Building trust in PPP

One of the biggest challenges posed for the construction industry by the Public Private Partnership (PPP) initiative is the need to break with its usual rush to litigation. In other words, instead of construction companies suing everyone else over everything, they have to develop the kind of mature relationships that can sustain the 25-to-30-year partnerships that are the bedrock of PPP.

Euan Wilson, a partner in the capital projects department of law firm Maclay Murray & Spens, says the construction industry has developed a reputation for bidding low, then talking the price up through the life of a contract by an adversarial treatment of every issue with possible cost implications. “Traditionally, this is a pretty litigious sector, and it is par for the course for a building contract to end up in adjudication or in the courts,” he says.

So what is it about PPP that makes a different outcome likely? To give one instance, at present, one rumour is that Amey and the Miller Group, successful joint bidders, along with Bank of Scotland, on the Glasgow Schools project, and again on the Edinburgh Schools project, have fallen out, at least as far as cooperation on future projects is concerned. Certainly, they are not bidding jointly for the next slice of Scottish Schools PPP, which tends to suggest that the rumours have some foundation.

“Rubbish,” says Miller Group finance director John Richards. “We’re still working very well together on the Glasgow and Edinburgh projects. Besides, we don’t play the litigation game. We got out of that four or five years ago and we’ve transformed the way we do business to a negotiated contract model.”

Broadly, this model is one in which the construction company and the client work together from the project inception stage to create a true joint design and build. Traditionally, the construction company would get the contract late in the day, when the plans were set in concrete (so to speak). The contractor’s estimators department would then get to work and, as each section of the work was completed and part payment became due, a battle between the client’s professional cost experts and the contractor would ensue. Everything that could possibly be called a variation from plan would be charged for according to the contractor’s view, and contested from the client’s point of view.

In a negotiated model, the client and the contractor agree on two things: the client wants to drive out costs and the contractor wants a reasonable margin. With those goals on the table, the two sit down to work out the best solution, with the contractor having a substantial say from the outset.

It can then bring its experience to bear to protect its margin and to help the client drive out costs. This works best in a big capital project, where the client and the contractor have a history of working together.

At its best, PPP is similar, because the public sector client is prepared to give the contractor a substantial say in the bid process. However, it should improve on the private sector deal in that the PPP is run by a special-purpose vehicle in which the contractor will have a substantial equity stake, perhaps around 40%. Wilson argues that it is therefore unlikely the construction company will litigate against the special purpose vehicle to try to drive up its margin.

“What you want in the design stage is the client to agree an output specification that is loose enough for the contractor to add value to the whole process,” he says.

If, for example, the public sector client specifies down to the level of a particular make of door handle, all that will happen with the bid process is that half-a-dozen companies will bid prices based on that handle.

This offers very limited scope for cost savings. If instead, you simply say, the doors will have handles, you can leave it up to the facilities management company and the contractor to agree the right balance between up-front and maintenance costs. For example, if you specify titanium door handles, maintenance costs drop to near zero, but up-front costs go through the roof, so there is a balance to be struck.

Where the PPP contract is approached in this spirit, Wilson says, the scope and necessity for litigation start to fade. “This should not be an issue for litigation, since all these details are worked out before financial close on the deal. This is the big difference between PPP and a traditional build,” he says.

The down-side of this method is that the amount of detailed work required at the proposal stage leads contractors to generate a huge bill, which they have to absorb before they are certain of winning the contract. This, together with a change in accounting practice that means the costs associated with failed bids now have to be fully recognised in the year in which they are incurred, instead of being written off over many years, is having a profound impact on PPP. This will only really work its way through the system in the next year or so.

Gareth Parry, head of construction procurement at McGrigor Donald, says the change in accounting for failed bid projects is having the effect of making construction companies much more selective about the projects they bid for.

This, he suggests, is a far bigger threat to the continued health of PPP than any fractiousness or litigious tendency in the contractor community.

“The costs of these bids are so high that they have a material impact on a construction company’s P&L,” he says.

Euan Wilson agrees. “If you are looking at making a margin of £2m on the build phase of a PPP, having to spend £500,000 to get into the later stages of the bidding is a formidable obstacle. We are already seeing construction companies being much more circumspect and careful about the contracts they bid for, and, taken individually, they are each bidding for far fewer deals,” he says.

Parry points out that another factor that is making the industry less litigious, at least where PPP is concerned, is that some innovative work is being done to head off problems before they begin.

“One of the difficulties for employers in the past with PPP, and even with traditional builds, was that it was often not clear who they should sue, the contractor, or the designer and architect,” he says. “Now we have Novated Design and Build contracts. This is where the design team begins as an independent show, but works very closely from the outset with both the employer and the contractor, with the latter advising on ‘buildability’ issues. When matters reach the stage where everyone is satisfied, the design team becomes part of the contractor’s work force, and is employed directly by the contractor. The employer then only has one supplier to deal with.”

Ultimately, both Parry and Wilson believe PPP projects are now substantially less likely to end up in the courts than most construction contracts.

“If the contractor is involved from the outset, and is properly incentivised, many of the grounds for litigious conflict fall away,” Parry says.