Press Release - The refinancing of the Fazakerley PFI prison
contract
29 June 2000
Sir John Bourn, head of the National Audit Office (NAO), told
Parliament today that the Prison Service had secured £1 million of
the expected £10.7 million increase in returns to shareholders of
Fazakerley Prison Services Limited, following the refinancing of
the Fazakerley prison contract let under the Private Finance
Initiative (PFI). Further refinancings of PFI contracts are likely
to occur, and the NAO's report suggests a number of principles
which should guide departments faced with similar refinancings.
The refinancing of this first PFI prison contract took place in
November 1999. The contract had been let in December 1995 to
Fazakerley Prison Services Ltd (FPSL), a project company formed by
Group4 and Tarmac. Under the contract, FPSL is responsible for
constructing the new prison and operating and maintaining it for 25
years. The refinancing followed the prison's successful
construction and first two years of operation. The benefits which
the refinancing brings to shareholders can be seen as the reward
for taking risks in managing this novel prison contract.
The PFI contract did not give the Prison Service a contractual
right to share in the benefits of a refinancing. But the
refinancing involves the Prison Service in increased risk, so the
Prison Service sought compensation for accepting it. The increased
risk arises because the refinancing increases the project's bank
borrowings, and in certain termination circumstances the Prison
Service might have to pay off that debt. The contract did give the
Prison Service a right to seek such compensation.
The Prison Service achieved its objective for this negotiation.
The Service accepted compensation of £1 million, having rejected
lower offers. The £1 million compensation was consistent with the
Service's estimate (adjusted for risk) of the extra payment which
might arise. The actual payments could range between £8 million and
£47 million with a low probability which the Prison Service
assessed as no more than 10% in the worst case.
The Fazakerley refinancing has important lessons for departments
because further refinancings are likely to occur. This is because
banks are often prepared to offer better terms once the project is
successfully developed and the perceived risks reduce. Refinancing
opportunities apply especially to early PFI deals where better
terms are now available in the developing PFI market.
The report recommends that departments should keep in mind a
range of principles when developing PFI contracts and if they are
faced with a refinancing. The key ones are:
- appropriate benefits should go to those bearing risks
- benefits from reducing costs in a developing market should be
shared if they have not already been reflected in the contract
price;
- it is reasonable for departments to seek compensation for any
increased exposure to termination liabilities arising from a
refinancing;
- substantial refinancing gains to the private sector may
threaten the perceived value for money of the project;
- a refinancing should not jeopardise the stability and success
of the long term contractual relationship between a consortium and
a department; and
- if the private sector seeks to improve its returns by
renegotiating parts of a PFI contract it is reasonable for
departments to seek a share of refinancing benefits.
The report identified a number of other key learning points for
future projects :
- Departments should give careful consideration to refinancing
issues when planning PFI projects. They should address whether they
should establish within the PFI contract the right for them to
share in refinancing benefits.
- They should also unambiguously set out in their PFI contracts
the circumstances in which they will be required to consent to
part, or all, of a proposed refinancing.
- Given the complex issues which arise from refinancings it is
essential that departments take early advice from experienced legal
and financial advisers as the Prison Service did in connection with
the Fazakerley prison refinancing.
- Where departments will be exposed to increased termination
liabilities as a result of a proposed refinancing they should
consider whether they wish to limit this risk.
- Where a department has given itself flexibility to negotiate
over refinancing benefits it should give careful attention to
preparing a robust but reasonable negotiating strategy.
- Departments should consider linking at least part of their
advisers' remuneration to the outcome of any negotiations to which
the advisers contribute.
Sir John Bourn said today:
"The Prison Service has obtained a share of refinancing
benefits which recognises its exposure to increased termination
liabilities. This review has identified important lessons for other
departments who are likely to have to deal with the refinancing of
PFI projects in the future."
Notes for Editors
Press notices and reports are available from the date of
publication on the NAO website at http://www.nao.org.uk/ Hard copies can
be obtained from The Stationery Office on 0845 702 3474.
Hard copies can be obtained from The Stationery Office on 0845
702 3474.
The Comptroller and Auditor General, Sir John Bourn, is the head
of the National Audit Office employing some 750 staff. He and the
NAO are totally independent of Government. He certifies the
accounts of all Government departments and a wide range of other
public sector bodies; and he has statutory authority to report to
Parliament on the economy, efficiency and effectiveness with which
departments and other bodies have used their resources.
Press Notice 46/00
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