Govt bids to stem PFI gold rush frenzy

Mike Yuille reports on how Government reforms may leave the City with the lion's share of lucrative PFI-related work. City pages edited by Richard Tyler.

Big City law firms are set to squeeze out the smaller players in the government's review of project finance initiatives (PFIs). The PFI, devised by the Thatcher government to bring private finance into public sector schemes, is set for a regulatory shake-up.

The big firms' complaint is that the profitability of PFI work is increasingly threatened as more firms scramble to compete for business. Low-balling fees on smaller local projects appears to be an increasing trend, squeezing profit margins to win the contract.

Though disorganised project management and a culture clash between the private and public sectors have been big factors affecting mounting costs and delays to projects, low-quality lawyering, say critics, is the most significant factor. Project lawyers in the City, who frequently advise the banks on local projects, claim that smaller firms are offering substandard services.

“I've been surprised by the unacceptably low quality of service from some smaller firms,” said David Courtney-Hatcher, projects partner at Denton Hall.

Andrew Preece, head of Herbert Smith's PFI team, said: “There's no doubt that some firms have bitten off more than they can chew. Smaller firms just don't have the resources or expertise to deliver the product.”

Some firms outside London can provide a good service, but they are hampered by a lack of cutting-edge resources, said Nick Bliss, head of Freshfields' PFI group. “PFI [is] seen as a new practice area, and under-equipped firms have leapt into it,” he added.

Typical projects work is highly complex. The two core areas are assembling project agreements with Government, project companies, subcontractors and operators of the facilities, and financing, involving banks and insurers. But other areas of expertise are also required, including employment, competition, procurement, tax, property and environmental law.

Large firms believe that they are best positioned to offer expertise in these areas. Clifford Chance managing partner Tim Steadman said: “The ability to integrate these two areas effectively is a skill which a small number of larger firms have developed in project work at a premium.”

But local law firms cannot be blamed for attempting to penetrate PFI as a growth area, as the field is booming.

“The situation from law firms' perspective is that the volume of work for the next few years is pretty robust, while the recession bites other areas of law,” Steadman said.

After a slow start in the late 1980s, PFI has now become a major growth industry. More than £10bn-worth of projects have been signed, and much of that is under now construction – as new hospitals, schools, prisons, roads or IT projects.

This month the Government announced another £4bn-worth of projects, from central departments as diverse as defence, health and the LCD, to be tendered over the next year.

The PFI Taskforce is largely to blame for the gold rush style frenzy surrounding PFI. “The Taskforce abandoned its plan for accreditation of advisors, on the basis that it would be too hard to do. They ducked the issue,” said Steadman.

“The Treasury's advice to local authorities is that they should go for quality advisors, but it is leaving them at the mercy of firms' marketing departments' sales pitches,” continued Steadman.

Courtney-Hatcher added that the Taskforce seems to be “paying lip service” to the quality issue. “They don't discourage local authorities from using smaller, local firms, who may be superficially attractive because of their local knowledge and price, but don't have the specialist expertise,” he said.

But this will change. The Government, having boosted the flow of PFI contracts this year, now aims to drive up standards of their execution. The move is a bid to cut costs and speed up implementation.

The Treasury's PFI Taskforce, led by former Linklaters partner Adrian Montague, aims to produce a set of standardised contracts and guidelines for PFI by the end of the year. “Parties have been crying out for standardisation of contract documentation for some time,” Montague said last month, when announcing a consultation exercise on the issue.

His comments found obvious support in the City. Steadman said: “There's a massive need for standardisation and management co-ordination by the public sector. Everything tends to be rather ad hoc, particularly in health and education, where local authorities are involved.”

But for those firms who are concerned about fees being driven down by the small players, Montague does intend to pinpoint lawyer fees. “With this [standardisation], legal and other costs should be sharply reduced,” he said.

But Herbert Smith's Preece believes that this will be ben-eficial for City firms in the long run: “If a transaction becomes more standardised, clearly there will be less work involved in each. There will [also] be time to handle more transactions.”

As a result, standardised contracts are supported by the big firms. Their view is that cutting costs and delays would be more readily achieved by ensuring that clients – particularly those in the public sector – are advised more thoroughly on appointing firms with the skills and resources appropriate to their needs.