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8 January 2014
The last few months have not been kind to the PFI industry. The usual hostile commentators appeared to be justified in their scepticism on the share prices of leading companies - Amey, Jarvis, Balfour Beatty et al - as they dropped sharply and the Labour Party conference voted against future projects. But away from the deluge of pessimism, last month a ray of sunshine came along in the form of a new National Audit Office (NAO) report.
"The theory is that PFI should incentivise the private sector to deliver good-quality buildings on time and to the price agreed with the public sector. The results of our census show that this is being achieved in central government," declared NAO head Sir John Bourn.
As always, PFI professionals believe that the bad press is undeserved and lawyers are no exception. "PFI seems to be in a PR pincer," reflects Barry Francis, head of the major projects group at Pinsent Curtis Biddle. "Some people are saying that it's all doom and gloom because share prices are falling. On the other hand, you have the critics saying that the private sector is making too much money out of the public sector."
Someone has to be wrong. It is a point that David Lee, projects partner at Allen & Overy, echoes. "It can't be bad for both the pubic sector and the private sector," he says. "If somebody is ripping somebody else off the critics of PFI need to decide who's ripping who off."
In fact, the NAO gave PFI a clean bill of health. The Government's spending watchdog revealed that under PFI only 22 per cent of public building projects had exceeded the cost expected by the public sector at contract award - a "dramatic improvement" on a previous survey of public building projects in 1999, which found that 73 per cent had overshot the cost expected by the public sector. In addition, under PFI only 24 per cent of public building projects had been delivered late, with just 8 per cent being delayed by more than two months. This was another substantial improvement on the previous survey, which found that 70 per cent of building projects had been delivered late to the public sector.
Nevertheless, the perception of private sector excess at the expense of the public sector persists and there is more pressure than ever on lawyers to deliver value for money, especially at the bidding stage. Add to that last year's Urgent Issues Task Force Abstract 34, which had a dramatic effect on the PFI industry. 'Abstract 34' means that companies must charge as expenses in their profit and loss accounts any costs incurred before it is 'virtually certain' that a PFI contract will be signed. This had a dramatic effect on Amey, decimating its profits and sending sizeable shockwaves through share prices elsewhere in the industry.
But Lee believes that the troubles at the end of last year were short-lived. "It didn't mean that these companies actually had any less cash, it just looked like they had less profits than before," he says.
"Share prices need to be put to one side," agrees Stan Gniadkowski, a projects partner at Denton Wilde Sapte. "The stock market is a relatively short-term beast whereas these projects may well be 60-year projects and the companies that are investing take a much longer view." According to Gniadkowski, the rule change might have been a big issue for the likes of Amey but not for the likes of Laing, who take a more "prudent approach" to their accounting practices.
Nonetheless, it means that bid costs - and their legal component - will come under greater scrutiny than ever. There has already been a drastic cutback in the amount of tender work available as PFI companies become more selective about projects, and some, such as Carillion, have slashed their legal panels in response to this more cautious climate. Francis says that he has seen the number of bids in the healthcare sector halve in the last two years.
According to Lindsay Grist, director of private sector lobby group PPP Forum, the bidding process has been successfully streamlined. "It's very important that it isn't too expensive because it will mean fewer people will want to become involved and take the risk of not getting the contract if the costs are too much," she says. "And that is not just about lawyers' fees but it's about working with the Government on how the bidding process is organised." There must be enough bidders to ensure that there is a truly competitive tender and there are already concerns about a shortage of interested parties.
John Holden-Ross, a partner at Trowers & Hamlins and until last year legal director of Carillion Private Finance, has recently set up a PFI partnering scheme to help reduce the legal costs of PFI bids. Contract standardisation, for example, through last year's Office of Government Commerce guidance and more specifically in the healthcare sector, has done much to smooth the way, he claims. A survey by the NHS Finance Unit last year found that legal costs had fallen by 41 per cent since the introduction of standardisation. But Holden-Ross argues that a proliferation of approaches has devalued the status of a precedent. And standardisation does not cover the bid phase, he adds.
"The idea is to create a real focus around project bid deliverables in a binding partnering timetable, which will have real incentives for all parties, linked to compliance," Holden-Ross says. "Once the preferred bidder has been chosen, the timetable becomes a binding partnering timetable to financial close. The timetable will also tie-in the public sector." Trowers & Hamlins' existing project partnering contract, PPC 2000, has already been applied to new non-PFI projects worth more than £2bn.
Despite the pessimism, lawyers remain upbeat about PFI work. Gniadkowski points to what he calls a "secondary market" developing in the relatively young industry. He explains: "Effectively, what we are doing when we set up these markets is create land, a new asset class, which is capable of being securitised or being used to provide an investment for pension funds and insurance companies who need long-term returns."
Are clients more demanding in this environment? Yes, reckons Francis, but it is as much to do with a further maturing of the market than a response to the troubles that have beset PFI. "What you are seeing is not just bidders cutting down on the panels of lawyers, but the people in the consortium are now much more stable and they tend to have the same building companies, facility management companies, and probably the same bankers working together from one project to another." And that is clearly a good thing if you are a law firm with a track record. As Francis sees it, the relatively youthful sector has just come through its troublesome teenage years and is now in its early 20s.
Allen & Overy's Lee takes a similar upbeat view. "You could argue that there is going to be more pressure on legal fees because people want to keep bid costs down," he says. "But then if people are doing fewer bids, people are being more discerning and there is less competition without having to reduce their price in the way they have had to do previously," he says. But it is best to keep things in perspective, as legal costs make up less than 10 per cent of the bid costs of a consortium, he claims.