LAWYERS TO THE
PROJECTS INDUSTRY
www.klng.com
Spring 2006
Projects Bulletin
Key issues for long term IT and
outsourcing contracts arising from
the passing of time
Long-term IT and outsourcing
contracts form part of the category of
facilities management agreements, by
which a broad range of services or
activities are provided to the company
or person in charge of the operation and
management of a facility (rather than
the owner of the asset). The prime
contractor usually relies on specialist
service providers to manage the
provision of specific services to the
facility.
"FM contracts", as they are known in
the PPP/PFI industry in the UK,
usually run over a 25-year period. As
PPP/PFI projects are service-based
rather than asset-based, their success in
the long term does not only rely on the
quality and cost of the design and
construction of the buildings or
facilities. Long-term success relies on
the quality, performance and cost of
the service or services provided to the
end-users (public authorities, tenants of
social housing, students, patients,
doctors, etc). Historically, the initial
construction of a PPP project was the
focus point. This has now changed and
the high operation and maintenance
costs of running the facilities in
healthcare, education and
accommodation for 25 to 30 years have
been occupying centre stage.
The key obligation placed on any
service provider in a PPP/PFI contract
is to deliver its services at the required
level, expressed in output terms. Being
long-term contracts, service PFI
contracts must be flexible enough to
allow for the passage of time. This is
an area particularly sensitive for
information, communication and
technology PPP contracts as both
technologies and requirements will
evolve considerably over a 25-year
period. IT contracts are used for ongoing development of IT
infrastructure, as well as network and
software services.
In order to deal effectively with the
dramatic rate at which IT hardware and
software become faster, more powerful
and more fully functioned, lawyers in
the industry have developed a number
of specialised clauses to manage the
change itself. Bespoke provisions are
typically drafted for sophisticated PPP
and PFI transactions.
Technology is changing as the result of
many forces. One of the forces is the
rate of change in customer or user
requirements. Public bodies and
private companies increasingly rely on
IT to cut costs and risk and to increase
business performance.
Welcome to the Spring Edition of
the Projects Bulletin.
In this edition, we focus on PFI and
public procurement law. The
prohibition of pay-when-paid in
construction contracts continues to
raise much debate in the context of
PPP/PFI contracts. A recent case
relating to the Birmingham toll road
indicates that equivalent project relief
provisions may not always be
effective to circumvent the pay-whenpaid provisions of the Act (page 4). In
addition to our recent alert on the
new regulations on public works,
services and supplies contracts, we
provide a round up of recent
developments on public procurement
law (page 7).
Contents
Key issues for long term IT and
outsourcing contracts arising
from the passing of time
1
New case on pay when paid
4
Domenici-Barton Energy Policy
Act 2005
6
Update on public procurement
7
Who to contact
8
Projects Bulletin
Three of the main categories of clauses
which deal with the rapid changes over
time relate to benchmarking
throughout the life of an agreement,
managing the technical upgrades in
hardware and software and avoiding
any detriment from corporate changes
within the industry.
Benchmarking
Benchmarking is the process by which
a user (for instance the facility prime
contractor or public authority) checks
that it is continuing to get the best deal
over time, consistent with the objective
of ensuring that, as the general quality
of service increases and price decreases
in the market for IT products and
services, the user is able to continue to
take advantage of them.
Prices across the industry, typically but
not necessarily, country by country, are
compared with the price, of the
services set out in the agreement
between the supplier and the user. An
adjustment is made (typically
downwards) when a difference is
found. Checks on quality are carried
out in much the same way. The usual
response to any deviation is that the
supplier "raises its game" to the
2
SPRING 2006
standards prevalent in the market at
the time of the benchmarking check.
Several issues arise which have a
material effect on the usefulness of,
and from the perspective of the
supplier, the risk associated with, the
implementation of benchmarking. It is
necessary, for example, for a
comparison to be "like for like". That is
to say, the prices of software
development or processing services in
the UK should be compared with the
prices under contracts for other
development or processing in the UK.
