REUTERS | Ricardo Moraes

PFI interface agreements

In our previous post we outlined the facts in Kent County Council v Robertson Construction Northern Limited and considered the court’s decision on the allocation of availability and performance deductions in PPP/PFI projects. Another interesting aspect of this case is the comments the court made in relation to interface agreements, which are a common feature in projects of this nature.

What is an interface agreement?

The primary purpose of an interface agreement is to regulate the relationship between the construction sub-contractor (Construction Co), the facilities management sub-contractor (FM Co) and any other key sub-contractors (such as an ICT sub-contractor) with regard to certain liabilities and payments and the recovery of certain sums by one from the other. It is intended to protect a thinly-capitalised project company (Project Co) from costly disputes between sub-contractors by requiring the sub-contractors to settle various issues between themselves, largely without the involvement of Project Co. It is likely to include, amongst other things, reciprocal liability and indemnity provisions, caps on liability, and provisions concerning the allocation of deductions by Project Co.

Key areas of contention

Each interface agreement is different, depending on the nature of the particular project. However, there are some common areas of contention, one of which is the extent of Project Co’s involvement in allocating deductions between its key sub-contractors. This is because of:

  • The cash flow risk it imposes on the sub-contractor to whom the deduction is allocated in the first instance.
  • The insolvency risk (in respect of the other sub-contractor) if the sub-contractor who is initially allocated the deduction seeks to recover the amount of that deduction from that other sub-contractor.

In our experience, many interface agreements provide that if either Construction Co or FM Co is in breach of their respective sub-contracts, and this results in Project Co incurring deductions under the project agreement, Project Co can pass on such deductions to the defaulting sub-contractor. This sub-contractor can then seek to recover these deductions from the other sub-contractor if it considers they have been wrongly allocated in the first instance.

It is common for the initial allocation of deductions to be at the discretion of Project Co acting in good faith, although the extent of this discretion varies from project to project. Sometimes Project Co has to allocate a deduction to a specific sub-contractor in specified circumstances. For example, to the construction contractor where a deduction has been levied against Project Co under the project agreement for unavailability and this has been caused by defects in the construction work.

Sometimes Project Co is able to allocate such deductions against the sub-contractor it feels is most able to bear the loss. The interface agreement in this case seemingly did exactly that; it allowed Project Co to allocate deductions to Construction Co or FM Co “as appropriate” and this is what Construction Co sought to argue. Impossible, said the court, it makes no commercial sense. Where a breach by A caused Project Co loss, you cannot pass that liability to B.

Did the judge get it wrong?

An interface agreement contains a straightforward allocation of risks and liabilities between Project Co and its key sub-contractors on a project. It is a commercial agreement and the parties to that agreement are free to agree the way in which Project Co can allocate deductions to its sub-contractors. In fact, it makes good commercial sense from Project Co’s perspective to allocate the deduction to the sub-contractor best able to bear that loss. However, this is rarely acceptable to FM Co because this will almost always be FM Co: it is much easier administratively for Project Co to reduce FM Co’s monthly payment by an amount equivalent to the deduction than to recover such amount from Construction Co.

On the facts of this case, the judge was probably right that this interface agreement only entitled Project Co to allocate a deduction to a sub-contractor where that sub-contractor was in breach of its sub-contract and this had caused Project Co to suffer a deduction under the project agreement for poor performance and/or unavailability. However, this will not necessarily always be the case.

Some interface dos and don’ts

  • Although interface agreements are commonplace on PPP/PFI projects, there is no “standard” form. Do not take a “one size fits all” approach.
  • Do not push issues into an interface agreement that should properly be dealt with at sub-contract level.
  • Whether you are Project Co, Construction Co or FM Co, make sure you understand exactly what issues your interface agreement deals with and how this fits with your respective sub-contract(s).
  • Consider what practical interfaces may usefully be addressed in the interface agreement, such as design development, mutual rights of access, and so on.
  • Consider what project-specific issues may need to be addressed, for example, FM Co’s control of site prior to completion of construction on secure accommodation projects.

2 thoughts on “PFI interface agreements

  1. If the FM Contractor is properly advised he simply will not have liability for deductions where such are caused by the Building Contractor and any attempts by the SPV to levy such deductions should be countered by an immediate adjudication against the SPV.

    It is commercial nonsense for the SPV and funder lawyers to advocate that it is acceptable for the FM Contractor to take the risk of a Building Contractor default, even more so where lifecycle risk sits with the SPV. It is also wrong to suggest that the risk to the FM Contractor is simply cash flow: what about the legal and management costs associated with recovery proceedings and litigation risk?

    The only conceivable situation when the FM Contractor should consider assuming any risk for Building Contractor default is where the FM Contractor controls the lifecycle reserve and has sufficient security by way of a guarantee from the Building Contractor’s parent. The FM Contractor should not take the risk of Building Contractor insolvency, limitation caps or limitation periods.

    In my experience the only time an FM Contractor has agreed to accept the risk of deductions for Building Contractor default is where it has either failed to understand the interface risk allocation or where the FM Contractor’s Group owns a significant majority of the equity

  2. I agree with Matthew that, in the normal course, it makes no commercial sense for one party to a contract to accept responsibility for the default of another contracting party under a separate contract. Certainly, this is not something that the blog advocated.

    However, in PFI projects sub-contractors do sometimes accept risks that they would not generally accept in a traditionally procured project. For example, construction sub-contractors accept the risk of certain neutral events delaying completion: they are not granted an extension of time in these circumstances.

    In relation to the allocation of deductions under an interface agreement, I have been involved in PFI projects where the SPV/funders have sought to argue that they should have a discretion to allocate deductions to the sub-contractors “as appropriate”, that is, to the party best able to bear the deduction and this is precisely the argument that was raised in the Kent County Council case. This is not to say that sub-contractors should accept this position. On the contrary, it will rarely be acceptable to them, as I mention in the blog.

    The key point is that an interface agreement will vary enormously from project to project. There is no “standard” approach: it will depend on many things, including the nature of the project in question, the contractual structure and the risk profile. Matthew has pointed out some instances where it may be acceptable to an FM sub-contractor to accept the risk of deductions for construction sub-contractor default. There may be others.

    For example, on a secure accommodation project the operator of the facility will have complete control of the facility for obvious security reasons and may well be able to accept the allocation of all deductions that arise during the operational period in the first instance (other than those which very clearly arise from a construction defect) and deal with any re-allocation of these under the interface agreement. On more complex projects, such as road projects, there may be so much overlap between the respective roles of the contractor and operator in terms of carrying out different elements of the work and their respective maintenance responsibilities in respect of these elements that a more innovative approach to the allocation of deductions is necessary.

    Clearly there are a number of risks that sub-contractors need to be aware of when accepting responsibility for deductions under an interface agreement or other agreement. This is why it is absolutely imperative that every party, and in particular the sub-contractors, understand precisely the nature and extent of the risks allocated to them under this type of agreement and that issues which should be dealt with at subcontract level are not pushed down to the interface agreement.

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