House of Commons - Public Accounts

Select Committee on Public Accounts Fifteenth Report

2 The termination of the PFI Contract

11. Construction work on site began in July 1998.[31] Deficiencies in JLC Ltd's designs were identified by the Department's technical advisor, HDR, and the project's Independent Certifier in early 1999.[32] As construction continued numerous problems arose, including significant problems with the performance of JLC Ltd's designs, which resulted in delays in the completion of all construction phases. These delays ranged from six months up to nearly four years, and altogether the project has been delayed by five to six years.[33]

12. The Department offered advice to Laser on solving the design problems, including advice from the Department's engineering advisers, HDR.[34] The Department was however concerned not to take back from Laser the design risk that had been transferred to it under the PFI contract. The Department therefore felt unable to step in and insist on design changes for fear that by doing so it would accept some of the design risk, and decided to leave the problems with Laser.[35]

13. The Department considered terminating the contract on three occasions between 2001 and 2003.[36] On the first occasion, in 2001, it considered doing so on the basis of Laser's performance. On the second, towards the end of the same year, it considered doing so because Laser had signed an agreement with John Laing plc relaxing the performance requirements in the construction contract without the Department's consent; and on the third because of Laser's late delivery.[37] On each occasion the Department received firm legal advice from experts in construction law that it would be risky to initiate termination, particularly while Laser was still solvent and willing to continue, because it might itself be liable for damages.[38] The Department was also concerned at the potential difficulty of finding a replacement contractor, and the likelihood that the project's evident problems would have meant that it could only have done so by paying a much higher price.[39]

14. Treasury guidance recommends the provision in PFI projects of step-in rights for lenders. These rights entitle the lenders in defined circumstances to take control of a project and are intended to provide an opportunity for the lenders to revive the project, thereby avoiding the disruption of a termination.[40] However, Laser's lenders chose not to exercise their rights to step-in to the project because they did not want to assume responsibility for solving the problems with the design.[41]

15. By mid-2004 Laser had exhausted the funds available to it to complete the building and on 7 July 2004 it proposed to the Department that the PFI contract should either be revised and re financed, or terminated.[42] The Department decided on termination, but sought to achieve it by negotiation, which it considered would probably get a better and quicker result than a formal termination for contractor default.[43]

16. The agreement between Laser and the Department provided for the appointment of an Independent Certifier to determine the completion of each phase of the building, paid for jointly by Laser and the Department.[44] By 5 July 2004, the Independent Certifier had signed off completion of the last of the building modules.[45] The Department considered that some of the construction phases had been wrongly certified and referred the matter to adjudication.[46] The adjudicator concluded that the Department did not have beneficial use of the space at issue, and decided in favour of the Department.[47]

17. The Department and Laser formally terminated the contract in December 2004.[48] The Department paid Laser £75 million for its interest in the building and assumed responsibility for its completion.[49] The Department's opening position in negotiating the termination sum was informed by the contractual provisions governing contractor default. Under these provisions the termination sum was the lesser of the lender's liabilities, initially assessed at £93 million, and Laser's construction costs, adjusted for the projected cost to the Department of completing the project and any unpaid damages owed by the company, initially assessed at £54 million.[50] As negotiations progressed, the Department estimated that a more realistic assessment would be between £86 million and £73 million; the agreed termination sum was near the lower boundary of this range.[51]

18. Over three years passed from when the Department first considered termination of the contract to the actual termination, but a lot of work was completed during this period.[52] And if had it pushed for termination of the contract in 2001, it would not have been in as good a position as had been achieved, with a nearly completed building.[53] It was confident that the remaining construction work could be completed within a budget of £18 million and that the scientific modules would be 98 per cent ready for occupancy by the end of March 2007.[54] With completion, the Department's investment in the new facilities was likely to total £140 million (2005 prices), £10 million more than the total of Laser's budgeted construction cost of £113 million (2005 prices) and the Department's procurement and other budgeted costs of £17 million (2005 prices).[55] Laser, its owners and its contractors reported losses totalling over £100 million.[56]