The supplier will argue that prices
should not be compared, for example,
with processing and development in an
offshore location. Furthermore, the
frequency and timing of the
benchmarking checks should be set so
as to treat the user and the customer in
an even-handed fashion. If, for
example, the parties have agreed to a
hardware refresh 3 years after the
commencement of the PPP/PFI
outsourcing or IT agreement, it would
be unfair to the supplier to conduct a
benchmarking review at the 30 month
point. This would otherwise unfairly
penalise the supplier for falling below
the then current standard.
Another issue which often raises the
temperature of negotiations is the
identity of the company which is to
conduct the benchmarking survey.
Sophisticated suppliers will wish to
avoid having any of their competitors
conduct the survey. Users however
may be tempted to engage
organisations with which they have an
existing relationship and may be
subject to subtle pressure in reporting
the results.
Upgrades
Upgrades, patches and other
modifications to software, and the
installation of new hardware, need to
be managed carefully to avoid any
incompatibility or inefficiency. The
supplier will be concerned to see,
however, that the user does not fall
behind in its implementation of newer
products. The supplier will not want to
maintain a support capability for old
software past the date at which doing
so becomes uneconomic.
Contractually, these issues are
managed by agreeing upgrade
schedules and limiting support
obligations to the current and the one
www.klng.com
or two immediately preceding versions
of a particular application. Users are
also sometimes required to take sole
responsibility for upgrading their
hardware, or agree to pay for the
supplier to upgrade it, in order to ensure
that applications will continue to run
efficiently.
Corporate changes
As many have observed, IT companies
come and go at an alarming rate,
sometimes simply being swallowed by
other companies and, at times,
disappearing altogether. Users,
predictably, wish to ensure continuity of
supply to a high standard at least during
the crucial early stages of an agreement.
Frequently for the benefit of their
shareholders, users wish to ensure that
they have the opportunity to take
advantage of corporate restructuring
opportunities as they arise.
The provisions required to deal with
corporate changes are relatively well
known. Standardisation of PPP
contracts, issued by the Treasury
Taskforce, contain guidance on change
of control, which supplements the
contractual change mechanism. They
include the right of the user to
terminate an agreement should there
be a change in control. The value of a
provision such as this increases with the
size of the transaction. The risk of
losing a major customer could
potentially kill a particular merger or
acquisition. This also encourages the
supplier to take that user's interests
significantly into account in whatever
arrangements are agreed.
Similarly, customers frequently insist
that escrow arrangements are put in
place to afford a mode of protection
against the vicissitudes of the industry.
Escrow arrangements can be triggered
immediately upon any default with
respect to support or any apparent
demise of the supplier.
Summary
Time, and in particular the rate at
which change takes place in short
periods of time, plays a key role in the
structure, drafting and negotiation of
PPP/PFI agreements for IT and
outsourcing. The provisions used to
deal with these concerns are frequently
complicated and difficult to negotiate
because each party has considerable
advantage or disadvantage riding on the
result. Thus, the normal changes in
the IT industry can transform a
seemingly favourable agreement into a
costly error if the requisite protections
with respect to time and change are not
dealt with properly.
For further information please contact
John Enstone, partner (London office)
email: jenstone@klng.com
tel: +44 (0)20 7360 8262.
SPRING 2006
3
Projects Bulletin
New case on pay when paid
Midland Expressway Limited v.
(1) Carillion Construction Limited, (2)
Alfred McAlpine Construction
Limited, (3) Balfour Beatty Group
Limited, (4) AMEC Capital Projects
Limited, (5) John E Price (No 2), TCC,
Jackson J, 24 November 2005
Provisions which seek to protect SPVs
from the risk of being obliged to pay
their sub-contractors (construction
contractors and service providers)
before receiving payment from the
Authority are common in PFI contracts.
The Government saw fit to exclude the
contract between SPV and the
Authority from the operation of the
Housing Grants Construction and
Regeneration Act 1996 ("the Act") but
not the sub-contracts, thereby creating
a problem for SPVs and their funders.
Various imaginative drafting provisions
have been tried to circumvent the "pay
when paid" provision of the Act.
