Lawyers to the projects industry
projects
bulletin
Winter 2003
contents
What is the future for PFI’s
preferred bidders?
1
Decent homes initiative
2
Not for profits in the
waste management industry
3
Corporate governance update 5
VAT on PFI projects
5
Tax relief on the
composite trade structure
5
Excellent construction drive
7
PFI - no longer the only
game in town?
7
Who to contact
8
Welcome to the
Winter edition...
of the projects bulletin. This
edition contains a number of
articles on a wide spread of
topics.
www.ngj.co.uk
What is the future for PFI’s
preferred bidders?
Proposals to simplify the EU public
procurement regime were put forward
in 2000. The reforms are in many
respects useful but some aspects of
them have worried the UK PFI market.
may be clarified at the authority's
request but it has not been clear
whether this would allow further
development of terms and conditions
following tender submission.
The market is concerned not to lose
the current system which, under the
negotiated procedure, allows an
authority and its preferred bidder to
conduct post-tender negotiations.
This will change if PFI projects are
procured under the new competitive
dialogue procedure, for use in
"exceptionally complex projects".
Under this procedure, final tenders
The European Parliament has backed
an amendment to allow tenders to be
"fine-tuned" at the request of the
authority, so long as it does not
involve fundamental changes. Being
able to make final adjustments to bids
in complex procurements was
unfortunately not allowed by the
Commission, which has made it clear
that it considers that dialogue must
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not be reopened with the preferred
bidder (as this would weaken the
basic position that tenders must not
be changed after submission).
So unless the position changes, the
competitive dialogue procedure will
not be suitable for use in PFI projects,
even if it could be argued that all PFI
projects (in a now well-developed
market) are "exceptionally complex".
An amendment setting out an
"exclusive" dialogue procedure was
on the table, which would have
allowed dialogue between the
authority and the preferred bidder.
Unfortunately the Council (the most
powerful of the EU's legislative
bodies) rejected this by vote back in
March and the Parliament has not
reinstated this amendment. The EU
seems determined to limit post-tender
negotiations, which is bad news for
the industry.
Interestingly, the negotiated
procedure, currently used for most UK
PFI, will (on current indications) still
stand but of course the EU has never
been happy with the UK's use of the
negotiated procedure for PFI. Exactly
which process will be followed in the
UK PFI market in the future will
depend on the contents of the
Directive and of course any UK
regulations issued under it. Much will
rest on political debate between the
UK and the remainder of the EU.
The next step will be for the Council
of European Ministers to consider the
amendments proposed by the
Parliament but it is likely that the
Conciliation Committee (comprising
members of the Council and the
Parliament, aided by the Commission)
will have to rule. We will not see any
clarity (in the form of the final
Directive) until the beginning of next
year and the PFI industry will be in a
state of uncertainty until then.
One hope stems from the fact that
the Commission, in its March
statement, proposed having specific
and separate legislation dealing with
public private partnerships and
services concessions; the aim being to
guarantee operators in the market a
better opportunity to take advantage
of their rights within the common
market. This is out for consultation
with Member States and we will have
to wait and see.
Decent homes initiative
The Government has set a target that
all social tenants must have a "decent
home" by 2010. A "decent home"
must fulfil criteria, eg. it must be in a
reasonable state of repair. The
initiative received a boost on 25
September, with an announcement
from the ODPM that a further £600
million would be made available
through PFI.
PFI
There are two avenues through which
PFI housing projects deliver investment
in affordable housing. These are
Housing Revenue Account PFI and
non-HRA PFI. With the former, the
local authority retains ownership of
the stock and tenants have secure
tenancies. A private sector
2
Non-HRA PFI provides new stock via a
registered social landlord.
LSVTs
Less novel but also important is the
Large Scale Voluntary Transfer. Stock
transfer began in 1988 and by the
end of 2005 it is estimated that one
million homes will have transferred to
private sector ownership.
