It's not easy, but firms negotiating PFI deals must identify the risks they're running. Here's how to go about the job
A key driver behind any successful project is the proper identification and allocation of the construction risks. This is as much true for projects procured on a traditional basis as it is for those procured using debt finance. The consequences of getting it wrong in both cases can wipe out the profit margin 鈥� or lead to significant losses.

Project finance does not, by itself, add any areas of construction risk that are not encountered in more traditional projects. However, in PPP or PFI, the contractor is typically asked to take on greater risks, given that the special purpose project company acting as employer does not have any spare cash to allow it to bear these risks. The contractor will therefore be expected to manage or to include those risks in its price; the latter being increasingly difficult given the very competitive marketplace.

A lot of time, effort and money is therefore spent in negotiating PPP/PFI contracts to establish procedures to manage risk. These procedures can be novel and complex, and compliance with them is necessary to gain any available relief. And they will certainly be new to those used to working with JCT forms and the like. Those who suffer from "bottom drawer syndrome" and tend to assume what the contract says without getting it out and reading it until there is a major problem, may therefore find that they have missed a trick or exposed themselves to much greater liability than they needed to.

Contractors can stay ahead of the game in three ways:

  • Sharing knowledge In many cases, the project drafting and negotiating team is dispersed at the beginning of a project and an implementation team is brought in. This new team will have a very steep learning curve to climb as they try to get to grips with a enormous number of complex documents and procedures, and start to build the job. It is critical that where the implementation team is different from the drafting team, it is given as much help as possible.

  • Understanding the relationship between the contract and the project agreement At the heart of this are the "equivalent project relief" provisions in the contract. These seek to ensure that the project company is generally liable to the contractor to the extent that it is able to get equivalent relief under the terms of the agreement between the project company and the procuring authority.

    Many of these procedures are not well understood and even less well implemented by contractors and project companies. Careful consideration of the contractor's rights and the project company's obligations needs to be given by the contractor's project team to what, particularly from a timing perspective, should happen if these procedures are not carefully adhered to.

  • Understanding the interfaces A defining feature of PPP/PFI projects is that there are many parties trying to interface with each other. For example, the design-and-build contractor may have an interface with a specialist equipment supplier, a hard facilities management contractor and a soft facilities management contractor, all of whom will have competing demands for access at the same time. At completion, for example, the design-and-build contractor will have an interface with the operations and maintenance contractor at a time when:

    a) the design-and-build contractor will want to be shot of the site and off the hook for liquidated damages;
    b) the lenders and the project company will want the contractor gone, too, and to lump as many outstanding issues as possible into the snagging box to enable payments to start;
    c) the operations and maintenance contractor is going to want to make sure that there is nothing wrong at all with the facility that has been built.

    PPP/PFI projects present contractors able to properly identify and price risk at the contract formation stage with great opportunities for improving margins on construction work.

    Such opportunities can however easily be squandered if those implementing the projects do not understand and therefore cannot take full advantage of the gains hard won at the drafting stage.

    • Postscript

    Ron Nobbs is a partner in the London office of solicitor Masons. Co-author Fraser McMillan is a partner in the Glasgow office.