Waste Management Procurement Pack: briefing note

Transcription

1 Lawyers to the projects industry Waste Management Procurement Pack: briefing note Autumn 2004 Introduction The PFI market has become accustomed to Government guidance prepared for individual market sectors, such as schools, hospitals and street lighting. The introduction of sector specific guidance is intended to lead to easier, and possibly cheaper, procurement exercises for the public sector client and for the bidders. The latest in the series of sector specific guidance prepared by the Public Private Partnerships Programme (4ps) emerged in July. It covers waste management projects (the "Waste Management Procurement Pack"). This note seeks to answer three questions: What contractual guidance should now be followed in this sector? (Not as easy to answer as you might think.) What is the political background to all this guidance, and how do waste management projects differ from other PFI projects? What are the most important points in the new guidance? The Waste Management Procurement Pack runs to 480 pages, so readers will appreciate that this note only provides a snapshot. For further discussion on any of these points, or on other matters within the procurement pack, please contact one of the lawyers listed on page 8. What contractual guidance applies to waste projects? In brief, there are the following main sources: Standardisation of PFI Contracts, version 3, April 2004 ("SoPC3") Local Government Supplement to SoPC3 (July 2004) The new procurement pack Letters from the Treasury (19 July the "Treasury Letter") and Defra (20 May the "Defra Letter") attempting to clarify the position. The Defra Letter sets out the obligations which local authorities have in relation to the adoption of SoPC3. (It acknowledged that the issue of the Waste Management Procurement Pack was then imminent). The provisions of the Waste Management Procurement Pack specifically require local authorities to consider amendments to SoPC3 in certain areas, including planning, the performance regime and the payment mechanism (all fairly crucial areas!). Clearly, any necessary standard form derogations for waste management projects ought to be put in place as soon as possible to reduce the delays and confusion which will reign when local authorities set out to procure their waste management projects,

2 briefing note armed with SoPC3, the Local Government Supplement to SoPC3, the Waste Management Procurement Pack, the Treasury Letter and the Defra Letter. Any changes to SoPC3 recommendations which are required for waste management projects generally (which should presumably already be identified in Parts Five, Six and Seven of the Guidance) will need to be drafted into a sector specific PFI contract and this document will then need to be approved by HM Treasury. Once that has been done, any individual derogations for specific projects will have to be approved on a case by case basis in accordance with the Treasury Letter and the presumption is that they will meet stiff resistance from Defra and the Treasury. A final thought, if waste management projects evolve along the lines of the "Building Schools for the Future" model (with local waste partnerships instead of LEPs) local authorities will need to read the HM Treasury "Guidance for Public Sector Bodies forming Joint Venture Companies with the Private Sector". What is the background to all this guidance? Waste management has become a pressing political and practical issue for a number of reasons. The Landfill Directive (99/31/EC) requires member states to make significant reductions in the volume of biodegradable municipal waste ("BMW") sent to landfill. The targets are to reduce the volume of BMW sent to landfill to: 75% of that produced in 1995, by 2010; 50% of that produced in 1995, by 2013; Waste Strategy 2000 Waste Strategy 2000 Best Value Performance Standards 35% of that produced in 1995, by Furthermore, waste management projects need to take account of the objectives of the national Waste Strategy 2000 and must show that local performance standards for recycling and composting match or exceed local performance standards set under Best Value. The relevant targets are set out below: Recycle or compost 25% of household waste and recover value from 40% of municipal waste by 2005 Recycle or compost 30% of household waste and recover value from 45% of municipal waste by 2010 Recycle or compost 33% of household waste and recover value from 67% of municipal waste by 2015 Individual recycling rates set for each local authority aimed to increase national recycling rates to at least 17% in 2003/4 and at least 25% in 2005/6 Other waste legislation such as the Integrated Pollution Prevention and Control Directive 1996/61/EC, the Waste Incineration Directive 2000/76/EC, the Household Waste Recycling Act 2003 and other items of environmental and local government legislation are additional drivers. The targets set in this legislation are very challenging and the obligations thereby imposed on the UK (notwithstanding certain time derogations which it has managed to obtain) are enormous by any standard. The programmes for recycling alone are set at levels which many in the industry regard as unattainable without major resource commitment - which is not currently in place. This has led in turn to the need to implement a waste strategy at a national and local level. This will mean a marked change in the collection, treatment and disposal of waste, and in the infrastructure of waste management, as local authorities struggle to find new and cost effective ways of implementing their obligations. A relatively small number of waste management projects have been carried out to date under the Private Finance Initiative. Up to 2001 the 2