ALMOs
Another option for local authorities to
access extra funding to meet the 2010
target is to use Arm’s Length
Management Organisations. An
ALMO is a 100% local authorityowned company with a board of
tenants, councillors and independent
members. ALMOs cover over half a
million homes, comprising 20% of all
local authority owned housing stock.
The upshot of all this is that local
authorities can utilise a combination
of various investment options (PFI,
ALMOs and LSVTs). Consultation is
ongoing to devise additional models
for funding future housing stock
transfers and the ODPM is striving to
make it easier for local authorities to
refurbish housing stock through PFI.
All of this is good news for local
authority tenants.
consortium refurbishes the homes and
then repairs, maintains and manages
them. Financial support is provided
through PFI credits.
Winter 2003
Not for profit organisations a way forward for waste management projects
Introduction
At present there is a good deal of
interest in "not for profit
organisations" ("NFPs") being used in
PFI projects in a number of fields.
Indeed, they may be of particular
relevance in the waste management
sector.
Waste management
The public sector, including waste
disposal and collection authorities,
NHS trusts and the like, is facing
considerable challenges in complying
with obligations concerning waste
disposal and recovery, as identified by
the EU Waste Programme and now in
course of clarification by the UK
Government. In particular, the
emphasis on recycling and recovery
and the crackdown on consignment
to landfill present rigorous tests for
the responsible public sector. At the
same time innovative solutions are
expected to be delivered by both
public and private sectors.
It is widely agreed in the waste
management business that much
more progress could have been made
if there had been a greater readiness
by the British public to accept
solutions in the form of waste to
energy plants, well managed landfills
(perhaps with gas harvesting) and
effective treatment plants. These
types of projects will be critical in
meeting recovery targets. However,
there has been a general distrust of
them, together with an unwillingness
to invest, especially where people are
content to use facilities, but "not in
their own backyards". With better
recognition, the essential solutions
may have real public financial
benefits.
PFI in the waste
management field
The private finance initiative has
certain advantages of general
application. Firstly, it may allow the
transfer of problems and associated
risks to the private sector. As noted
above, in the waste management
sector, there are a number of
significant challenges, including the
requirements arising pursuant to the
EC Landfill Directive that a greater
proportion of waste be recycled and
landfills be less relied upon. Local
authorities may wish to transfer such
matters and (where possible) the risks
involved to a private consortium.
Those risks include (a) the uncertainty
as to what actual amount of waste
will need to be dealt with and (b)
what new requirements and costs will
arise. In the first example above, the
imposition of a new housing quota
involves a new burden on the existing
and proposed waste management
facilities.
projects not to feature on its balance
sheet. Significant expenditure is
needed in waste management. NHS
trusts may face similar problems of
waste management and there may be
cost savings and other synergies of a
combined approach that a third party
can deliver. The private sector may
have levels of expertise in an area and
may benefit from private sector
disciplines. Innovative waste
management, and particularly the
design and use of integrated solutions,
is clearly an area where specialist
practices and expertise are needed.
The private sector has the ability to
put together consortia which can
make significant capital investments in
projects. The procuring authority may
not be encouraged to do so by central
government, or may not be able to do
so, and may instead prefer to pay for
the services it receives over a long
period. The public authority may also
find it preferable for significant
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Is profit the problem?
In some cases outside waste
management there have been
substantial and unexpected profits
generated in the context of PFI.
Procuring authorities are legally
obliged to pay the agreed unitary
charge even if this generates much
higher levels of profit than predicted.
Refinancing (although now more
adequately covered in standard
contract guidance) is one factor which
can create unexpected "windfall"
profits for the private sector.
The costs of waste management are
set to rise. Recycling and
environmentally-aware methods of
disposal are being encouraged and
indeed required. Landfill taxes are set
to rise substantially in support of this
initiative, altering the way in which
costs are looked at. However, the
higher costs will inevitably fall,
whether directly or indirectly, on the
public. This may itself work to change
public perception. The issue of waste
management can therefore be
expected to attract greater public
awareness and concern. As
prominence increases and the level of
expenditure rises, the risks involved
for the local authority also increase.