These are usually :
(i) a pay-when-certified mechanism,
as a condition precedent to the
contractor or service provider
exercising its entitlement to
payment;
(ii) a loan-back agreement in favour
of the SPV, should the pay-whencertified fail; and
(iii) an extended postponement of
the due date for the payment, which
allows a "buffer" period for the SPV.
The loan-back agreement requires that,
if the sub-contractor is entitled to
payment and demands payment from
the SPV where the SPV does not have
the necessary funds, the sub-contractor
or its parent company make a loan of
4
SPRING 2006
the amount due to the SPV. The loan
enables the SPV to make the payment.
The sub-contractor or parent company
(as the case may be) is repaid when the
SPV is placed in funds.
A recent judgment of Mr Justice
Jackson in the TCC, Midland
Expressway Limited -v- Carillion
Construction Ltd, Alfred McAlpine
Construction Ltd, Balfour Beatty
Group Ltd, AMEC Capital Projects
Ltd and John E Price, dated 24
November 2005 has put to the test just
one such set of provisions.
Several disputes arose between the
SPV Midland Expressway and the
contractor (a joint venture formed by
the four contractor defendants).
According to the construction contract,
if a dispute arose between the SPV and
the contractor and was referred to
adjudication, the SPV was required to
provide copies of all adjudication
documents to the Secretary of State
("SoS"), who could choose to become a
party to those adjudication
proceedings.
The first question was whether there
was a construction dispute between the
contractor and the SPV. The SPV
argued that it was merely the conduit
through which payment passes from
the SoS to the contractor. Jackson J
rejected this argument: the contractor
was bringing a claim for extra payment
against the SPV as its employer and
this was plainly a construction dispute.
The next question was whether the
contractual provisions prevented the
contractor from pursuing its
adjudication at any time. The
construction contract expressly
debarred the contractor from pursuing a
claim for a SoS change until the value
had been determined upstream.
Jackson J held this mechanism to be
contrary to Section 108 (2) of the
Construction Act, which allows either
party to refer a dispute to adjudication
at any time.
The contractor then argued that it was
entitled to press on with its claim for
interim payment against the SPV
before the claim under the concession
agreement had been fully resolved.
The construction contract (clause 39.6)
was drafted as to debar the contractor
from pursuing its claim before the
claim was finally resolved under the
concession agreement.
Clause 39.6.2 prevented the contractor
from being paid any money in respect
of the SoS change until the SPV had
established its entitlement to be paid
under the concession agreement. Also,
if the original evaluation under the
concession agreement was made in
error, the contractor could not be paid
the correct sum due to it until the
dispute resolution procedure under the
concession agreement is fully operated.
Readers will recognise clause 39.6 as
being similar to the usual contractual
provisions used in PPP/PFI
construction contracts.
Jackson J held that "the practical
consequence of clause 39.6.2 is that
CAMBBA [the contractor] will not be
paid for department's changes unless
and until MEL [the SPV] has received
a corresponding sum from the
department. This is so even in cases
where CAMBBA has established or
could establish an entitlement to
payment or additional payment under
www.klng.com
the dispute resolution procedures of
the construction contract. This state of
affairs is precisely what Section 113 of
the 1996 Act is legislating against."
Note that clause 39.6.2 uses the phrase
"the amounts to which the employer is
entitled to be paid" rather than "the
amounts which the employer is paid".
Such drafting did not however rescue
the clause from the pay-when-paid
prohibition.
Finally Jackson J held that, should he
be wrong in his interpretation of clause
39.6.2 on proceedings, the same clause
ought to be read in conjunction with
the provisions on equivalent project
relief. The construction contract
contained provisions on equivalent
project relief, which are also familiar to
our readers. In accordance with clause
7.1.3 of the construction contract, the
contractor was expressly entitled to the
proportion of equivalent project relief
as fair and reasonable in the
circumstances provided that two
conditions were met:
an agreement between the SoS and
the SPV has established that the SPV
is entitled to equivalent project relief
in the circumstances; and
the SPV has received the funds for
the price adjustment or has certified
that it has funds available to it for the
payment of the price adjustment.
