Although the majority of Building Contractors are aware that the risk profile of PFI contracting is significantly more onerous than that under traditional forms of procurement, many Contractors remain ignorant of the true risks to which they are exposed or how to mitigate such risks when negotiating the terms of the Building Contract with the special purpose vehicle (“SPV”).
Arguably, the real risk of PFI contracting is not in the flow down of risks from the Project Agreement but rather the risks that the SPV and Funder seek to pass down to the Contractor, risks that the SPV can accept but would prefer not to. Too few Contractors appreciate the finer points of PFI Building Contracts and the commercial position that can be secured if a robust stance is taken against the SPV. Admittedly the current financial climate may cause Contractors to accept risks that they would not normally assume and funders are particularly keen to protect their balance sheets, but there is no reason why the following points should not form the basis of risk allocation in all contracts between the Contractor and SPV.
1 Limitation of Liability
It is relatively common practice for the Contractors’ liability under the Building Contract to be capped at a sum equivalent to 50% of the Contract Sum. There will be some liabilities carved out from this cap but such exclusions should be minimal and restricted to insured losses, fraud, prohibited acts, abandonment, wilful default and certain indemnities in respect of physical injury or damage to property. The Contractor should be particularly wary of carve outs that seek to undermine the protection afforded by the limitation clause, such as for defects.
The Contractor should insist on an express provision excluding it from any liability in respect of proceedings not commenced at a date which is twelve years from practical completion which is necessary due to the on going nature of the Project Agreement.
2 Liquidated Damages
A significant issue for the Contractor is the imposition of liquidated damages upon the occurrence of an event where the Contractor would normally expect to receive an extension of time. The majority of PFI Building Contracts make it clear that the Contractor will only be awarded an extension of time upon the occurrence of an event which entitles the SPV to compensation (a “Compensation Event”) or an SPV variation or breach of contract. The Contractor needs to be aware of those Building Contracts that grant extensions of time but elsewhere provide for liquidated damages to be paid notwithstanding the award of an extension of time.
The Contractor can reduce its exposure to liquidated damages by the effective use of a liquidated damages caps on liability although consideration should be given as to whether any such cap should be in addition to or inclusive of the cap for general damage. The Contractor should be aware of its potential liability for general damages in the event of either the liquidated damages cap being exceeded or the Building Contract being terminated for breach of longstop date because in such circumstances the liquidated damages cap will not protect the Contractor from general damages unless drafting of the Building Contract provides otherwise.
3 Insurance
The Contractor should take a keen interest in the insurances effected by the SPV and should ensure that the adequacy of policies are confirmed by its own insurance adviser. The SPV may seek to make the Contractor liable for the adequacy of insurance and although such liability should be avoided, if the Contractor is to assume such risk then it is essential that it understands the terms and conditions upon which any such insurance has been placed.
Of particular interest to the Contractor should be the Delay in Business Start Up insurance (“DSU”) which indemnifies the holder for consequential losses incurred should service commencement be delayed by the occurrence of one or more of the risks insured under the Contractors All Risk policy. DSU insurance is not the same as LAD insurance and only provides indemnification in limited circumstances.
It is common practice for DSU policies only to cover the interests of the SPV and Funder and the Contractor should note that the insurer usually reserves a right of subrogation against the Contractor in the event that the DSU is called upon . Further, DSU policies are frequently worded so that they only provide indemnification in the event that the SPV is unable to recover its losses elsewhere, which presumably precludes indemnification to the extent that the SPV is able to claim liquidated damages from the Contractor. There is usually an excess period of at least 30 or 45 Business Days and although the latter is more common this is only because the SPV seeks to minimise the insurance premium.
It is apparent from the above that there are a number of issues that can undermine the interests of the Contractor in the DSU. Fortunately these can be overcome with the careful and precise use of words within the Building Contract.
The issue of uninsurability and excesses is another area where the SPV frequently seeks to pass risk to the Contractor. The Contractor should not be taking risk for any excesses save where they relate to a claim caused or requested by the Contractor and further the risk of uninsurability should sit with the SPV to ensure that the SPV is able in turn to secure full entitlements under the Project Agreement.
4 Project Agreement issues and Indemnities
There is a tendency for the SPV to seek an all embracing “sweep-up” clause in respect of Project Agreement risks along the lines of “Contractor to undertake all SPV obligations in respect of design and build as are provided for in the Project Agreement”. Such a provision should be resisted by the Contractor who should insist on the Building Contract being a stand alone document setting out the entirety of the Contractor’s obligations, something easily achieved by stepping down each applicable clause of the Project Agreement. The SPV’s requirement for a sweep up clause serves little purpose other than to benefit the SPV’s lawyers.
Likewise requests for indemnities should be largely resisted save where such indemnities are a replication of Project Agreement indemnities. General indemnities in respect of breach of contract, damages or losses should not be given.
