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PPP Early Termination - balancing the books

On 22 June 2015, HM Treasury ("HMT") published a policy note on early termination of Public Private Partnership ("PPP") contracts to help contracting authorities navigate this potentially hazardous process.

For those unfamiliar with PPP contracts, these are typically long-term arrangements of between 25 and 30 years, under which a government service or private business venture is funded and operated through a partnership of government and one or more private sector companies. Ordinarily the aim of the partnership is the delivery of public assets and/or infrastructure. Within the PPP model, the private sector designs, builds, finances and operates or maintains an asset, and in return the public sector pays an annual unitary charge.

Following strong criticism over the high financing costs of the PPP model, the government has been keen to impose cost savings on contracting authorities. This approach was instigated in 2012 through the Treasury's Operational PPP Efficiency Programme, which aimed to recover savings of around £1.5bn.

Given the fact that budgets are constrained, many public sector contracting authorities have sought ways to reduce the costs of existing PPP contracts.  In some cases, through no fault of the supplier, the most efficient option for contracting authorities has been to seek early termination of some of its existing contracts. 

In the addendum to the DAO (Gen) 2/14, HMT stated that early termination of PPP or Private Finance Initiative ("PFI") contracts should be regarded as "a novel, contentious and potentially repercussive transaction within the terms of Managing Public Money." Clearly, early termination is not a step to be taken lightly. The practice for early termination of a PPP contract requires a contracting authority to first seek business case approval from its sponsor department, who in turn must seek the consent of the Treasury. Ultimately, approval to terminate will only be given where changes in circumstances make it likely that a significant improvement in the delivery of public value for money will be achieved. 

In light of the above concerns, the recently issued HMT policy note will be seen as welcome solace for cautious contracting authorities who have found themselves in this scenario. The policy note states that, prior to seeking consent to terminate, contracting authorities should (a) determine the business case for early termination, and (b) carry out a value for money assessment. The HMT policy note clarifies best practice for carrying out both of these tasks, with reference to the relevant qualitative and quantitative factors a contracting authority ought to consider, as well as the Treasury's Green Book Guidance. 

The HMT policy note also underlines the budgeting, accounting and fiscal implications for the contracting authority of carrying out the early termination of a PPP contract. Key considerations include:

  • The post-termination reclassification of PFI property assets on the public sector balance sheet.
  • Increases to Public Sector Net Debt and Public Sector Net Borrowing in relation to any termination costs which are paid.

Furthermore, there has been some concern from HMT over the increased use of "termination for convenience" clauses, which give compensation to private sector suppliers for early termination. Levels of compensation are normally based on projected supplier profits to contract end.  In the addendum to DAO (Gen) 2/14, HMT warned contracting authorities that inclusion of these types of clause must be shown to provide value for money and that the decision can be adequately explained.

In summary, the HMT policy note will be of great use for any contracting authorities hoping to carry out a compliant and stress-free early termination of a PPP contract.  Nevertheless, HMT have been keen to point out that predicted levels of early termination of PFI contracts are expected to be low. The principal deterrents are the affordability of early termination and the hurdle required of contracting authorities to show that early termination will result in value for money for the public sector as a whole.