It follows from this that local
authorities may consider that they
wish to take advantage of PFI whilst
avoiding the perceived risk of
unexpected profits being made in the
private sector. The procuring
authorities will have an ever greater
awareness of their obligation to
deliver services in a cost effective
manner but with greater
environmental care.
Not for profit structures
There is a growing recognition that
NFPs may potentially offer
4
improvements to traditional PFI
structures. This is because NFPs are a
means by which public services are
seen as being delivered for their own
sake, rather than for the purposes of
making a profit for their owners. This
may be highly desirable from a
general political perspective. In the
sphere of waste management this
may be particularly important as
charges increase.
In the context of waste treatment,
most of the PFI projects that have
been done to date have involved the
procuring authority taking a
shareholding in the project vehicle
with the effect that the scope for
enhanced profits for the private sector
is reduced (or the profits are shared
with the public sector). However,
NFPs offer presentational advantages
over such structures and can provide a
more complete protection to the
procuring authority.
There is also an awareness that NFPs
may be used to help ensure that there
is an appropriate correlation between
service standards and the costs of the
services. Since the NFP is not
inherently run for profit, any surpluses
it generates are not automatically
available for distribution to the
members of the consortium. Such
surpluses may only be used for the
purpose of the relevant public service.
Therefore, provided the NFP is
structured correctly, a virtuous circle
can be created of public services being
provided efficiently and with cost
savings being used for further
improvements.
However, the structuring of the NFP
needs to pay particular attention to
the constitution of the NFP and the
sub-contracts it enters into. The
private sector is entitled to receive
rewards that are appropriately linked
to risks. This has been apparent from
the PFIs in the waste management
sector to date, as well as more
generally within PFI. The constitutions
of the NFPs should also focus on
environmental objectives provided that
they have a sufficient degree of
flexibility to enable projects to be
delivered in the best way possible.
Fiscal issues will also need to be
considered. Companies limited by
guarantee are one type of NFP which
may have advantages as may trust
structures and companies with
constitutions limiting profits. The
government is also considering
proposals for a new type of company
called the Community Interest
Company, which may provide an
appropriate vehicle, particularly for
community recycling or recovery
programmes.
In summary, NFPs may be a method of
combining the advantages of PFI
whilst taking out some of the political
risks (actual or perceived). They can
be used in structures for providing
environmentally sound solutions to
waste management problems. Waste
management is certainly set to
become an ever more prominent issue
in the next few years and NFPs, when
properly financed and structured, may
offer an answer.
An NFP guidance note is
available on request. Contact
details on p.8
Winter 2003
Corporate governance update
Further to the Higgs Report released
earlier this year (on the role and
effectiveness of non-executive directors
in UK listed companies) the definitive
revised Combined Code of Principles
of Good Governance and Best Practice
has now been published.
The new Combined Code will come
into effect for reporting years
beginning on or after 1 November
2003.
The principal differences from the
current Combined Code are:
Board balance
J At least half the members of the
board should be independent nonexecutive directors. There is an
exception for smaller listed
companies (i.e. those outside the
FTSE 350) who need only include
two such independent nonexecutive directors.
Chairman and the chief executive
The same individual should not act
as both chairman and chief
executive.
J The chief executive should not
become chairman of the same
company.
J
The role of the non executive
director and the independent
director
J The chairman should hold regular
meetings with the non-executive
directors without the executives
present.
J A senior independent director
should be available to receive
shareholders' concerns which
cannot be resolved through the
normal channels of contact with
the chairman, chief executive or
finance director.
Appointment and tenure
J The nomination committee should
consist of a majority of nonexecutive directors.
J Any term beyond six years for a
non-executive director should be
subject to rigorous review.
J Executive directors should not take
on more than one non-executive
directorship in a FTSE 100.
company, nor become chairman of
such a company.
J No individual should be appointed
to a second chairmanship of a FTSE
100 company.
Training and performance
evaluation
J The chairman should ensure that
new directors receive a full, formal
and tailored induction on joining
the board.
