Select Committee on Public Accounts Fourth Report


The Committee of Public Accounts has agreed to the following Report:—



1. The Royal Armouries originally entered into a PFI-type contract with Royal Armouries (International) plc ("RAI") in December 1993. Under this contract RAI were to build a new museum in Leeds which would allow the Royal Armouries, then based principally in the Tower of London, to display a greater proportion of its collection. (The collection itself remained—and remains—in the Royal Armouries' ownership). The Royal Armouries agreed to contribute £20 million to the £43 million cost of construction, with RAI meeting over £14 million and Leeds City Council and Leeds Development Corporation £8.5 million.

2. Once construction was complete, RAI was to operate the new museum for 60 years. In return RAI would retain all the income the museum generated from visits by the public. Once the new museum opened in March 1996, however, visitor numbers were so low that it never made enough money to meet its operating costs and the costs of servicing RAI's debts. Consequently, by early 1999 RAI's cumulative losses were estimated at £10 million, despite two refinancings by RAI.

3. As part of the second refinancing in 1998 RAI's bankers, the Bank of Scotland, advised that it would not be able to make additional funding available to RAI after July 1999 if the financial problems persisted. Withdrawal of the Bank's support after that date would have resulted in RAI becoming insolvent.

4. In response, therefore, in July 1999 the Royal Armouries negotiated a revised deal with RAI which ensured that the museum in Leeds remained open. Under the re-negotiated deal the Royal Armouries took over responsibility for running the museum, while RAI retained responsibility for the provision of catering, car parking and corporate hospitality services at the museum.

5. On the basis of a report by the Comptroller and Auditor General, the Committee took evidence from the Department for Culture, Media and Sport, the Royal Armouries and RAI on the negotiation of the original commercial deal in 1993, on the forecasts for visitor numbers, on the re-negotiation of the deal in 1999, and on the extent of risk remaining with the private sector under the terms of the revised deal.

6. The key findings to emerge from our examination of these questions are:

  • Although there was no Treasury guidance on PFI available at the time the original deal was reached, the absence of such guidance does not fully excuse the lack of commercial awareness and absence of forethought on the part of the Department and Royal Armouries when reaching this deal. When undertaking any project with commercial aspects, departments should ensure that they have access to the necessary skills and business knowledge, irrespective of whether central guidance is available.

  • This case provides further evidence that the forecasting of visitor numbers for new attractions is very uncertain. When negotiating deals the eventual success of which is heavily dependent on the number of visitors, or on the number of users of the new services being provided, departments need to treat projections of visitor numbers with due caution, to understand exactly what it is that consultants are telling them, and to manage the resulting risks accordingly.

  • When faced with the possible insolvency of the private sector partner, RAI, and the consequent disruption to the museum's operations, the Department did not appear to have used the full strength of its negotiating position or sought appropriate commercial advice. RAI's failure could have constituted a fundamental breach of contract, thereby placing no moratorium on the Royal Armouries' ability to get back the museum. In re-negotiating PFI deals, departments should ensure that they fully grasp the strength of their commercial position as well as their legal rights so that they are well placed to get the best possible deal for the taxpayer.

7. Our detailed conclusions and recommendations are as follows:

On negotiating commercial deals

    (i)  There had been a lack of market interest in the deal when it was put out to the market and only one bid had actually been received. Tussauds, when withdrawing from the competition for this project, had expressed concern over the practicality of the proposals for joint working between the public and private sectors in certain areas. The operating specification which was to detail those areas where such co-operation and joint working was required was not agreed subsequently. The Royal Armouries were not given access to RAI's financial records and there were disagreements between the two parties over issues which were of fundamental importance to the museum's future. Departments should be aware of such warning signs that the deal being negotiated will not eventually be sustainable (paragraph 16).

    (ii)  Before signing the contract, the Department and Royal Armouries had taken comfort from assurances from their financial advisers, Schroders, that the deal on the table was the best available from the market at the time, given the deal's parameters. However Schroders had been involved for almost two years in putting this deal together and therefore might not have been in the best position to provide the objective assurances that were being sought. No other advisers had been approached to cast a more detached eye over the deal proposed. In considering future deals, departments should get impartial advice on the merits of a proposed deal before it is signed (paragraph 17).

    (iii)  Under the current guidance the Department would have had to consider at the very start of the project what would happen at the contract's end. On this deal the Royal Armouries' ability to terminate the contract and take possession of the museum due to RAI's insolvency was limited for two years. This compares with the more general practice on PFI deals where departments seek to protect their positions by having immediate access to any assets involved should a PFI contractor become insolvent. Departments need to consider in advance how they will eventually exit from deals should this prove necessary (paragraph 18).

On the forecasting of visitor numbers

    (iv)  As with the Millennium Dome, the deal for the new museum had foundered because of lower than expected visitor numbers. According to the Department there were also a number of other attractions which had received public funding and were also at risk because of low visitor numbers. We therefore welcome the Department's attempts to identify, along with a number of other bodies, good practice when reviewing visitor projections for proposed projects (paragraph 35).