In any case, the construction contract
expressly provided that the SPV was
obliged to make a payment to the
contractor only to the extent the funds
were available.
The judge concluded that the two
clauses (39.6.2 and 7.1.3) read together
constitute express and ineluctable paywhen-paid provisions". Therefore the
contractor was entitled to proceed with
the adjudication.
For further information please
contact:
Trevor Nicholls
email: tnicholls@klng.com
tel: +44 (0)20 7360 8177
Sophie Charveron
email: scharveron@klng.com
tel: +44 (0)20 7360 8154
SPRING 2006
5
Projects Bulletin
Domenici-Barton Energy Policy Act 2005
The Domenici-Barton Energy Policy
Act of 2005 (the Act), passed by the
U.S. Congress in August 2005, is
comprised of over 1700 pages of text
affecting virtually every aspect of the
U.S. energy industry. It also addresses
key areas that have been long
neglected such as transmission
investment, grid stability and market
integrity.
by the Nuclear Regulatory Commission
after 1993).
Clean Coal Facility Credits
Two separate investment tax credits
are created for facilities using
“Integrated Gas Combined Cycle” or
other qualifying “clean coal”
technologies.
Domestic Fossil Fuel Incentives
The Act authorises approximately
$14.5 billion in tax incentives intended
to promote U.S. energy production and
conservation and to improve the
reliability of existing energy
infrastructure. It also includes
provisions aimed at enhancing
investment in transmission facilities,
promoting renewable energy and
enhancing energy efficiency.
Here is a sample of the tax incentives
contained in the Act:
Production Tax Credit
This credit applies to wind energy,
closed-loop biomass, geothermal, small
irrigation power, landfill gas,
incremental hydropower capacity and
solid waste combustion, and has been
extended for two more years.
Clean Renewable Energy
Bonds
The Act creates a new category of taxfavored “Clean Renewable Energy
Bonds” that can be used to finance
Section 45 facilities.
Advanced Nuclear Power
Production Tax Credit
A production tax credit is established
for electricity produced at an
“advanced nuclear facility” (defined as
a facility with a reactor design approved
6
SPRING 2006
The Act provides a variety of economic
incentives (e.g. tax credits and
accelerated depreciation) for producers
of coke and coke gas, petroleum
refiners and natural gas producers and
distributors.
The Act also includes several research
and other incentives for renewable
energy technologies and nuclear
energy. Despite these substantial
incentives, the Act is distinctly less
generous in providing guidance on
structural issues that will affect
investment, resource diversity and
effective regulation of electric markets.
Accordingly, investors (be they U.S. or
non-U.S. based) should beware of key
risks in the areas of fuel market
volatility, lack of investment capital for
independent generation and
transmission, and the internalisation of
environmental costs being driven by
Kyoto and its U.S. cognates.
The Act’s repeal of the Public Utility
Holding Company Act (PUHCA) will
have widespread and transformative
effects on the U.S. electric industry.
Under the Act, the arcane rules for
defining utility “holding companies,”
and the exemptions to those rules, will
be replaced by the application of
FERC competition “screens”. The
FERC screens consider proposed
mergers in terms of market power of
the merged entity, thereby guarding
against potential competitive abuses.
PUHCA repeal will substantially
simplify an investor’s economic
analysis. However, industry
consolidation in the wake of PUHCA
reform will be likely to engender
litigation concerning FERC’s
implementation of the market screens.
On the other hand, the need for private
investment in transmission and
generation should open the way for
new financing vehicles (including,
perhaps, some variation of publicprivate partnerships).
The rules for market participation and
interaction - in effect, the central
architecture for the U.S. electric
industry - have remained substantially
unchanged for decades, and the Act has
done little to change this fact. In the
wake of PUHCA repeal, and in the
surge in competitive activity that is
virtually certain to follow passage of the
Act, investors should be mindful both
of hidden risks, and of hidden value.
