This Practice Note, produced by Mathias Cheung in partnership with LexisNexis, considers insolvency aspects of PFI/PFI2 projects including contractual provisions such as step-in rights, enforcement of security, insolvency of Project Co and protective measures to counter insolvency risks.
To view the article on Lexis®PSL, please click here (login needed).
Reprinted with permission of LexisNexis, all rights reserved.
This Practice Note is a guide to insolvency in PFI/PF2 projects. The aim of this practice note is to provide restructuring and insolvency practitioners with an overview of the relevant contractual provisions, restructuring options and potential measures to protect a client’s position.
What are PFI/PF2 projects?
The Private Finance Initiative (PFI) is a public private partnership (PPP) model, the purpose of which is to procure and deliver a variety of public infrastructure and services, including schools, hospitals, prisons, railway links, roads and social housing.
A PFI project is typically funded by private sector lenders, with private sector contractors taking on the burden and risk of the design, construction and/or day-to-day operations. Each PFI project is usually a long-term arrangement which lasts for 25–30 years.
Private Finance 2 (PF2) was introduced by the government in December 2012, with a view to increasing the sources of equity and debt finance, increasing transparency, and reducing the cost of the procurement process. In particular, the government often acts as a minority equity investor in PF2 projects.
For more background information about PFI/PF2 projects, see the Practice Notes on Introduction to PFI and PF2 and PFI/PPP terms (Glossary).
References:
The parties involved in a PFI/PF2 project depends on the type of infrastructure/service being procured and the funding arrangements in each project. For a more detailed discussion of the parties typically involved in a PFI/PF2 project, see Practice Notes: Key parties in a PFI/PF2 project and PFI structure—diagram.
References:
Key parties in a PFI/PF2 project
For the purposes of this practice note, the key parties and documents include:
Further details of the key documents in a PFI/PF2 project are set out in Practice Note: Key documents in a PFI/PF2 project.
References:
Key documents in a PFI/PF2 project
Political context of PFI/PF2 insolvency
Although insolvency in PFI projects is not a new phenomenon, the collapse of Carillion in January 2018 has thrown the political complications of such insolvency events into sharp relief. In light of the nature of PFI/PF2 projects, it is common to have extensive negotiations with the Authority/Trust and the government both before and after an insolvency event.
To take a concrete example, Carillion engaged in high-level discussions with its lenders and the government to negotiate a restructuring of its debts and a potential bail-out, but the government’s decision not to bail out Carillion made its collapse inevitable. This gave the government a high degree of control over the liquidation through the appointment of an Official Receiver, and the government was also able to transfer numerous contracts back into public ownership. For more discussion on the insolvency of Carillion, see News Analysis: Carillion crisis—restructuring and inevitable insolvency.
References:
Carillion crisis—restructuring and inevitable insolvency
Therefore, the success of any restructuring exercise often requires some form of political compromise, taking into account public perception, public interest in the continuing delivery of the infrastructure or services, and the impact of the restructuring exercise on the continuing affordability of the project. This provides essential context to the issues arising from insolvency and restructuring in PFI/PF2 projects.
Navigating PFI/PF2 insolvency—steps and provisions
Perhaps the most daunting task in the face of insolvency in a PFI/PF2 project is getting to grips with the numerous agreements and documents, which necessarily inform the steps to take in any intended restructuring exercise. The terms of the documentation will be key in determining the options your client may have and form the basis of any contingency planning around the potential insolvency of a party to the PFI/PFI2 project.
In summary, the key provisions and steps which often come into play in the face of insolvency include the following:
(i) Acceleration provisions under the Loan Agreement
Insolvency and insolvency-related proceedings in respect of Project Co or one of the Contractors are usually defined as an ‘Event of Default’ under the loan agreement.
In the event of such occurrences, the loan agreement typically provides for the right of the lenders (collectively, and often through a facility agent) to take a range of actions to protect the interests of the lenders, including:
Given the potentially draconian effect of the steps outlined above, in the case of a contractor becoming insolvent, the loan agreement usually allows a grace period for the Project Co to replace the Contractor on the same terms, or at least submit a plan to rectify the situation. The expiry of such a grace period is usually a condition precedent for the lenders to take any action under the acceleration provisions.
Depending on the specific loan agreement in question, the facility agent may have the discretion to exercise the powers provided by the acceleration provisions, and will usually be required to do so if instructed by a majority of the lenders. Individual lenders do not usually have the right to take independent action.
(ii) Enforcement of security under the security agreements
The enforcement of the security provided by Project Co and/or the Contractors is governed by the express terms of the relevant security agreement. The security often becomes immediately enforceable by virtue of a notice given under the acceleration provisions of the loan agreement (as outlined above), and is directly triggered by an ‘Event of Default’ under the Loan Agreement.
Once the security becomes enforceable, the security agent is usually given an absolute discretion to enforce all or any part of the security or express instructions from the majority of lenders.
The options available to the security agent after the security becomes enforceable depend on the specific terms of the security agreement in question. The security agent is usually entitled to exercise any powers of sale and leasing conferred by law, take steps to protect and maintain the security asset, and appoint a receiver to perform these functions.
