Toll road re-think

24 April 2008

Some 55000 Vehicles Use the M6 Toll Road - the UK's first Private Finance Initiative (PFI) toll road - each day, and the UK Government's recently reaffirmed commitment to support road charging schemes through the Transport Innovation Fund, indicates the PFI procurement model is here to stay. Indeed, the Highways Agency, the UK Government authority responsible for motorways and major roads, has already procured 11 schemes, 8 of which are operational under its Design Build Finance Operate (DBFO) Programme.

While the programme has not been without its difficulties, public opinion has moved from fervent opposition to a resigned acceptance of road charging; a change which gives the market a real opportunity. But this was before Midland Expressway - a recent legal judgement, professed by some to send “shock waves through the world of PFI.”

The Midland Expressway Case

Midland Expressway Limited was the contractor appointed to build, finance and operate the M6 Toll Road. As is commonly the case with PFI projects, all risks and obligations owed by the contractor to the authority, were “passed down” to subcontractors who were responsible for the actual building and managing of the road once operational. Midland Expressway was merely their interface with the authority and an entity within which its liability was ring-fenced.

In PFI arrangements, the pass down of risks between the contractor and its subcontractors is commonly handled through the use of “equivalent project relief” (“EPR”) provisions. These are contractual terms which restrict the subcontractor from claiming payment, extensions of time or any other relief to the extent that the contractor is entitled to, and has obtained such relief from the authority. In this case the subcontractors could only seek payment from Midland Expressway for an additional UK£ 9 million (€ 13 million) of work they had undertaken once, and only if, Midland Expressway had recovered such monies from the authority.

Whilst EPR provisions have been extensively used within the PFI industry, there has always been an acknowledgement that such terms may be contrary to Section 113 of the Housing Grants, Construction and Regeneration Act 1996 (“Act”) which prohibits, “making payment under a construction contract conditional on the payer receiving payment from a third party.”

The judgement has meant Midland Expressway is required to assume a risk which it had not priced for nor planned to manage.

The industry has always argued that EPR provisions deal with when a subcontractor is entitled to payment, and not how, and are therefore not subject to Section 113. However, the Technology and Construction Court (TCC) did not accept this argument and stated that ‘pay when entitled' clauses, just like ‘pay when paid' clauses were not of themselves compliant with the Act. The EPR terms were deemed to be unenforceable, allowing the subcontractors to pursue Midland Expressway for monies which Midland Expressway did not have, since it had not received payment from the authority. The judgement has meant Midland Expressway is required to assume a risk which it had not priced for nor planned to manage.

Implications

So what does this mean for PFI road schemes? It probably does not mean that there will be no more PFI road schemes but it does mean that there is a change to the perceived risk allocation underlying such schemes. Contractors cannot pass EPR risk down to subcontractors and they will have to find ways of mitigating and managing any residual risk.

The judgement of the TCC must also be seen in context. The TCC is a court of first instance and therefore the decision could be appealed. It was made in the context of injunction proceedings and only relates to construction contracts (not operational contracts) and there is very little discussion in the key parts of the judgement. Rather than “shock waves” pervading through the PFI industry, its more likely that the judgement has given the industry a wake-up call necessitating the careful re-examination of EPR drafting.

New PFI Road schemes should be procured on the basis of:

• revised risk allocations accepting that contractors may not be able to pass down EPR risk to subcontractors,

• new mechanisms to manage any such residual risk.

These mechanisms could include the use of a working capital facility from the parent company, longstop dates for payment of monetary claims or even ‘pay now dispute later' clauses. All of these have recently been mooted as possible practical solutions.

Regardless of the route chosen, the prevailing public mood and the Government's renewed approach to road charging means the M6 Toll is not likely to mark the end of UK PFI roads, but will herald the starting point for an underlying contractual re-think of how to deliver new toll roads.

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