Tameside Hospital – what does it mean for distressed PFI projects?

In this first of a series of articles looking at current issues and recent case law in the world of distressed PFI/PPP projects, we consider the recent outcome of the Tameside Hospital dispute, and what pointers can be taken from it which may help avoid or resolve disputes in future so that distressed projects can get back on track.  This is a tale of disagreement, adjudication, threats of insolvency, Court proceedings and – ultimately – a settlement which may offer a useful benchmark to which other troubled projects can have regard.

Consort Healthcare (Tameside) Plc v Tameside and Glossop Integrated Care NHS Foundation Trust^[1]

The parties had entered into a PFI project agreement in 2007, with a 34-year term, in respect of a £100m hospital project. The parties were in dispute concerning Project Co’s performance of its obligations to deliver the services, and that dispute had gone to adjudication, with the result that a significant award had been made against Project Co.

Project Co considered that the impact of the adjudication award, coupled with the implications of the award for the service levels it would need to provide going forward, made it continuing in business unviable. In a “first” for a PFI project, Project Co proposed a restructuring plan under Part 26A of the Companies Act 2006; a restructuring plan is a statutory arrangement which allows a company to continue to operate as a going concern.  Such restructuring plans must be sanctioned by a court.   

The Trust – as one of three creditors of Project Co – opposed sanction of the plan. The other two creditors, which included the guarantor of Project Co’s bond financing arrangements, supported the plan. The sanction hearing was due to begin in July 2024.

The Trust brought an application for security for its costs of the proceedings, on the basis Consort would not be able to meet those costs.  Consort defended the application on the basis that any costs liability that it might have to the Trust for the restructuring plan proceedings would be dwarfed by the financial liability that the Trust would have to Consort in due course arising from the termination of the Project Agreement.  This meant that the Court needed to engage with the substantive issues around what would happen if the restructuring plan were not sanctioned, and Project Co became insolvent.

This gave rise to some crucial questions – if Project Co became insolvent, would the Project Agreement be terminated, or could it remain in place?  And if it was terminated, would compensation on termination ultimately be payable to Project Co or could the situation arise where the Trust would be owed money by Project Co? 

Compensation on termination

Typically, if a project terminates early, compensation on termination is determined on the basis of the fair value of the project agreement.

There are two means by which fair value can be arrived at. Firstly, a project can be retendered on election by the employer, if there is a liquid market (i.e. sufficient bidders to allow fair value to be ascertained). The highest bid will be taken to be the fair value of the project agreement, less applicable deductions. The alternative approach is a calculation which allows fair value to be estimated, applying various criteria set out in the project agreement. This is, in simple terms, the net present value of the future service payments less the costs the Trust would incur in providing services going forward, and any permissible deductions made by the Trust for termination costs, service failures or rectification costs for defects.  The parties accepted that, in principle, a retendering process could be expected to result in a lower payment of compensation on termination than the estimation approach, because of bidders’ assessment of the risk in taking on a distressed project.

Would the Trust terminate?

Both parties agreed that, if the restructuring plan was not sanctioned, Project Co was likely to go into administration.  Project Co contended that the Trust would then terminate the project agreement and apply the estimation approach to arriving at fair value, on the basis that there was no liquid market for it to carry out a retendering process.

The Trust challenged that argument by claiming that if the restructuring plan was not sanctioned, what it would actually do would be to exercise step-in rights over a period of 30 months, during which it would require Project Co’s subcontractors to continue to provide the services. Step-in rights would effectively allow the Trust to run the project itself, while Project Co sat in limbo as a ‘zombie’ project company. The Trust claimed that it would use the 30-month period to set up a retendering process to ensure a liquid market, which it would then complete in 18 months.

The Trust also claimed that, having instructed modelling of various scenarios and outcomes, there was a significant risk of it not being able to set-off a costs award against its liability to pay compensation on termination. This was because of the likelihood of construction defects being found during a survey currently being carried out. The Trust led opinion evidence, based on experience of surveys on other projects, that deductions flowing from the survey could wipe out the entire service payment due to Project Co.

The Court gave this evidence short shrift; no evidence of actual defects having been discovered was led at the hearing. The Court also gave weight to Project Co’s submission that the hospital had been functioning for many years, and was still functioning, and there was no evidence that any defects emerging from the survey would be so significant that they could eradicate a compensation on termination payment to Project Co entirely.

However, the Court ultimately granted the Trust’s application for security for costs on the basis that, if the plan was sanctioned (in which case the Trust had said it would terminate prior to retendering), the retendering process would be undertaken in a shorter period of time and without full information on the costs of defect rectification being available at the outset.  In that scenario, bidders would be likely to bid less, reducing the compensation payable to Project Co and thereby creating a material risk that Project Co would not be entitled to sufficient compensation from the Trust to enable the Trust to set-off of any costs awarded in its favour.

Settlement

The case was heard in July 2024,, since when it has been reported that a settlement has been reached with the intention of allowing the project to continue. The reported elements of the settlement may provide a useful benchmark for others to consider if facing similar circumstances. The core elements of the settlement, as recorded in Project Co’s regulatory announcement of 10 December 2024, included:

• Project Co to pay a settlement sum, achieved by way of a ‘sculpted’ reduction in the monthly service payments due to Project Co under the Project Agreement for the remainder of the term
• The Trust would in turn waive its financial claims and entitlements to service failure deductions and service failure points in performance monitoring reports up to the settlement date
• Project Co to carry out rectification works, including known items and those arising from a survey, with relief from Deductions and Service Failure Points arising from such works up to the agreed Longstop Dates (subject to specific provisions where decanting is required)
• Where any future issue arises from a design or construction defect affecting multiple areas of the hospital, a joint surveyor may be appointed to determine the remedial works and timescale, with relief from Deductions and SFPs
• The restructuring plan would be discontinued, and the Trust would not enforce the court order for costs
• A Steering Committee would be established including senior representatives of the Trust, Project Co and the Services subcontractor, to oversee delivery and coordination of the rectification works and also to provide a forum for strategic discussion to try to reduce the potential for future disputes arising.

Comment

The news of an agreed settlement brings a more positive conclusion to the Tameside story than many had anticipated, and the settlement may provide a helpful benchmark for other parties to consider when faced with similar scenarios – recognising, of course, that such solutions are not “one size fits all” and much will depend on individual circumstances of any project.

Nevertheless, the case remains a high profile example of what can go wrong in PFI projects – as has been commented on extensively in the White Fraiser report and elsewhere – and demonstrates that termination of a PFI project is rarely a straightforward affair.  Issues such as the limited market for taking over distressed projects, the incentive to proactively search for defects in order to maximise scope for rectification costs and deductions to reduce or eliminate termination compensation, and the potential postponement of any termination (and consequently, compensation) via step-in have the potential to generate costs and disagreements on all sides.

Of particular interest in this case is the Trust’s stated intent that, should Project Co become insolvent, it would defer termination while using its step-in rights to survey for defects pending a retendering exercise.  Whether this is a proper use of step-in rights is likely to be a contentious issue which may require determination in future cases
 

^[1] [2024] EWHC 1702 (Ch)