J The board should undertake a
formal and rigorous annual
evaluation of its own performance
and that of its committees and
individual directors.
Although the Combined Code strictly
applies only to companies on the
Official List, it is anticipated that AIM
companies will continue to follow it as
a matter of best practice. Compliance
is often seen as necessary to meet the
high standards of corporate
governance required to attract and
retain institutional investors.
For advice on corporate governance
issues please contact our corporate
governance team:
Kevin McGuinness
kevin.mcguinness@ngj.co.uk
tel: 020 7360 8120
Elizabeth Dillabough
elizabeth.dillabough@ngj.co.uk
tel: 020 7360 8240
VAT on PFI
projects traps and
opportunities
The VAT tribunal has decided the case
of West Lothian College SPV Ltd v
Commissioners of Customs & Excise.
It is rare for PFI cases to reach the
tribunal.
The taxpayer, a service provider, won,
and as readers will note from the
comments below there may be an
opportunity for other service providers
to reclaim more VAT in the future, or
even reclaim past VAT.
Background
West Lothian College ("the College")
wanted to replace their Bathgate
Campus. HBG Construction Ltd won
the tender to construct the new
building and provide both hard and
soft facilities management services.
"Hard" services are those required to
maintain the fabric, structure and
functionality of the building so that it
is continuously 'available' for use.
"Soft" services are those by which the
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building is operated, for example,
cleaning and catering services. HBG
Construction Ltd set up West Lothian
SPV Ltd ("the SPV") for the purposes
of the project.
The College granted a 25 year
headlease to the SPV partly in order to
provide its funders with security. The
SPV granted a sublease back to the
College. The College and SPV entered
into an Agreement for the design,
building and operation of the campus.
Instead of the SPV receiving a single
unitary charge for its services, the
College agreed to pay the SPV two
income streams. The first was the
"availability charge" which was
treated by the parties as exempt from
VAT (as being for the supply of the
building) and the second was the
"facilities management charge" which
was payment for the hard and soft
services, on which VAT was billed.
SPV subcontracted out many of these
services and so incurred VAT from
third parties both on the construction
and provision of services relating to
the building. The SPV sought to
reclaim its VAT and Customs
challenged this.
The arguments
Customs sought to refuse the SPV
recovery of its VAT arguing that there
was a single commercial transaction
involving the single VAT exempt
supply of a custom built college and
that the hard and soft facilities
management services were merely
ancillary to this. In VAT law, no VAT
can be reclaimed on costs which
relate to an exempt supply. Customs
argued that following the case of
Card Protection Plan v Customs,
where services are ancillary to an
6
exempt supply, they can be effectively
ignored. The tribunal disagreed with
Customs' argument. Although the
facilities management services were
supplied as part of a package, they
could not be regarded as merely
ancillary. These services were
substantial and constituted taxable
supplies in themselves.
Customs then tried to argue that
none of the VAT on the construction
costs could be reclaimed because all
this VAT related to the exempt supply
of the availability of the building.
Again the tribunal disagreed. The
construction costs were a cost
component of both the charge made
for the facilities management services
(taxable) and the College's right to
occupy (exempt), and accordingly the
VAT on the construction costs
constituted residual input tax and was
recoverable in accordance with the
SPV's partial exemption recovery rate.
Comments
We believe the case is correctly
decided. The decision is
important, and may result in
additional VAT recovery for service
providers.
If any service provider has not
reclaimed VAT particularly on
building costs in the belief that the
VAT is a cost component of an
exempt supply of the availability of
the building, it may be able to take
steps to reclaim the VAT subject to
the three year deadline for input
tax recovery.
If Customs' principal argument had
been correct, no VAT would have
been chargeable on the facilities
management services which was
an odd argument for Customs to
take, seeing that the College is no
doubt largely VAT exempt and
unable to recover most of its VAT.
We think that the case would have
been decided the same way if there
had been a single unitary charge
rather than two income streams.
