those in the health sector) may also have specific provisions dealing with epidemics or medical contamination. The government’s statement should probably be regarded as guidance to contracting authorities not to lightly accept a claim for relief on grounds of force majeure. It should also be noted that the standard UK PFI/PF2 definition of Relief Event is unlikely to be relevant, although in a construction context the impact of cross-border trade might be argue to be an embargo.
That said, the issuance of the IPA Guidance Note may have some direct legal status in itself.
The definition of Law in PFI/PF2 contracts typically includes Guidance as a head. One typical definition of this is “any applicable guidance or directions with which the [Authority/Trust][and/or][the PFI contractor] is bound to comply”. It seems likely that the procuring authorities are directly bound to comply with the IPA Guidance Note, although it is less clear that a Guidance Notice would be directly binding guidance on PFI contractors, because they are private companies and not arms of government. Nevertheless, the PFI contract may well require the PFI contractor to comply with all guidance applicable to the procuring authority in that sector issued from time to time, and so it would become indirectly bound to comply through the PFI contract. But there may well be differences between the PFI contracts on this.
On the assumption that it is directly or indirectly binding, then the IPA Guidance Note would constitute a Change in Law, and there would be a good argument that it would class as a Discriminatory Change in Law, as it applies specifically to “persons who have contracted with the Government, a Local Authority or other public or statutory body to provide services under [PFI/PF2] and not to other persons”. The impact of a Discriminatory Change in Law is typically that it should leave the PFI contractor in a no better and no worse position.
In any event, if procuring authorities start to vary the contracts in a manner consistent with the IPA Guidance Note to achieve its purpose, we would expect that the precise changes would be treated locally as an Authority Change/Variation, and the impact on the PFI contractor should ultimately be addressed through the Change procedures, which should in principle also leave it in a no better and no worse position.
Aside from this, the existing imposition of restrictions on personal movement already announced by the government may themselves have a contractual effect as a Change in Law, albeit as a General Change in Law, although the protection available to the PFI contractors will be less extensive.
Given the fast-moving nature of the emergency, it may be difficult to match practical steps against legal and contractual positions in real time, and if parties take an approach which is overly legal it may hinder efforts where they should be focused: i.e. on providing necessary services in the time of an emergency and also ensuring business continuity during and after the outbreak.
This is clearly an emerging situation, and we envisage that the implementation of the IPA Guidance Note by different contracting authorities is likely to give rise to different solutions. It will be critical for businesses with interests in multiple projects with different government counterparties to try and take a consistent line and encourage government to do so. A consistent approach by government across its projects will also provide strong comfort for the funder and supply chain community.
Update
The COVID-19 pandemic poses immediate and future challenges for businesses on a global scale with unavailability of workforces, disruption to international supply chains and the inevitable impact on cash-flows. Businesses need to shore up their financing arrangements for a bumpy period ahead.
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