THE RENEGOTIATION OF THE PFI-TYPE DEAL
FOR THE ROYAL ARMOURIES MUSEUM IN LEEDS
Negotiating commercial deals
Lack of PFI guidance
8. Although the new museum was delivered on time
and to budget, once it did open it never made enough money to
meet its operating costs. The operator, RAI, then faced the prospect
of insolvency in July 1999.[1]
The Department explained that this project had been one of the
trailblazers for the PFI, where the public sector had been learning
lessons. In 1993 the Government's aim had been to maximise the
transfer of risk on such schemes. However this project showed
the problems involved in maximising risk transfer as that objective
had resulted in the deal becoming unsustainable. The private sector
had been given obligations it could not fulfil, with the result
that the deal had had to be renegotiated. In light of developments
in the PFI since 1993, the Government's objective is now to optimise
the transfer of risk on such schemes. The Department acknowledged
that the deal had not been as good as it would have been if current
guidance had been available then.[2]
9. The Treasury confirmed that guidance on PFI projects
had moved on a good deal and it was now generally recognised that,
when going into a PFI project, one should seek the optimum arrangement
for risk sharing between parties, so that risk lay with the party
which can handle it best, rather than the maximum transfer of
risk. The Treasury agreed that, if today's guidance had then been
available, the Royal Armouries would have been better placed to
deal with some of the problems which occurred later.[3]
Inadequate planning
10. While acknowledging the effect of the absence
of guidance, we were still concerned that, even without the benefit
of hindsight, basic precautions had not been taken. For example,
the Department should have been alerted when this high risk project
failed to attract more than one seriously interested party and
Tussauds, who had extensive experience of visitor attractions,
withdrew from competition. The Department agreed that, given the
lack of private sector interest, they should have reconsidered
the deal. Indeed, according to the Department, current guidance
for PFI projects would have obliged them to reconsider the offer
it was putting to the market.[4]
11. Instead of reconsidering the project, the Department
and Royal Armouries had proceeded with it. In so doing they had
taken some comfort from the opinion of their financial advisers,
Schroders, that the deal was the best that could have been achieved
in the market at the time, given the project's parameters.[5]
We were concerned about the reliance placed on this opinion as
Schroders had been involved in the project from the start and
might naturally have been keen to see it proceed. We therefore
asked whether the Department and Royal Armouries had employed
any other adviser to give a more detached view of the proposed
deal. The Royal Armouries told us that Schroders were the only
advisers on the financial side.[6]
12. The Committee questioned the Royal Armouries
about the concerns about the project which members of the Royal
Armouries' support group had expressed at the time and subsequently
communicated to us. The Royal Armouries replied that, while certain
members of the group had expressed concerns, they did not reflect
the view of the support group as a whole. No group associated
with the Royal Armouries and as experts had, for example, advised
them that the new museum would not achieve the projected visitor
numbers.[7]
Poor co-operation
13. Co-operation between the Royal Armouries and
RAI was essential to the success of the project. Details of the
areas where such co-operation was required, such as income generation,
were to have been provided by the operating specification which
was to have been agreed after the signing of the deal but before
the new museum opened. In practice, this document had never been
agreed.[8]
The Committee asked what possible advantage there could have been
for the Royal Armouries waiting until after the contract was signed
before putting the specification in place. The Department replied
that this was the first deal of its type and the first such sharing
of responsibilities, and the Royal Armouries and RAI had not known
what should be included in this operating specification. Then,
once the museum had opened, RAI had been in financial difficulties
and would not agree.[9]
The Royal Armouries told us they accepted that the specification
should have been put in place. However this specification was
not intended to have legal force. Nor, according to the Royal
Armouries' legal advice, would it have put the Royal Armouries
in a substantially stronger position with regard to determining
the contract for material breach. The specification was to be
an aid to good management which would be codified after the new
museum's opening and once the Royal Armouries had some experience
of running it.[10]
RAI said that one of Tussauds' major worries, which had caused
them to withdraw from the competition for this deal, had been
the proposal for split control between the Royal Armouries and
its chosen operator. Such operators preferred to have control
over matters such as the visitor experience and marketing.[11]
14. A lack of co-operation was also apparent in the
absence of any right on the part of the Royal Armouries to have
access to RAI's underlying financial records.[12]
The Department agreed that the lack of that access had left the
Royal Armouries and the Department in the dark when things went
wrong.[13]
The Royal Armouries also admitted that there had been disagreements
between RAI and themselves over issues of fundamental importance
to the future of the museum. These issues included RAI's attempts
to boost their income, the programme of exhibitions, the ticketing
policy and the approach to marketing the museum.[14]
Inadequate contract exit provisions
15. The Committee examined the provisions in the
original 1993 contract for dealing with the museum's failure.
The problem for the Department and the Royal Armouries when faced
in 1999 by RAI's threatened insolvency was that this was an important
museum, the closure of which they considered to be unacceptable.
However the Royal Armouries' right to terminate the contract and
take possession of the museum in the event of financial failure
by RAI was limited for a period of two years after the appointment
of a Receiver or Administrator.[15]
The new PFI guidance would have required the Department to face
at the start of the project the question of what would happen
to the museum in the event of failure.[16]
Conclusions
16. 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.
17. 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.
18. 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.
1 C&AG's report, para 1.1 Back
2 Qs
5, 66-68, 78-79, 118 Back
3 Qs
17, 74 Back
4 Qs
62-63, 66, 78, 177 Back
5 C&AG's
report, para 1.24 Back
6 Q69 Back
7 Qs
31-33, 35, 55, 95 Back
8 C&AG's
report, para 1.46 Back
9 Q160 Back
10 Q161 Back
11 Q55 Back
12 C&AG's
report, para 1.61 Back
13 Q76 Back
14 Qs
92-94 Back
15 C&AG's
report, paras 1.67, 1.76-1.80 Back
16 Q175 Back
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