In practice Customs' general view is
that the entire package of services
provided by a service provider for a
unitary charge is standard-rated so
that the service provider must
charge VAT on the entire unitary
charge and can recover VAT in full
without needing to opt to tax any
supplies of buildings. We do not
believe this view can be entirely
relied upon, and the provider
should opt to tax to avoid making
an exempt supply of supplies of
buildings with a consequential loss
of input tax. Of course this may
not always be possible e.g. where
the project relates to housing.
Winter 2003
PFI - no longer
the only game in
town?
Cash-strapped local authority
departments have long realised that
PFI is the only game in town when it
comes to investment in capital
projects. This is all about to change.
The Local Government Act 2003 sets
out a prudential borrowing code for
local authorities. Under this code, a
local authority will be able to borrow
money on the open market without
Central Government approval,
provided that certain criteria are
complied with.
Excellent construction drive
The Treasury launched Achieving
Excellence in March 1999. The aim
was to reform the procurement
practices of government departments
and non-departmental public bodies
and for them to become "best
practice" clients. The initiative,
originally programmed to last three
years, has been extended for a further
two. A key target is to achieve zero
defects on the majority of
construction projects.
OGC launched a new suite of guides
on 24 September. These draw on
lessons learnt over the past five years
and reflect recognised best practice in
delivering improved value for money
over the whole life of construction
projects. The guides are available on
the OGC website.
Guide 2 provides a recommended
framework for project organisation
and explains the roles and
responsibilities involved. Procurement
routes are dealt with in Guides 3 and
6, which put Gateway reviews in
focus. Guide 4 is fundamental as it
explains the management of risk and
value. Risk is to be continuously
assessed throughout the procurement
lifecycle. It must be examined at each
stage in the Gateway and if not
assessed properly, finance will not be
given to the project.
First, direct borrowing will most
probably be cheaper than PFI debt
finance borrowing. Second, a local
authority will be able to retain inhouse delivery and management,
which it cannot do under PFI.
It is anticipated that prudential
borrowing will be particularly
attractive for smaller schemes, for
which PFI is less cost-effective (no
economies of scale) and less attractive
(proportionately high start up costs).
However, PFI is likely to remain the
vehicle of choice for larger local
government capital projects.
Local authorities will be pleased to be
given this extra freedom to choose
how best to invest in capital projects
where they do not have enough cash
swilling round in their bank accounts.
The guides represent a commitment
to best practice in procuring
government projects. Whether
procurement practices will actually
change is something which needs to
be monitored closely.
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A warm welcome to........
Sebastian Charles has recently joined
the firm. He has advised on the
planning and environmental aspects
of a number of high profile PFI/PPP
and project finance transactions.
Sebastian has acted for banks and
sponsors in projects in the power,
health, education, prisons, waste and
defence sectors He advised:
J
Annes Gate Property Plc in
connection with an award winning
PFI project for the provision of
newbuild central London
accommodation for the Home
Office;
J
in respect of a power project at
Shoreham, West Sussex including
resolving s36 issues, securing
planning consent for a gas pipeline
and obtaining consents;
J
Abbey National Treasury Services
on the planning aspects of a £345
million pilot PFI scheme to
transform facilities at Tower
Hamlets Schools; and
J
a bank on the financing of a large
newbuild integrated waste
management facility at Neath Port
Talbot.
J
Abbey National Treasury Services in
relation to the financing of the
£50 million development of the
new West Middlesex Hospital.
J
Royal Bank of Scotland on the
planning and environmental aspects
of the £140 million financing of a
PFI project for prisons at
Peterborough and Ashford;
For more information contact one of the following partners:
Christopher Causer
christopher.causer@ngj.co.uk
tel: 020 7360 8147
Nicholson Graham & Jones
110 Cannon Street, London EC4N 6AR
020 7648 9000
The contents of this projects bulletin
have been gathered from various
sources. You should take advice before
acting on any material covered in this
publication.
© Nicholson Graham & Jones 2003
8
Carolanne Cunningham
carolanne.cunningham@ngj.co.uk
tel: 020 7360 8160
Stuart Borrie
stuart.borrie@ngj.co.uk
tel: 020 7360 8155