    (v)  The actual number of visitors to the new museum was much less than any of the consultants commissioned by the Department, Royal Armouries and RAI had forecast. However those forecasts were based on a certain pricing assumption and the consultants warned that the actual number of visitors would vary, depending on the admission price charged. In particular, MORI appeared to have forecast accurately what actually happened with its predictions of the level of visitors at the admission price eventually chosen (paragraph 36).

    (vi)  Departments should therefore ensure that they have a clear understanding of what it is exactly that their consultants are telling them when providing forecasts of future visitor numbers, in particular with regard to the sensitivity of those forecasts to different pricing levels. Departments should assess the reasonableness of these projections by comparing them with the performance of comparable existing attractions (paragraph 37).

    (vii)  Departments should also ensure that the capital structure of a proposed deal is consistent with the riskiness of the project. If the project involves a high degree of commercial risk, the project needs to be financed with a high level of risk capital relative to bank debt. If it is necessary to proceed with a project in the absence of adequate levels of risk capital, the sponsoring department should plan for the contingency that extra funding will be required (paragraph 38).

    (viii)  The warnings on pricing appear to have been ignored by RAI. RAI had placed reliance on their own consultancy advice and had charged a high entrance fee of £6.95. Visitor numbers had then collapsed. In response RAI had taken a number of measures to boost attendances, including price discounts and a programme of major exhibitions. It is surprising that RAI increased the full adult entrance price from £6.95 to £7.95. One of the first things that the Royal Armouries had done, on taking the museum over in 1999, was to reduce this entrance fee to £4.90 (paragraph 39).

    (ix)  The reduction in the entrance fee appears to be working, as recent visitor numbers have been up on the similar period twelve months ago. It is likely that this improving trend will continue as the Royal Armouries are planning, in line with government policy, to introduce free admission to the museum in 2001. Despite these actions, the Royal Armouries have prudently based their future strategy on cautious estimates of future visitor numbers in line with the museum's past experience in Leeds (paragraph 40).

    (x)  There were a number of other factors, in addition to the pricing policy, which contributed to visitor numbers being less than forecast. The included an increase in the number of other, competing, visitor attractions and delays in the development of the Clarence Dock area surrounding the museum. Expenditure on marketing had also been reduced over time in line with the planned strategy for the museum (paragraph 41).

    (xi)  This was a high risk project as it involved the establishment of a new museum, in a redevelopment area, with no proven track record of visits by the public. The Royal Armouries nevertheless had no contingency plans in place, as they considered that the risk of the project's failure lay with RAI in the private sector. However, on this deal the business risks ultimately lay with the public sector as the Department and the Royal Armouries had been unwilling to countenance the closure of the museum and had therefore stepped in to rescue the project. In considering future PFI projects, therefore, departments should consider where the business risks ultimately lie and draw up their own contingency plans accordingly (paragraph 42).

On re-negotiating an existing deal

    (xii)  The Department's objective was to avoid the museum's closure. Based on legal advice and statements from RAI and their bankers, the Department considered that, if RAI had become insolvent, there would have been a two-year moratorium on the Royal Armouries' ability to get back the museum and the museum would have closed. There is room for doubt, however, as to whether that view took full account of the Royal Armouries' rights in the event of fundamental breach of the contract by RAI, where no such moratorium would have applied. Faced with similar situations, departments should be clear both about their legal rights and the strength of their commercial position, and be prepared to use those rights and powers aggressively in negotiations (paragraph 45).

    (xiii)  In negotiating the deal to save the museum the Royal Armouries and Department commissioned only legal advice. They did not seek appropriate commercial advice from an insolvency practitioner, although they were faced with a threatened insolvency. Departments should ensure that their negotiation team includes people with previous experience of commercial negotiations and that they are supported by appropriate commercial advice (paragraph 46).

On ensuring risk remains with the private sector

    (xiv)  Under the terms of the revised deal, the public sector has failed to achieve all the objectives it set itself at the very start for the new museum. It has nevertheless effectively bailed out RAI, as the public sector was unwilling in the end to let the risk lie with the private sector. While RAI have retained responsibility for the debts of £21 million they ran up when building and operating the museum, they have also kept the profitable elements of the museum's business, such as corporate hospitality and car parking, worth in total over £10 million. In contrast, the Royal Armouries have taken over the loss making aspects of the museum and will be dependent on funding from the Department and the income from the lower-than-expected visitor numbers (paragraph 56).

    (xv)  The possibility that RAI's shareholders will still receive some return on their investment, despite the original deal's failure, may be greatly increased by the introduction of free access to the museum later in 2001. Free access should result in greater numbers of visitors to the museum, and consequently higher income for RAI's car parking and catering operations. Under the terms of the revised deal, the public sector will share in these benefits, once RAI have paid off their outstanding debt, as the Royal Armouries will then be entitled to receive twenty per cent of RAI's turnover at the museum. Departments should ensure that they have the right to share in the benefits of any future windfall gain resulting from any re-negotiated deal (paragraph 57).

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Prepared 12 December 2001