3 Autumn 2004 total number was eight. Since then we have seen a number of further projects including projects for Neath/Port Talbot, Leicester City Council, the East London Waste Authority, Argyll and Bute Council and East Sussex County Council/Brighton and Hove Council. There are at least sixteen other waste management PFI projects in the pipeline. The slow progress in this sector may be about to change as local authorities devise and implement their waste strategies and local waste action plans. Clearly the authors of the 4ps guidance think so! Waste management projects have particular idiosyncrasies which fly in the face of the conventional risk allocation for a DBFO project under the Private Finance Initiative. This, taken with variations in size, scope, degree of integration, geographic region and urban and rural location, means that new ground has to be broken in terms of the risk profiling of these projects and in their documentation. A review of some of the more important points in the procurement pack The Procurement Pack is made up of two volumes, one containing Guidance and the other containing Model Documentation. Both contain considerable detail, particularly the Guidance. Much of it is useful and will undoubtedly assist in achieving the short-term objective of obtaining speedier procurements. Arguably, however, a detailed and prescriptive approach will not ultimately transpire to be the right approach for projects of the diversity of waste management projects. The projects signed to date in this sector have all been very different and have shown that imaginative procurement approaches and novel funding structures are likely to produce the "Best Value" solution. The Guidance, while acknowledging that there are different degrees of integration in waste management projects, is written primarily to cover fully integrated waste management projects (ie one contractor provides a full range of waste management services to one local authority). This may not represent the Best Value approach. Some of the more important or interesting sections in the Guidance are the following: (a) The Output Specification This section gives some useful if basic information on the purpose of output specifications. It also covers "Key Points for a Waste Management Output Specification" and contains a "Performance Management Framework". The Model Documentation includes at Model Six a draft Output Specification. The "Best Value" solution may involve the provision of waste management services to a number of waste disposal authorities, rather than on a unitary basis. The Guidance points out at paragraph 386 that in fully integrated waste management projects, the Authority will be able to pass more risk to the contractor on the type and performance of the collection service to be provided. In semi-integrated projects, where a third party operates the collection service, the Authority and the contractor will need to agree an "input specification" to manage the interface between collection and 3

4 briefing note treatment. Paragraph 388 contains guidance as to the points to be covered in such an input specification. This guidance is useful, although in practice it will take some careful negotiation to agree a suitable input specification and how relief will be granted if the agreed inputs are not provided by the third party collecting the waste. The Guidance also points out (at paragraph 376) that the performance criteria for waste minimisation are still in their infancy, and this is another area where detailed negotiation will be required between the Authority and the bidders to arrive at a sensible performance regime. (b) The Payment Mechanism The Guidance contains an Overview (Part 6, Section 1) and Model Guidance (Part 6, Section 2) which is most of the way towards a fully drafted payment mechanism. There is a useful comparison between payment arrangements for waste management PFI projects and accommodation PFI projects. The Guidance states that local authorities must follow the broad structure of the payment mechanism but that "specific elements of the payment mechanism are given as guidance only". This is a difficult and confusing approach to follow especially given the recent edicts of central government which require all local authorities to follow the guidance unless the consent of the Treasury has been obtained to a derogation. Key points to note in the payment mechanism are: There are performance standards in the output specification covering landfill diversion - these targets increase during the contract term to reflect the higher levels of diversion required under the Landfill Directive. Thus the contract builds in an increasingly rigorous specification for the contractor. Payments from the Authority commence before the construction of the relevant facilities are complete, unlike in a "conventional" PFI project. This reflects the transfer of existing assets and services to the contractor on day 1, which is very much a feature of waste management projects. Failure to meet the agreed landfill diversion targets may lead to the Authority being required to make additional payments to central government (and possibly to the Authority being fined). The recommended payment mechanism seeks to recover these losses from the contractor. This is different from a conventional payment mechanism, where generally the financial remedy is a limited deduction from the unitary charge. The Guidance at Part 6 sets out in considerable detail the micro approach which local authorities are recommended to adopt in relation to the payment mechanism for waste management projects. The effect is to render redundant in the context of waste management projects the approaches advocated by Section 10.4 of SoPC3. The section dealing with the development of the payment mechanism (Part 6, Section 2), while simpler in its approach than the consultation draft, nevertheless requires a knowledge of advanced mathematics in order to calculate the unitary charge. Given that it is not the external financial advisers to the local authority who will be calculating the unitary charge on a daily basis, one wonders how in practice this will work. In addition, given the complexities associated with the Landfill Allowance Trading regime to be introduced in April 2005 and questions over the value of trading permits, precise calculations will be difficult to achieve. As a minimum, some reconciliation provisions will need to be built into the payment mechanism to minimise the likelihood of windfall gains arising in this context. (c) Indemnities, guarantees and contractual claims The provisions of Section 23 of SoPC3 apply in this area, with modification as appropriate to include indemnity cover for "Tipping Away Payments". These are payments to a waste collection authority for which a local authority may in the first instance be liable and the recommended approach is to include a cross indemnity from the contractor to the Authority. A specific drafting recommendation is made at paragraph 622 of the Procurement Pack. The Guidance considers the circumstances in which some form of parent company guarantee should be sought by the Authority. 4

