Dealing with Brexit and Insolvency Risks in PFI Projects25th May 2018
Mathias Cheung discusses the potential implications of Brexit on insolvency risks in PFI projects:
- The ongoing joint inquiry on the collapse of Carillion has resulted in much public scrutiny of the relationship between Brexit and insolvency in the PFI industry.
- Brexit may potentially heighten insolvency risks for PFI contractors, due to the reduction in funding and new projects, and the increased risk of labour and materials shortages.
- Adjudication may prove to be a speedy and helpful recourse where a PFI contractor is facing cash-flow issues, but this may give rise to complications if the PFI contractor becomes insolvent before an adjudication decision is enforced.
Nearly three months have gone by since the collapse of Carillion back in mid-January. With the ongoing joint inquiry conducted by the House of Commons Work and Pension Committee and BEIS Committee, the jury is still out on the underlying culprits(s) of Carillion’s cash-flow problems and ultimate liquidation.
The whole construction industry, various pundits, and even former Carillion executives have been trying to put their finger on Carillion’s financial downfall, at times pinpointing specific causes such as poor management or aggressive bidding. The reality, however, is likely to be multifaceted, with a combination of factors contributing to a perfect storm. The interesting question is: did Brexit play any role at all in this unfortunate saga?
Many would recall Carillion’s complaints back in December 2016 that the uncertainty of Brexit was to blame for a slowdown in its new orders and projects, and this was shortly followed by the three profit warnings in July, September and November 2017 respectively. Indeed, an ex-Carillion director, Mr Zafar Khan, has recently given evidence that the inability to win substantial new contracts led to cash-flow problems. Others have pointed out that the writing has been on the wall, and that the government’s attention may have been too distracted by Brexit to act in time.
The benefit of hindsight is a wonderful thing, but all this has to be taken with a pinch of salt – it is dangerous to rush to any conclusions. Nevertheless, what cannot be dismissed out of hand is the uncertainty created by Brexit and its potential impact on PFI projects generally (especially since the National Audit Office has warned that one-third of government projects could fail in the coming years):
- Many PFI construction and services contractors operate on wafer-thin profit margins and ambitious programmes, due to aggressive bidding strategies triggered by stiff competition. They often rely on other projects, both existing and new, to maintain cash-flow and/or cross-subsidise their various undertakings. The risk of cash-flow problems may be exacerbated by the reduction in funding and number of new projects due to the uncertainty of Brexit.
- The increasing risk of labour or materials shortage (as I have discussed in previous Bulletins) as a result of changes entailed by Brexit may significantly affect PFI contractors’ ability to deliver projects and services according to agreed timeframes or service performance levels. This may increase the risk of project failures, liquidated damages, and/or substantial deductions to monthly unitary charges, all of which can lead to potential cash-flow problems.
In the post-Brexit world, it is likely that there will continue to be an increasing number of contractual disputes arising from PFI projects, and the various parties involved will have to be ready to deal with such disputes effectively while taking into account the heightened risks of cash-flow issues and insolvency.
Indeed, over the past year, I have been involved in a large number of adjudications in respect of disputes between a Project Co and a PFI construction contractor, disputes between a PFI construction contractor and its specialist consultants, and even contractual adjudications between a public authority and a Project Co. Adjudication has proven to be preferable to long-draw-out litigation in various scenarios, for instance:
- Where there is a dispute regarding the interpretation of payment mechanisms or performance specifications, with substantial sums of deductions and payments at stake, a Project Co may be keen to resolve the difference swiftly through adjudication, in order to avoid any overpayments becoming irrecoverable from a PFI contractor at risk of insolvency.
- Where a PFI contractor is facing serious cash-flow problems, and there are difficulties balancing the accounts by winning new contracts in the post-Brexit climate, adjudications against e.g. specialist consultants or sub-contractors to recoup deductions incurred (or even settlement sums upstream, based on the principles of Biggin & Co Ltd v Permanite Ltd  2 KB 314) may well be the best recourse.
Where there is a real prospect of insolvency, it is essential in every case to assess, amongst other things, whether an adjudicator’s decision would be enforceable, before deciding to commence any adjudication process:
- If the winning party turns out to be a PFI contractor verging on liquidation, chances are that the court would grant a stay of execution on any summary judgment granted: see e.g. Alexander & Law Ltd v Coveside (21BPR) Ltd  EWHC 3949 (TCC), where a petition for winding up has been presented against the enforcing party.
- If the losing party becomes insolvent before enforcement, it is arguable that the court would (depending on the facts) proceed to grant summary judgment: see e.g. the recent case of South Coast Construction v Iverson Road  EWHC 61 (TCC), where Coulson J observed that there is a good case for saying that enforcement proceedings could proceed nonetheless due to the special nature of adjudication decisions.
These and many other considerations will gain mounting importance in the effective resolution of PFI-related disputes, and timely legal advice is key to the effective management of insolvency risks posed by Brexit. At the same time, the government and the construction industry will have to review the viability of the current financial and contractual model of PFI projects, and it is safe to say that there will be no single panacea for the PFI industry.
Mathias’ practice covers all areas of Chambers’ work, including construction, engineering and infrastructure, energy and utilities, information technology, and professional negligence. In addition to these specialist areas, he has gained experience in a wide range of commercial disputes, including cases on fraud, insurance, assignment, subrogation, and conflicts of law. Mathias is also the winner of the SCL Hudson Prize 2015 for his essay entitled ‘Shylock’s Construction Law: the Brave New Life of Liquidated Damages?’.
As a native of Hong Kong, Mathias is fluent in both Cantonese and Mandarin, and he is therefore able to take instructions for cases involving Chinese-speaking parties and Chinese documentation in Hong Kong, Mainland China, Singapore and other jurisdictions.