Examination of Witnesses (Questions 40
WEDNESDAY 1 NOVEMBER 2000
40. Move on to the refinancing deal itself.
How does that affect the taxpayer? Does it actually mean a longer
(Mr Narey) No, the term of the contract, 25 years,
41. Who actually gets the prison at the end
of the contract?
(Mr Narey) We do. At the end of the contract we get
a prison with a life of at least 35 years in perfect order. Anything
that is wrong with it has to be rectified and it is handed over
42. When does the taxpayer stop paying for it?
(Mr Narey) At the end of the 25-year period.
43. The profits which have been made from the
refinancing deal have been shared very unequally between yourselves
and the Prison Service and have basically gone into the pockets
of your shareholders. Why did you not reinvest it into the company?
Why did you not buy new equipment? Why did you not use that money
to improve the service?
(Mr Herzberg) Group 4/Carillion is effectively investing
it in equity in future projects, in future prisons and other projects.
44. You are saying that the shareholders have
not received a better dividend.
(Mr Herzberg) I am not saying that. I have agreed
with the figures that Mr Williams quoted previously.
45. You cannot invest it twice.
(Mr Herzberg) We are taking monies out of this project,
as a result of dividends etcetera, and will be using that to invest
in future PFI projects.
46. It seems to me that you are a magician because
you are using the same money for two reasons or two years. You
are paying your shareholders a bigger dividend than they would
normally have received if you had not made those extra rewards
and you are also investing it in new infrastructure.
(Mr Banks) Fazakerley Prison Services Limited has
one project which is the Fazakerley prison, Altcourse prison.
As a result of this refinancing dividends were paid to the shareholders.
A new project we are involved in is the project at Rye Hill which
is another PFI prison which is due to open in January next year
which Carillion and ourselves are jointly working on in terms
of building, financing and we propose to operate.
47. I am sure you are. There is a huge PFI in
my constituency in Durham in the hospital so I am trying to compare
the two. What you are saying is that if anything goes wrong with
thisobviously it will not, but if it didthen the
prison would come back to the Prison Service, would it?
(Mr Narey) Yes, if the contract were terminated, the
prison comes back to us.
48. When I read the report what I did not really
understand perfectly was that when a contract is agreed, in the
original deal, how can the consortium then come along and change
what seems to me the contract which has already been made in the
(Mr Kent) Effectively the contract has not changed.
Nothing has changed except for the rate of return that the contractor
is getting and the compensation we got. The rest of the contract
49. Does it say in the contract that you can
refinance the deal if you want to?
(Mr Kent) Not in this contract; it did not say so
in this contract.
50. Why were they allowed to go ahead and do
(Mr Narey) Because at the time we were in the dark.
This was an innovative deal. The Treasury guidance which has been
published since and which is being re-issued next year, was not
available. We did not anticipate the prospect of refinancing;
I wish we had but we did not. We accept that our advisers did
not know of it, there was no Treasury guidance to suggest we should
be aware of it. We have learned from this now and have made it
an integral part of our contracts.
51. At the end of the day why were they allowed
to proceed. By proceeding you have made money but you might not
have. I am thinking on behalf of the taxpayer and it could have
lost money so why was it allowed to proceed if it did not say
in the contract originally that they could do this? How can they
just come along and do something they want to do?
(Mr Narey) Because allowing them to proceed was to
the taxpayers' advantage. There is an argument to suggest we did
not need to approve the refinancing at all. We came to the conclusion
that we probably did need to approve the refinancing of £5.5
million. The consortium could have made all the gains bar £5.5
million without giving us anything. We let them go ahead on the
basis of the additional £5.5 million and we got 20 per cent
of that back for the taxpayer. That resulted in a significant
underspend last year and that money was returned to the Treasury.
52. But you could not be certain of that, could
(Mr Narey) We were certain in the negotiations because
we did not agree to the refinancing until we agreed the sum of
53. If you look at paragraph 1.6 on page 9,
the last sentence, which begins "Lazard Brothers & Co.Limited",
it is basically saying that the refinancing was viable as long
as there was no increase in liabilities for the Prison Service
as a result.
(Mr Narey) Yes.
54. How could you be certain of that? You still
cannot really be certain about that, can you? You cannot be certain
of that now.
(Mr Narey) No, I volunteer we are certain and there
is a potential increase in liabilities because our termination
costs through the contract, if we had to terminate, have risen.