5 Autumn 2004 It points out that parent company guarantees are not normally required (or appropriate) where there is a conventional PFI structure, with funding provided to a stand-alone SPV. However, where a project is funded on a corporate financed basis, or where there is some form of hybrid structure which falls between the two, the Authority will need to consider carefully the need for requiring guarantees from creditworthy sponsors. Paragraph 625 contains detailed drafting relating to a parent company guarantee. (d) Insurance The general guidance on insurance contained in Section 24 of SOPC 3 applies. However, there are two areas which are dealt with as being specific to waste projects: Whether in the case of a corporate financed scheme, it represents value for money to utilise a group insurance policy. Whether the Authority should concede to the lenders a "project economic test" in the case of reinstatement of the project facilities. The Guidance recommends at paragraph 629 that in the majority of waste management projects funded by external debt "an economic test will not be appropriate". Any Authority considering conceding the requirement for an economic test is required to refer specifically to the Treasury for guidance on this issue. We would envisage that this is one area where funders and sponsors may well push for derogations. Note that the Guidance also expresses the view that there is no role for an economic test in a corporately funded project. (e) Land and property interests The identification of suitable project sites and the treatment of land and property interests, given the number and potential variety of ownership interests involved, are key issues in waste management projects. The Guidance at paragraph 637 endorses the approach which is set out in Section 31 of SoPC3. Unlike school or hospital projects, for example, where the sites are invariably already in the possession of the Authority, the sites from which waste management services will be delivered may fall into any of three categories: Land already owned or leased by the Authority Land owned or leased by a waste collection authority (where the Authority is not itself responsible for waste collection) Land to be provided by the contractor, either from its own existing portfolio or by acquiring new sites for the purposes of the project. The second and third bullet points above are cases which frequently arise on waste management projects and which require a different treatment from SoPC 3. In particular the Guidance suggests that the Authority may need to assume some of the risks associated with third party waste collection authorities where they are leasing sites to the contractor for the purposes of the Authority's project. Where the contractor is proposing to acquire sites for the purposes of the project, arrangements will need to be made to ensure that the acquisition risk rests with the private sector. Related issues are the development of a Waste Plan at the outset of the project, the desired balance sheet treatment for the project assets and associated debt (though this is unlikely to be definitively ascertained until financial close) and most importantly, the planning risks associated with the sites. (f) Alternatives to project finance The Guidance (see paragraphs 545 to 549, and the section headed "Alternatives to and variants of project finance" - paragraph 653 onwards) contains a very useful discussion of the way in which waste management PFI projects have been (or should be) funded. The Guidance points out that in this sector, as in the IT sector, bidders will frequently propose a structure which differs from the "conventional" stand-alone SPV used in other PFI sectors. The Guidance refers, somewhat inelegantly, to "corporate financed" solutions, meaning projects where the finance is provided by the parent company as opposed to external lenders funding on a limited recourse basis. Corporate financed solutions are 5

6 briefing note particularly relevant to waste projects because, like IT projects, there is often a low capital to revenue ratio in the contract, the projects tend to be multi-site/multiservice in nature and the contracts need to allow for significant change during the contract term. The exception to this is where a single large new facility, such as a thermal treatment plant, is required at the outset of the project. In that situation external funding will almost certainly be required. If a corporate financed solution is proposed, or some variant which falls between a conventional limited recourse SPV and a full corporate finance solution, the Authority will need to consider carefully the need for parent company guarantees and performance guarantees, whether amendments need to be made to the provisions covering compensation on termination (for a full corporate financed solution, the principles set out in annex 3 to SoPC3 should apply) and what are the appropriate contractual provisions to deal with a future refinancing. As the Guidance points out, even if the bidder proposes a corporate financed solution initially, it is often the case that the sponsors anticipate converting the financing to a project finance structure at a future date. The refinancing provisions will have to take this into account. Generally the guidance in this area is helpful, although it serves to underline why projects in this sector will always be demanding of external advisers, since it is entirely possible that the three bidders for a project will each suggest a different financing structure which will (for the reasons outlined in the procurement pack) require detailed analysis by the Authority and its advisers. (g) Planning risk One of the more emotive issues associated with waste management projects is planning risk. In recognition of this, Section 2 of Part 7 is entirely devoted to this topic. It initially includes a very brief review of strategies for the mitigation of planning risks. However, the Guidance is superficial and fails to appreciate the wide range of planning risk scenarios that could arise, which in turn depend on how up to date the waste local plan and development plan are, the type of facility concerned and the likely planning effects of it, the location of the facility and proximity of neighbours, and strength of local feeling. The Guidance fails to advocate detailed analysis of the risks and preparation of a detailed mitigation strategy at a very early stage, which all waste authorities ought to consider. The Guidance proposes either that the preferred bidder should submit a planning application as soon as it is selected, in the hope that planning permission can be secured by financial close, or that the Authority itself should attempt to secure consent for a generic facility meeting its requirements. It is submitted that neither of these 6

