Standardisation of contract terms can reduce transaction time/expense and provide a consistent risk allocation understood by the contracting parties.
For example, over 100 hospitals were procured under the Private Finance Initiative using the NHS Standard Form contract (“SF”). Honed over many years with the input of the NHS (in particular their Private Finance Unit), contractors and funders, it created a workable, well understood set of mandatory standard terms – leaving only project specific elements to be wrangled over by clients and their advisors.
As a procurement strategy PFI (and its successors) has its critics but the SF and the drive for contract standardisation was widely welcomed.
Despite PFI’s passing, good contract forms never die. The SF (in its final incarnation as SF3) has been resurrected to facilitate a new set of priorities and objectives - achieving energy efficiencies through procurement of energy assets and infrastructure. So what is the importance of standardised energy contracting, and why is this important for the sector?
The Carbon and Energy Fund (“CEF”), which launched in 2011, was specifically created to fund, facilitate and project manage complex energy infrastructure upgrades for the NHS and wider Public Sector. The CEF adopted SF3 resulting in two CEF energy performance contract forms that can be deemed as on or off balance sheet and work on a lease or concession basis.
In CEF’s words:
It was born out of frustration and co-created with the Department of Health to halt the excessive expenditure in procuring Energy Performance “type” Contracts. Traditionally Public Sector bodies would complete stand-alone procurements so contracts had to be purchased, consultants employed and contractors procured and once it was complete all the knowledge was lost
Use of the CEF contract is an important component in preventing the re-invention of contracting wheels. Many of today’s contractors and advisers in the energy infrastructure sector were heavily involved in PFI contracting so will understand its genesis and objectives.
To date, it has primarily been used by NHS Trusts with over 40 schemes completed or in the installation phase. Nevertheless, it is being increasingly used by other public sector bodies.
We are currently advising a private sector bidder on its use and in our view it is a solid basis for energy performance/savings deals, comprising the SF principles of:
- An output based approach that aligns well with an energy savings requirement
- Payment by the employer (including where appropriate, capex repayment) against performance
- Adherence to the old PFI idea – transfer risk to the party best able to bear that risk
- A detailed set of construction/installation and operational provisions that bidders will know are – for an appropriate risk premium – workable
- A comprehensive change of law regime
- An appropriate liability capping regime
- Tried and tested compensation on termination provisions based on asset value.
Furthermore, alongside those generic provisions, the CEF has introduced energy specific drafting. The performance requirements and payment mechanism provisions (including shared savings) are clear but comprehensive, to the benefit of both procurer and bidder.
Bidders have to accept that the CEF contract terms are designed to maximise performance risk transfer to the contractor, but an appropriate balance of risk can be struck if bidders:
- skilfully populate the available contractual carve outs from that principle
- carry out sufficient site and data due diligence to get comfortable with the level of risk transfer.
The CEF and its contract form provide a valuable resource in facilitating these complex procurements in the public sector. BEIS (formerly DECC) has also produced a form of energy performance contract, but again primarily focused on public sector schemes.
Transferring the benefits of that level of standardisation across the private sector energy performance market could provide a real boost to corporates who are looking at cost effective ways to reduce their energy usage and meet carbon commitments.
In our experience, the multiplicity of contract forms in the private sector market tends to reinforce a perception that these projects are too complex for the perceived benefits – particularly as clients already have their hands full with financing options, measurement and validation and balance sheet issues. In this, standardisation could help create a mature and more commoditised market.