For further information please contact
Roger Stark (Washington DC office)
e-mail: rstark@klng.com
tel: (001) 202 778 9435.
Projects Bulletin
www.klng.com
Update on public procurement
New UK Public Procurement
Regulations in force
The Treasury have recently issued new
Regulations regulating the procedures
for public sector authorities and utilities
awarding works, services and supply
contracts. We refer you to the K&LNG
Alert published on 1 February 2006.
Extensions of existing projects
require a new tendering
procedure
In a reasoned opinion against Spain
dated 15 July 2005, the EU Commission
has made clear that substantial
extensions of existing projects usually
require a new tendering procedure. The
Commission examined the procurement
of the concession for the construction
and operation of two connections of the
A6 motorway with Segovia and Avila. It
considered that the award of the
concession included extra work (two
new lanes, a new tollgate area,
improvement to a tunnel, new
reversible lane and tunnel) that was not
advertised in the initial concession
notice.
April 2004. The notes provide
clarification on the Competitive
Dialogue, the use of framework
agreements, the definition of special
and exclusive rights for utilities and the
application of utilities procurement law
to contracts involving more than one
utility activity.
The EU Commission confirmed that
the Competitive Dialogue is reserved
for "most complex projects" only. The
use of this exceptional procedure must
be assessed on a case by case basis,
taking into consideration the nature of
the market and the capacity of the
public authority tendering the contract.
EU guidance note on
competitive dialogue
A complex project may result from the
"technical impossibility to define the
means" needed for the satisfaction of
the contracting authority's
requirements. The Commission gave
the example of a contracting authority
wanting to create a connection between
the shores of a river but not knowing
whether a bridge or a tunnel was the
best solution. The use of the
Competitive Dialogue would be
justified. Another example relates to
PPP/PFI contracts. The Competitive
Dialogue is appropriate when a
contracting authority wishes an
economic operator to finance, build and
operate a facility (such as a school,
hospital or prison) for a long period.
The Commission recognised that the
legal and financial set up of this type of
project (PPP and PFI) "is very often
particularly complex and it may be
furthermore uncertain from the outset
whether the end result will be a
concession or a public contract".
The EU Commission has published
four guidance notes explaining
important aspects of the new
Procurement Directives adopted in
The Dialogue itself may relate to the
economic aspects of the tender (prices,
costs, revenues, etc) as well as legal
As the value of the additional work was
approximately equivalent to the value
of the works advertised in the
concession notice, this amounted to a
"substantial enlargement of the subject
of the concession" and should have
been advertised, either in the initial
notice or by way of a fresh, new award
procedure. The reasoned opinion can
be found on the EU commission's
website: www.europa.eu.net
aspects. These can be the allocation
and limitation of risks and guarantees,
the possible creation of special purpose
vehicles, etc.
Readers will be pleased to note that the
industry's concerns on confidentiality
have been taken into consideration.
According to the Commission,
contracting authorities must not
communicate any of the solutions
developed by one bidder during the
Dialogue to the others (unless with its
consent). The final tenders are based
on the solution of each participant and
no new specifications are required.
More importantly, the Commission
reaffirmed that all participants to
Competitive Dialogue may benefit
from European or national law on
"intangible property" (ie intellectual
property).
The Commission also recognised that
participants to the Dialogue may incur
additional costs (e.g from written
proposals, attendance to meetings,
design preparatory work). Contracting
authorities may specify that "awards" or
"prizes" can be given to participants,
similar to the awards in design contests.
The Competitive Dialogue presents
features of both the restricted and the
negotiated procedure. Unlike the
restricted procedure, negotiations
concern all aspects of the contract.
Unlike the negotiated procedure,
negotiations may only take place during
the dialogue phase once the final tender
is submitted, there is only room for
clarification.
Green Paper on PPPs communication on concession
As anticipated in our Projects Bulletin
Summer 2005, the results of the
SPRING 2006
7
Projects Bulletin
Commission's consultation on PPP and
concession contracts have been
published this Autumn, in a
communication dated 11 November
2005. The Commission's Green Paper
on PPPs launched a European
consultation in Spring 2004 to find out
whether economic operators in the
Member States have free and
unrestricted access to the various types
of public private partnerships, in a
context of effective competition.