7 Autumn 2004 approaches is realistic. However, depending on the particular circumstances of the project, and having regard in particular to the local waste plan, the Authority could devise a planning risk strategy, working with the preferred bidder once selected and before its selection, to mitigate planning risk in a way that neither stifles innovation nor prejudices securing best value. If there is significant planning risk to be allocated in the risk sharing mechanism, this may hinder, or add significant costs to, project funding. The Guidance reviews sharing mechanisms in three risk areas: planning process (although this is not expressly stated in the Guidance, this issue is principally one of cost); planning delay; and planning outcomes. Whilst acknowledging that there is a need to protect the contractor from certain elements of planning risk, the Guidance does not seek to differentiate risks over which the contractor has control from those which are beyond his control, and treats them all in the same way. The risk of a judicial review of a grant of planning permission is almost always beyond the contractor's control. Similarly where the contractor's proposed facility accords with the waste local plan and the development plan, if the planning authority fails to determine the application within the requisite time period, or the application is called in by the Secretary of State for his own decision, this would usually be beyond the contractor's control. There is a strong justification for a different risk sharing structure for this sort of risk, which will allow the contractor to offer better value for money. However, this opportunity is overlooked in the Guidance. There are some planning risks that it will always be appropriate for the contractor to bear, and waste authorities ought not to stifle innovation by penalising those contractors prepared to take a planning risk, by opting for lower risk, entirely conventional solutions. However where a contractor has an appetite for risk, the waste authority will wish to be reassured (where external funding is to be used) that the funder shares that appetite. The approach advocated by the Guidance is for a conventional Relief Event to apply to planning delay within certain parameters (with the developer bearing the cost risk of an initial delay), and force majeure termination to apply in the event of total planning failure. The Guidance also considers the capital recoupment effects of planning delay, and a solution based on an accelerated commuted payment is advocated (as opposed to extending the contract term by the period of the delay). The possibility of putting in place a contingency plan to deal with delay is also considered. However a further step of requiring an interim solution to be put in place in the event of planning failure might also have been beneficial, to help waste authorities deal with waste effectively in the interim period where termination is inevitable for total planning failure. This would tide them over until retendering is undertaken, and would soften the impact for the contractor. (h) Issues not covered in SoPC3 Finally, there is a useful section (starting at paragraph 711) which addresses contractual issues specific to waste management projects which are not covered in SoPC3. Subjects covered include the ownership of Contract Waste, priorities as between Authority waste and third party waste, drafting for the necessary consents and permits in a waste project, the allocation of risk in respect of Landfill Tax and recommendations as to how to deal with "deferred facilities" (the situation where the successful bidder proposes to construct facilities at some future point in time, with the result that it is not possible to tie down all the risks contractually at financial close). In relation to deferred facilities, the recommendation is that authorities should try and avoid agreeing risk share mechanisms for deferred facilities. Authorities need to identify early on whether deferred facilities form part of the bidder's proposals. 7

8 briefing note Conclusion The waste management sector is generally thought to be one of the areas where significant PFI activity will be required if the Government's future obligations are to be met. On the other hand, historically a relatively small amount of PFI credits has been allocated to such projects. Furthermore, the projects in this sector have been more difficult than most to negotiate and complete, given the disparate nature of waste projects, the need to accommodate frequent changes during the contract term and (not least) the significantly greater planning difficulties experienced in this sector. The Waste Management Procurement Pack will assist both public sector authorities and their private sector partners in addressing some of these issues, but for the reasons outlined in this note we think there will always be significant project specific structuring and negotiation in any waste sector transaction. Who to contact For further information contact Christopher Causer, Carolanne Cunningham, Elisa de Wit, Sebastian Charles or John Garbutt christopher.causer@ngj.co.uk carolanne.cunningham@ngj.co.uk elisa.de.wit@ngj.co.uk sebastian.charles@ngj.co.uk john.garbutt@ngj.co.uk 8 Nicholson Graham & Jones 110 Cannon Street, London EC4N 6AR Internationally a member of GlobaLex The contents of these notes have been gathered from various sources. You should take advice before acting on any material covered in this publication. Nicholson Graham & Jones 2004