5 Practical Completion
Completion is certified by the Independent Tester acting under a form of appointment with the SPV, public sector and Funder. Notwithstanding the fact that it is the Contractor who has the greatest exposure in the event of the Independent Tester failing to certify competition, all too often the Contractor’s requests for a duty of care from the Independent Tester are refused.
The Contractor must insist upon the benefit of a duty of care through either being a party to the Independent Tester appointment or through the provision of a collateral warranty. There is no justifiable reason for the Contractor’s requests to be refused.
The Contractor should also carefully consider the completion requirements to ensure that they are unambiguous as any uncertainty may be used by the SPV or public sector to put pressure upon the Independent Tester not to certify completion.
6 Defects and Deductions
Defects can lead to unavailability which in turn may result in the public sector making deductions against the unitary charge. The level of potential deductions will be prescribed by the Payment Mechanism and it is important for the Contractor to understand, prior to financial close, what deduction a particular event of unavailability will result in.
In order for the Contractor to mitigate its exposure to deductions, provisions should provide for the Contractor to be notified immediately upon the occurrence of a defect, for the Contractor to inspect and, if applicable, make good the defect so to limit its potential liability for deductions. The Contractor should consider granting itself such rights for the entire period of its liability and not just the defects liability period. Consideration should also be given to a de minimis threshold whereby the SPV is obligated to immediately rectify the defect so to avoid deductions and for the issue of liability to be resolved subsequently. Many of these issues should be addressed in the Interface Agreement (discussed below).
7 Design Liability
The Contractor should ensure that it does not acquire fitness for purpose obligations under the Building Contract. Because the Project Agreement will not address the issue of such liability, the Contractor will almost certainly need a clause limiting its liability to that of the professional designer, i.e. reasonable skill and care. In the absence of an appropriate clause the Contractor will have assumed a design obligation which may be uninsurable and most certainly would not have been backed off to its professional team.
8 Equivalent Project Relief and Dispute Resolution
The Contractor will be aware that it is the preference of the public sector to avoid joinder of disputes with the result that there may be a disconnect between disputes resolved at Project Agreement level and those resolved in the Building Contract. However, this does not prevent the public sector from trying to bind the Building Contractor into the outcome of the dispute at Project Agreement level, notwithstanding the fact that the Contractor plays no part in such disputes. Such a position must be resisted.
The Contractor should ensure that it has extensive rights to participate in any dispute between the SPV and public sector which impacts upon any dispute between the Contract and SPV. This may be achieved in a number of ways, such as, name borrowing or a robust commitment from the SPV to progress Contractor disputes with the public sector and not to compromise any dispute without the approval of the Contactor.
In agreeing Equivalent Project Relief provisions the Contractor must ensure that it has adequate rights of redress either directly or indirectly against those parties to whom the Contractor’s entitlements are linked.
9 Site Conditions and Land Interests
Liability for ground conditions, site access and general land issues is usually borne by the Contractor. Many of the site investigations may have initially been instructed by the public sector and if the Contractor seeks to rely on such investigations then it must secure appropriate collateral warranties from the authors of such reports prior to Financial Close. The Contractor will also need to note the underlying contract to which the warranty relates as it is not uncommon for the initial investigation to have been procured on terms unacceptable to the Contractor.
The Contractor should also note the risk that it is asked to assume in respect of the site and title issues, liabilities that will not be understood unless it has undertaken detailed title investigations. Generally the SPV’s solicitors are willing to provide the Contractor with a Certificate of Title, at no cost, the Certificate advising on the investigations undertaken and any impediments to title of which the Contractor should be aware. In the event of any impediment or concern then the SPV may effect Defective Title insurance although such insurance will not provide cover for liquidated damages.
10 Interface Agreements
An Interface Agreement is a tripartite agreement between the Contractor, the Services Contractor and the SPV. Interface Agreements are a relatively new phenomenon and although some Contractors have historically resisted their use, if negotiated correctly they can benefit the Contractor. The interface Agreement should not increase the Contractor’s liability over and above that agreed in the Building Contract.
The Contractor may wish to consider the issue of its liability to the Services Contractor in the event of delay and provide for this directly in the Interface Agreement, making a corresponding deduction in the level of liquidated damages in the Building Contract. The Contractor can then demand a reciprocal provision from the Services Contractor so that if the Services Contractor causes or contributes to any delay then the Services Contractor will be directly liable to the Contractor for such delay.
The Interface Agreement should set out in detail what the Contractor is expecting of the Services Contractor during the design and build stage, usually provided for by setting out a list of requirements as an Appendix to the Interface Agreement. This list can be used to seek confirmation of design from the Services Contractor so to prevent the Services Contractor subsequently claiming that the solution provided by the Contractor has resulted in the Services Contractor either incurring deductions or additional costs in providing the services.
Agreement should be reached in respect of general co-operation, access to the site, resolution of snagging issues and defects and resolution of disputes.
By taking into account all or some of the above, all of which will be resisted to varying degrees by the SPV but all of which are risks that SPV’s should and can assume, the Contractor will be redressing some of the disproportionate and unjust risks that are demanded by the SPV and Funder.