That was the basis on which we argued for what became a 20 per
cent share of the sum over which we had any leverage. I am not
trying to justify the contract or suggest that we would do it
again. At the time people sitting in my chair were not aware of
this prospect and they were going forward in good faith and they
have got a value for money prison out of it.
55. Page 10, paragraph 1.7. The Prison Service
accepted compensation from the consortium of a share of the refinancing
benefits as compensation for additional liabilities. What gives
the Prison Service the right to accept additional liabilities
so that FPSL can actually make profits for the shareholders which
could at the end of the day be at the expense of the taxpayer?
Who gives you the right to do that?
(Mr Narey) As I have explained, we only arguably had
any right to make decisions to approve or not to approve the refinancing
of about £5.5 million. We believed that the advantages for
us in getting about £1 million of that back were a good deal
for the taxpayer. It meant that Group 4 had more confidence in
the running of the prison and made the likelihood of termination
56. Paragraph 1.12, page 12. I cannot understand
what it seems to be saying here. Why should anybody be rewarded
for carrying out a successful contract? Presumably if you agree
a contract, you expect it to be successful, so why should you
be further rewarded for doing it or for being successful?
(Mr Narey) The Treasury may want to say something
because paragraph 1.12 refers to Treasury guidance. Because in
taking forward this venture, particularly this, the first ever
DCMF prison, there was a considerable risk involved. Although
I now think it is very unlikely and the prison has opened successfully,
there was a chance that the consortium could have lost considerable
sums of money on this in terms of commissioning a new and difficult
prison with category of prisoners.
57. Fair enough. I accept that but at the end
of the day you signed a contract with them, they signed a contract
with you and you would expect it to be successful otherwise you
would not have actually signed it, yet they get rewarded at the
end of the day. Not only do they get rewarded, they are even very
reluctant to pay you any part of the profit back. They offer you
a measly £100,000 which you rightly turn down. You then settle
for £1 million out of £14 million and then you give
them back £500,000 even though they have failed in part of
the contract. They are on a very good deal.
(Mr Narey) No, we got back £1 million of £5
million and yes, we did give them back £500,000 and that
was a very good deal indeed for the taxpayer because it meansand
this is very importantthat we do not have to pay for overcrowded
places there unless we are using them. In terms of the length
of the contract, I suggest we will save millions of pounds on
Mr Steinberg: It sounds like a very good deal.
I shall tell you a little story just before I finish which I can
remember a bloke telling me when he was negotiating with the old
pit owners. The negotiator went in and he came back out and was
asked if he had got a good deal. He said "I've got a grand
deal: nowt for the first three metres". That sounds about
the same sort of deal that you got, to be quite honest.
58. May I start by saying that I very much welcome
Mr Narey's comments about how well Altcourse fulfils the requirements
of the Prison Service and also cautiously welcome the savings
which have been made through refinancing? I want to concentrate
very much on the deal for the taxpayer in this particular refinancing
package. If I have this right, the FPSL has made about £14
million which it did not expect to make, of which over £10
million is as a result of refinancing. I think I read in the report
that this represents something in the region of an 80 per cent
return over four years. You deal with a huge amount of money in
PFI contracts but this is a good deal, is it not, for you? This
has turned out to be a good deal for you.
(Mr Herzberg) May I first of all confirm the facts?
Certainly the £10.7 million was from the refinancing, although
we have had discussions on which required consent and which did
not. I would say, if I were to compare this with the last contract
I was called before this Committee to discuss, this is certainly
a better one than the last one. I talked about a margin having
been substantially eroded on the last one. The last one we discussed
opened on time. This one opened early. This one we have performed
satisfactorily; I would argue very well. However, risk is related
to performance and in order to achieve those returns you have
to perform. I believe that we should actually get a reward for
59. My concern is the scale of that reward.
Let me just go back to something you said to Mr Steinberg when
you said that the £10 million windfall, let us call it, would
actually be reinvested in the future. You are not trying to tell
the Committee are you, that some of that would be taken off and
paid to shareholders?
(Mr Herzberg) No. Let me absolutely clear on that.
Mr Banks did touch on it. Fazakerley Prison Services Limited is
a joint venture between Carillion and Group 4. The benefits, the
£10.7 million arising from the refinancing, is available
to be paid as dividends to the two shareholders, to Carillion
and to Group 4. Carillion and Group 4 both happen to have a very
active and cash hungry PFI programme. It is there that we are
directly reinvesting the moneylet us be open about itin
order to make dividends and returns, construction profits and
operating profits, on future projects.