Select Committee on Public Accounts Fourth Report


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]


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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Prepared 12 December 2001