The aim was to study how, in practice,
PPP contracts are awarded and if the
rules are clear enough and suitable for
PPP contracts, as there is no specific
procedure or legal framework for the
award of PPP contracts. In any case, the
Competitive Dialogue will apply to the
PPP contracts used in relation to
"particularly complex projects" only (see
Article 29 of the new Works Directive
and our Projects Bulletin Summer
2005).
In its Communication, the Commission
indicated its intention to clarify how EU
rules apply to the choice of private
partners in "institutionalised" PPP
contracts and to assess whether specific
rules should be drawn for the
procurement of concession contracts.
Institutionalised PPPs
Institutionalised PPPs are public
service undertakings held jointly by
both a public and a private partner.
For example, the LEP (Local
Education Partnership) in the UK, or
the Société d'Economie Mixte in
France. The Commission will
publish an Interpretative
Communication in 2006. The
important point to note is that the
Commission does not envisage
drawing up detailed and harmonised
rules for contractual PPPs, such as
PFI contracts.
Concessions
All participants in the consultation
supported the idea of clarification of
the concept and applicable
procurement rules to concessions as a
"stable and consistent legal
environment for the award of
concessions at EU level [to] reduce
transaction costs (by decreasing legal
risks) and more generally enhance
competition" (EU Commission
Communication dated 17 November
2005). The Commission is currently
carrying out an in-depth analysis of
the required rules before drawing up
any proposal for a Directive.
Who to Contact
Finally, the Commission will clarify the
operation of the Competitive Dialogue
procedure in 2006.
New thresholds
The thresholds that are currently
applicable to public contracts (not
utilities) in the European Union are
£3,611,474 for public works contracts,
£93,898 for public supplies and services
awarded by central government bodies,
and £144,459 for supplies and service
contracts awarded by other contracting
authorities. These new values are valid
as from 1st January 2006 and were
published in the European Union
Official Journal and on the OGC
websitewww.ogc.gov.uk). Different
thresholds apply to utilities and can also
be found on the OGC website.
For further information please contact
Sophie Charveron (London office)
email: scharveron@klng.com
tel: +44 (0)20 7360 8154.
Kirkpatrick & Lockhart
For further information contact the following
Christopher Causer ccauser@klng.com
Nicholson Graham LLP
T: +44 (0)20 7360 8147
110 Cannon Street
Stuart Borrie
sborrie@klng.com
T: +44 (0)20 7360 8155
London EC4N 6AR
Trevor Nicholls
tnicholls@klng.com
T: +44 (0)20 7360 8177
www.klng.com
Kevin Greene
kgreene@klng.com
T: +44 (0)20 7360 8188
T: +44 (0)20 7648 9000
David Race
drace@klng.com
T: +44 (0)20 7360 8106
F: +44 (0)20 7648 9001
Kirkpatrick & Lockhart Nicholson Graham (K&LNG) has approximately 1,000 lawyers and represents entrepreneurs, growth and middle market companies, capital markets participants, and
leading FORTUNE 100 and FTSE 100 global corporations nationally and internationally.
K&LNG is a combination of two limited liability partnerships, each named Kirkpatrick & Lockhart Nicholson Graham LLP, one qualified in Delaware, U.S.A. and practicing from offices in
Boston, Dallas, Harrisburg, Los Angeles, Miami, Newark, New York, Palo Alto, Pittsburgh, San Francisco and Washington and one incorporated in England practicing from the London office.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or
relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
Data Protection Act 1998 - We may contact you from time to time with information on Kirkpatrick & Lockhart Nicholson Graham LLP seminars and
with our regular newsletters, which may be of interest to you. We will not provide your details to any third parties. Please e-mail cgregory@klng.com if
you would prefer not to receive this information.
8
SPRING 2006
© 2006 KIRKPATRICK & LOCKHART NICHOLSON GRAHAM LLP. ALL RIGHTS RESERVED.