Examination of Witnesses (Questions 80
- 99)
WEDNESDAY 1 NOVEMBER 2000
SIR DAVID
OMAND, MR
MARTIN NAREY,
MR DAVID
KENT, MR
ROBIN HERZBERG
AND MR
ANDREW BANKS
80. Can I then assume that the profits made
by the two partners, Carillion and Group 4 do not only consist
of the shareholders' return in FPSL but also indeed on profits
they have made on the various contracts they entered into with
that company?
(Mr Banks) Correct. There are risks and rewards associated
with those two contracts.
81. I am sure you will not give away commercial
confidentialities here but can we assume that the profits made
by those two companies on this particular contract are substantially
greater than those highlighted in this report? Would that be correct?
(Mr Banks) There is a potential for profit there and
the contract has been successful. It has been successful in terms
of the services it has delivered and it has met its expectations
in terms of the overall financial terms that it has delivered.
(Sir David Omand) That would not be the case in terms
of the rate of return because that would depend on the capital
employed by the two companies delivering the services. The high
figure is based on the fact that only £100 of capital is
actually employed in the business. To get at what I would regard
as the rate of return, comparing it with other contracts, I would
need to do some rather difficult calculations and I am not sure
I have the information on which to do them. They would actually
look at the total capital which was employed in the financing
of this prison.
82. Yes, but you would not disagree with the
comments made earlier by Mr Williams that they will receive a
return of all they put into the company within two and a half
years or just slightly under and they now have continuing profits
both for FPSL and for the two originating companies through the
rest of this contract.
(Sir David Omand) We want them to have profits throughout.
83. I am not against profit, it is whether that
is reasonable and justifiable in the circumstances that I am trying
to get at because that is our job as the Committee of Public Accounts.
May I move on to Mr Narey, in relation to the use of your advisers
in the negotiations? Two questions arising from that. Do you think
that there was any conflict of interest in getting FPSL to pay
for your advisers? Since the piper was not calling the tune you
may well not have thought there was the possibility that you may
not have got entirely objective information from them. Secondly,
you only seem to have used them to give you advice, yet according
to the report, which is a joint report, they could have amassed
quite a lot of evidence for you about the situation faced by both
Carillion and Group 4 which would have put you in a stronger bargaining
position. Why did you not use them in the negotiation process
itself?
(Mr Narey) In answer to your first question, I am
confident that the fact that we got FPSL to refund the cost of
our advisers did not in any way diminish the quality of the advice
we got or the help we got to try to obtain some leverage from
this. The money Rothschild obtained from this particular piece
of advice was relatively small. We do much more business with
them of a much greater magnitude and I am entirely convinced that
they were working as hard as possible to give us the best possible
advice. I am not even sure at what point they knew that their
bill to us was being refunded by FPSL.
(Mr Kent) Not until right at the end.
(Sir David Omand) May I make a general point that
we regard it as normal practice that if a company wishes to refinance
then they should pay the costs of that. The department, the authority
in the contract, would take the advice that we felt it necessary
to take and would bill the contractor. They would have no say
over either the choice of our advisers or the extent of advice
that would be offered.
84. Did that happen in this case?
(Sir David Omand) Yes.
85. On the second question?
(Mr Narey) I have already indicated that I accept
we should consider on future occasions whether we incentivise
our advisers and get them perhaps to negotiate direct. The net
result of the negotiation on this occasion was a very satisfactory
one. The fact is that we got ten times more than FPSL's opening
offer. That was a result of careful negotiations conducted by
Mr Kent on my left and I think he got a very satisfactory outcome
for it.
86. May I just press you on that? The impact
of the report itself would suggest, and I put it as the report
put it, that you may have been in a stronger bargaining position
than you realised. Would you accept that?
(Mr Narey) In hindsight, yes, I do accept that. At
the time I can say that last April when I reviewed the proposals
made by Mr Kent I thought that we got a satisfactory deal.
