Future shocks

Most users have found PFIs better and smarter than earlier procurement models, but as time takes its toll on contracts, disputes can arise. By Scott Johnston

To the casual observer, disputes may seem far less likely to emerge from PFI projects than from more traditional procurement models. In the earlier years of PFI in Scotland, that view was also shared by many involved in the procurement and operation of PFI projects. After all, PFI represented a new form of partnership between the public and private sectors. The relationship did not simply end with the construction of the public sector ‘asset’, but would continue for years in the form of facilities management (FM). Long-term relationships are established by PFI. Moreover, contractors or their associated companies frequently have equity stakes in special purpose vehicles (SPVs). Surely disputes are less likely to flourish in this environment?

As is often the case, the answer seems to be yes and no.

It does seem that what may be regarded as ‘typical construction disputes’ over payment and time are less common in PFI structures. Disputes over the level of contractor final accounts, for example, are uncommon. This may be partly as a result of provisions in construction contracts which restrict building contractor delay compensation and time relief to what is obtained by its direct employer, the SPV. In short, there is less scope for a mismatch between the SPV’s entitlement to time and compensation and that of the building contractor.

PFI projects also call for construction requirements to be specified at an early stage in the project. In theory at least, this minimises the prospect of a work scope change during the construction period – an event that often creates disputes in conventional procurement models. Others believe a clearer allocation of risk in PFI arrangements means less potential for conflict.

Disputes have, however, occurred at the construction stage. Any discrepancy between the specification of works presented to the building contractor and the SPV’s project remit may give birth to disputes up and down the contractual chain. Such disputes can create acute problems for an SPV if it is left to bear the burden of a gap between the project agreement and the building contract. As with many construction disputes, these problems lie within the DNA of the project documentation and not from the actual performance of the construction works.

An increasing number of disputes are also anticipated during the lifecycle of public sector assets. Inevitably, day-to-day use will take its toll on buildings, facilities and equipment. The lack of availability of a particular facility will have adverse financial consequences for the SPV charged with its maintenance and management. The SPV will in turn wish to pass these on to the FM contractor. Such scenarios have now begun to spring from some of Scotland’s earlier PFI projects.

But what if the real reason for non-availability is misuse or negligence by the end user? In these situations the SPV or the FM contractor may be expected to challenge payment deductions. The often muddy compromise positions set out in project agreements and subcontracts will then be tested, with each party having a different interpretation of the recorded agreement.

The interaction between soft FM and hard FM services may also be difficult to manage, particularly where one is the responsibility of the public authority and the other the SPV’s. One example given in a recent paper prepared on behalf of the Scottish Executive related to the apparently mundane, but potentially costly, process of replacing carpets in a school. The FM contractor may bear responsibility for replacing worn-out carpets, but what should happen if the carpets are worn out because of incorrect cleaning methods employed by others? This is a scenario ripe for controversy, but one which may be difficult, as with many other situations, to fully cater for at the stage of contract drafting, particularly where there are political reasons for implementing the contractual structures.

There are different approaches to mitigating the effect of disputes. The fact that most consortia are driven by construction contractors means that FM providers were, historically, another arm of the construction contractor. The market is now more mature, but old structures still remain, with interface a key concern. A number of mechanisms have been employed to deal with interface-type issues, from full-blown interface agreements down to informal ‘sort it out at group level’ approaches. Some are more successful than others. Ultimately, the key to disputes continues to lie in the relationships that exist; contracts often do not have all the answers.

Other key arenas for potential disharmony are only now being tested: changes, benchmarking and market testing. The scope for large pricing impacts from these areas makes them prone to significant conflict. There has already been at least one disagreement on benchmarking that has reached the Scottish courts. At the time of negotiation of such contracts, many of the concepts were new and untested. Somebody drafting the contract today may take a different approach. In the absence of a joint desire to resolve informally these unforeseen problems, the parties may become entrenched. Any ensuing dispute resolution may lead to surprising, and unintended, results.

The availability of adjudication under building and FM subcontracts may also make negotiated settlements of disputes less likely. A decision can be obtained from an adjudicator within, generally, four to six weeks of the process commencing, a tempting option for subcontractors. This has been a particular concern for SPVs, which fear being stuck with an adverse adjudication decision without immediate recourse under the project agreement. That concern has led to the widespread adoption of adjudication provisions in project agreements, notwithstanding that there is no statutory obligation to do so under the Construction Act of 1996. SPVs are also increasingly nervous, and with good reason, about inconsistent decision-making up and down the contractual chain. The ability to insist upon the same adjudicator to determine related disputes is one way of minimising such risk and is often now embodied in project agreements.

Given the massive capital value of PFI projects in Scotland over the last 10 years or so, it is hardly surprising that some disputes have occurred. It is to the credit of the PFI that these have been less common in the construction phase than may have been the case with more traditional procurement models. But new and unexpected challenges will arise with the passage of time and with end-user strain on facilities. Disputes will occur and be resolved. The real trick will be capturing the lessons learnt from these disputes and shaping future PFI arrangements to avoid them.

Scott Johnson is director of McGrigors’ construction and engineering unit in Edinburgh. He was assited by Stephen Tobin, a banking associate at the firm.