The proceeds from the enforcement of the security must usually be applied in accordance with the express terms of a security trust and intercreditor deed. For further reading, see Practice Notes: Enforcement—debentures and floating charges and Intercreditor agreements for R&I lawyers.
(iii) Termination of Project Co or Contractors
One of the natural consequences of the insolvency of Project Co is the termination of the Project Agreement, as Project Co’s insolvency is almost invariably an ‘Event of Default’ which entitles the Authority/Trust to exercise a contractual right of termination. The Construction and FM Contractors would usually have similar rights of termination under the Construction and FM Contracts respectively if Project Co becomes insolvent.
The Authority/Trust and Construction/FM Contractors are normally required to give advance notice to the Lenders under the funders direct agreement prior to any proposed termination. This is to afford the lenders a proper opportunity to consider exercising its step-in and novation rights, as will be discussed in the next sub-section below.
In a similar vein, the insolvency of a Construction or FM Contractor is almost always an ‘Event of Default’ under the relevant Construction Contract or FM Contract, such that Project Co would be entitled to exercise a contractual right of termination upon obtaining prior written consent from the Authority/Trust. In this case, it would be necessary to procure a substitute Construction/FM Contractor, or transfer the FM services back into public ownership.
For more details on termination, see Practice Note: Termination of PFI/PF2 contracts.
References:
Termination of PFI/PF2 contracts
(iv) Step-in and novation under Funders Direct Agreements
Step-in and novation rights are standard provisions which exist in almost every PFI/PF2 project, and they provide the lenders with an important means by which to protect their financial interests. As with the other rights and powers discussed above, the scope of the lenders’ step-in and novation rights depends on the express terms of the funders direct agreement in question.
In a typical funders direct agreement, the lenders are entitled to notify the Authority/Trust or the relevant Construction/FM Contractor that an appointed representative would assume Project Co’s rights and liabilities under the Project Agreement or the Construction/FM Contract respectively.
A step-in notice usually has to be given when an ‘Event of Default’ is subsisting, or within what is known as the ‘Required Period’ (ie the period of advance notice to be given by the Authority/Trust and the relevant Construction/FM Contractor, prior to terminating the Project Agreement and the Construction/FM Contract respectively). Advance notice of the identity of the proposed appointed representative must also be given to the Authority/Trust.
In addition, the lenders may procure the novation and transfer of Project Co’s rights and liabilities under the Project Agreement to a suitable substitute contractor. If this arrangement becomes effective, any subsisting termination notice or grounds of termination would have no further effect, and the lenders would provide funding to the substitute contractor under a new suite of finance documents.
Advance notice of the proposed substitute contractor must usually be given to the Authority/Trust for approval. Negotiations and political compromise are often at the heart of the novation process, and much would depend on the track record, technical expertise and financial resources of the proposed substitute contractor. It is of utmost importance to present a workable rectification plan in respect of any past breaches, and to instill confidence in the proposed substitute contractor.
These step-in and novation rights are designed to give the lenders a chance to prevent the wholesale collapse of the project. By appointing a suitable substitute contractor to operate the PFI/PF2 project, the lenders may be able to recover the loan from the revenue generated, and avoid incurring significant financial losses.
Restructuring options in the face of insolvency
The appropriate restructuring option depends on the provisions of the contractual documentation and the party becoming insolvent.
Insolvency of Construction/FM Contractor
The relevant Construction/FM Contract will most likely be terminated by Project Co upon insolvency. In this case:
References:
Public Contracts Regulations 2015
References:
Public Contracts Regulations 2015
Insolvency of Project Co
Upon Project Co insolvency, the Authority/Trust will most likely give notice to the lenders and, after the expiry of the ‘Required Period’, seek to terminate the Project Agreement. The Construction/FM Contractors may also seek to terminate the Construction/FM Contracts. In this scenario:
References:
Public Contracts Regulations 2015
References:
Public Contracts Regulations 2015
References:
Case C-396/14 MT Højgaard A/S v Züblin A/S
Protective measures to counter insolvency risks
If there is a known risk of contractor insolvency:
On the other hand, if there is a known risk of Project Co insolvency and any subsisting ‘Events of Default’:
If insolvency in a PFI/PF2 project appears imminent, and there are outstanding disputes between Project Co and the Construction/FM Contractors regarding performance failures, payment deductions, and compensation/relief events, the solvent party may consider protecting its position by referring a dispute to a contractual adjudication (which is commonly provided by PFI/PF2 contracts).
References:
Compensation events and relief events in PFI/PF2
For instance, if there is an ongoing dispute with substantial sums of deductions and payments at stake, it is common for Project Co to resolve the differences swiftly through adjudication, in order to avoid making any overpayments which may well become irrecoverable from a Construction/FM Contractor at risk of insolvency.
This paper was written by James Howells QC for the Society of Construction Law (Singapore)…
URS has been granted permission by the Supreme Court to appeal the decision of the…
For more information please contact our clerks on
+44 (0)20 7404 0102 or clerks@atkinchambers.com