(Sir David Omand) May I also add a point about incentivisation
of advisers which I think I am expecting to find in the new Treasury
guidance as something we would be advised to do. It is common
practice but I would advise that it should be done case by case.
There could be circumstances in which at a delicate point in a
negotiation I would not want to feel that my advisers stood to
benefit more by my taking a decision now or deferring a decision
or took this decision rather than that decision. Incentivising
the advisers only works if you are actually handing to them a
discrete task where you have a clear measure of success rather
than the cases that both Mr Narey and I have had where the advisers
are holding our hands as we go through a negotiation process.
87. Is there any likelihood that Bridgend or
any of the other early contracts will be coming for refinancing?
(Mr Narey) My understanding is that Bridgend, which
is now Parc, indicated some time ago the possibility that they
were considering refinancing. They have made no proposals to us
to do so. Because the contract with them is slightly different,
we have a rather clearer handle on their refinancing proposals
than we had for Fazakerley.
88. I hope you would learn from this experience.
(Mr Narey) I can promise you we shall.
Chairman
89. What is confusing me is the renaming of
all the prisons.
(Mr Narey) It is enormously confusing.
Chairman: It reminds me of videos of American
gangster films where the names have been changed to protect the
innocent.
Mr Rendel
90. I think you said in reply to one of my colleagues
that the taxpayer had benefited from this refinancing. Can you
tell me in financial terms exactly what you meant by that? What
was the financial benefit to the taxpayer?
(Mr Narey) The contract price remained the same but
we had refunded to us the equivalent of £1 million from our
payments to FPSL made to us last year. We traded half of that
back.
91. So you are talking about the £1 million
as the benefit to the taxpayer.
(Mr Narey) Yes.
92. I do not quite understand one thing about
how the £1 million was calculated. I assume, Sir David, that
you would accept what Mr Narey was saying about the £1 million
being the benefit to the taxpayer. Can you perhaps explain something
to me? In paragraph 9 of the summary it says that the probability
of failure was estimated at about ten per cent maximum. In paragraph
6 it says that the present value of the extra liabilities incurred
was £13.5 million. Can you explain why ten per cent is £1
million? Where is the £10 million that £1 million is
ten per cent of?
(Sir David Omand) May I direct you to Figure 5 on
page 19 where the National Audit Office have produced a ready
reckoner which relates the probability of termination to the expected
value of the liabilities? As Mr Narey has said, we are prepared
now to say in front of the contractors that we would not see the
probability of termination as ten per cent. However, that figure
does give us £1 million and that was the basis on which we
negotiated with the company and we stand by that.
93. What is the significance then of the £13.5
million in current value? I have misunderstood something in the
finances here obviously.
(Mr Kent) The two figures are not related. The £13.5
million is an expression of the increase in termination liabilities
expressed in today's money. The ten per cent was the probability
of termination and it was calculated on the basis that if it is
ten per cent over 25 years it is approximately half a per cent
per year. When you are doing the calculation of the increase in
each year of the lender liabilities, ten per cent works out at
about £1 million. It is a cumulative effect; it is a very
complicated mathematical calculation. We could write to you.
94. It is because the increase in liabilities
is not the same each year.
(Mr Kent) Yes, that is right.
95. If you work it out on a year by year basis
it is only £1 million as opposed to £1.3 million.[5]
(Mr Narey) We could provide a note explaining
exactly how that calculation is made if that would be helpful.
96. That would be helpful, thank you, but I
think I now understand what the difference is between the £1.35
million and the £1 million. This was therefore in effect
the extra costs incurred by the taxpayer for taking on this risk.
(Mr Narey) The additional risk; that is right.
97. The £1 million is effectively the extra
costs incurred in the risk.
(Mr Narey) It does not cover the potential cost, it
is a balance of the additional costs set against the risk.
98. It is the costs done into present value
taking into account the probabilities.
(Mr Narey) That is correct.
99. But it is actually therefore a cost of that
risk.
(Mr Narey) That is right.
5 Note: See Appendix 1, page 17 (PAC/293). Back
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