Is Lambeth the future of local authority PFI?

The Labour government has new plans for PFI. Andrew Walsh argues that the recent contracting out of Lambeth Council's services could point the way forwardA prime candidate for new Private Finance Initiative activity must be the local government sector, heavily regulated under successive Conservative governments and suffering a backlog of investment in infrastructure and services.

The recent externalisation of Lambeth Contract Services, the direct service organisation of the London Borough of Lambeth, may provide a blueprint for future local authority PFI projects.

To date PFI has been slow to develop in the local authority sector, for several reasons.

The structure and rules for local authority PFI have developed in a piecemeal fashion since the introduction of PFI in 1992, giving the impression of a “moving target”. This, combined with the complexity of those rules, has been a disincentive for authorities and private sector contractors.

Banks and other institutions have not forgotten the painful lessons of local authority ventures in currency trading. The recent decisions in the Allerdale and Waltham Forest cases – which found that council officers involved in PFI schemes were personally liable when the schemes collapsed – were hardly an encouragement to prospective investors.

The constraints placed on local authorities by Part V of the Local Government and Housing Act 1989, which regulates the involvement of local authorities in corporate joint ventures and cuts their government funding if they have more than 20 per cent of the shares.

Finally, many authorities have a political and cultural resistance to transferring local authority staff to the private sector. While the General Election was in prospect, most authorities simply adopted a “wait and see” approach.

A change of attitude

However, in recent months there has been a noticeable change in attitude towards PFI in the local government sector.

In part this is because of the recent consolidation of the rules relating to local authority PFI, the announcement of a group of PFI “pathfinder” projects by 4Ps (an advisory body established by the local authority associations) and the recognition that under a new Labour Government the current structure is likely to remain in place.

In addition, many authorities accept that essential funding for improved facilities will be available only through PFI and, if linked to improvements in management and working practices introduced by a private sector partner, may provide an acceptable trade-off to justify the voluntary outsourcing of local authority services.

Target areas for PFI funding by local authorities include schools – where there is an estimated £3.2bn backlog of maintenance and repairs; local authority road schemes; and property Design Build Finance Operate (DBFO) schemes – including office accommodation, leisure centres and car parks and IT systems, for Revenue and Benefits services and other service applications.

Current structure and rules

The Local Authorities (Capital Finance) Regulations 1997 came into effect on 1 April 1997 and consolidate changes to the local authority capital finance regulations made since 1990. These provide incentives to authorities to seek private finance for DBFO projects. There are two new key elements.

First is the transfer of risk of operational performance to the private sector contractor, based on what is known as the “contract structure test”. This requires that at least 20 per cent of payments under relevant contracts are based on performance – related to quality of service provision and/or rate of usage of the relevant asset.

Second, the regulations provide that value for money should be provided by the contractor, involving a comparison with a public sector comparator.

The principal benefit to a local authority of meeting the PFI requirements is that the contract will have no initial capital cost, which means that its regular payments to the contractor will not count as capital expenditure and will not eat into the limited amount the authority is allowed to borrow. In addition, it means that it can claim a revenue support grant from the Department of the Environment to help make the payments.

The authority must itself decide whether its scheme satisfies the contract structure test, before it is submitted to the District Auditor.

Legal advisers will play a key role in this process, assisting client officers to develop output specifications (most authorities are familiar with the detailed and prescriptive specifications required for CCT contracts), to devise key performance indicators and to liaise with DoE officials and the District Auditor to develop a structure which meets the contract structure test.

Lambeth project

The Lambeth project (which completed last month) comprised a sale of the assets of Lambeth Contract Services, the transfer of about 1,800 LCS employees and the award of 17 contracts to Lambeth Serviceteam, a joint venture established between the authority and Serviceteam Group (the authority's trade partner).

It is the largest externalisation to date in the UK of local authority contract services, involving aggregate contract payments of about £350 million.

The authority will claim PFI credits from the Department of the Environment for the capital part of the payments it will make to the contractor. This covers items like new dustcarts.

This demonstrates that the local authority DBFO rules, originally designed to provide private finance for buildings and other capital investment, can extend to the private provision of services, where there is a capital expenditure element involved.

Serviceteam and Lambeth created a corporate joint venture, in which Lambeth holds shares and is represented on the board. The council will have less than a 20 per cent share to avoid obtaining “influence” over the company – thereby avoiding potential transactional, accounting and capital finance restrictions.

In addition, the authority has certain entrenched rights and involvement in policy and contract monitoring arrangements.

Lambeth and Serviceteam have created a long-term collaborative partnership, quite different in nature from the arms-length relationship between client and contractor under Compulsory Competitive Tendering arrangements.

The two will share cost savings, will use non-contentious dispute resolution and will collaborate on policy decisions and commitments to improving services.

It is unlikely that the new Labour Government will legislate to change fundamentally the current capital finance system for local authorities in the short term, but will instead make some adjustments to the current system and rules.

The Lambeth project demonstrates that it is possible, under the current system, for local authorities both to obtain PFI credits and to develop a long-term partnership dedicated to improving service quality and providing value to the taxpayer. It is our belief that it will provide a model for local authority PFI under New Labour.

Andrew Walsh is a public sector partner at Pinsent Curtis who led the legal team which advised Serviceteam.