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News Release from: Chartered Institute of Building [CIOB] | Subject: PFI contract losses
Edited by the Buildingtalk Editorial
Team on 15 May 2006
PFI contract that cost 100m pounds to
terminate
Termination of PFI contract occasioned losses of at least £100 million in the private sector.
This was the first termination of a major private finance initiative (PFI) contract in the United Kingdom in which there were serious deficiencies in contractor performance, says the National Audit Office on release of its 55-page report dealing with the delays in completing the design and build contract for some £100 million worth of new facilities for the National Physical Laboratory, which for more than 100 years has been located close to the River Thames at Teddington Termination of the contract occasioned losses of at least £100 million in the private sector
This article was originally published on Buildingtalk on 12 Mar 2004 at 8.00am (UK)
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The equity investors in the venture lost £4 million; a damaging loss was inflicted at a difficult time on John Laing plc whose JLC construction company took a £67 million loss on the contract it entered into as sub-contractor to the design group Laser; £12 million is reckoned to have been lost by suppliers and sub-contractors; and £18 million by the banks which financed the project due to breaking agreements to hedge movements in interest rates.
The National Audit Office comments in its recommendations that the contractor failed to deliver the project to the time and quality required.
However, it says that the contract and the way it was managed by the Department of Trade and Industry were effective in transferring design and construction risk to the private sector, as the above figures amply demonstrate.
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"While the public sector has lost some of the benefits from the use of the buildings, it has not borne the full cost of making good the deficiencies in them.
We conclude that the Department did not achieve full value for money in the short to medium term, but it did protect its downside position.
"Some lessons that can be drawn from this project have already been captured in guidance since the contract was signed in mid-1998.
There are however new lessons to be learnt and older ones to be reinforced about awarding and managing a fixed-price contract involving a high degree of technical complexity." Where a contract is known to have technically challenging requirements, NAO recommends that the procurement process should require bidders to demonstrate convincingly that they can satisfy the performance obligations.
This brings out several aspects of risk management, for example ensuring before the contract is signed that it provides adequate incentives for all parties to avoid problems, or cure them if they occur.
The audit office found that the risks to the NPL project could have been reduced in advance.
It says that the department did not impose a design solution on Laser - a joint venture between John Laing and the Serco Group - following award of the contract, despite continuing concerns about Laser's design.
"This was because the DTI wanted to ensure that responsibility for delivering the buildings that met its specification would remain unambiguously with Laser".
Keeping it off the balance sheet.
The report explains that the department was seeking an arrangement under which the new and upgraded facilities would not appear on its balance sheet.
"The department therefore sought to transfer a substantial element of risk to the private sector.
Securing the risk transfer prevented the department from forcing resolution of its concerns over the design because it was of the view that to have done so might have reduce the amount of risk the private sector would bear, and result in the project coming on the balance sheet.
"The department expected that even though it had concerns about the design, the transfer of design to Laser and its partners meant that they would recognise that it was in their best interests to resolve those concerns.
Unfortunately, the department was mistaken in this expectation." 'No proof of design validity'.
NAO adds: "Neither Laser nor JLC sought to prove to the department the viability of their designs.
Nor did they take up the department's offer in Spring 1998 to send key personnel responsible for the design of environmental control systems to visit the laboratories of the National Institute of Standards and Technology (NIST), the American equivalent of the NPL.
"During the visit with Laser, the department had arranged to meet HDR which had designed systems at NIST to achieve temperature controls more stringent than those specified at NPL." The outcome today is that a project scheduled to finish in 2001 is now not expected to be fully available to NPL until 2007.
DTI has acquired an asset worth £85 million on a 2005 depreciated replacement cost basis at an investment cost of £122 million, of which £75 million was paid to Laser on termination of the contract.
A further £18 million of remedial work is now in hand for which Bovis Lend Lease is the project manager, working with the department's project team who know the facilities and have the skills required to correct the design defects.
So far progress with remedial work is said to be on schedule and within budget.
By the time the project is complete, some nine years since the original contract was signed, DTI investment in the new NPL facilities will amount to about £140 million.
This compares with an estimate of around £130 million for the total capital investment at the time of contract signature.
But as Sir John Bourn, head of the National Audit Office commented when the report was released, different handling of the project by all parties at the early stages might well have avoided the problems which led to the termination.
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