Pinsent Masons advises Photon Energy N.V. and Bankhaus Scheich Wertpapierspezialist AG on EUR 55m GREEN bonds
Out-Law Guide | 10 Jan 2012 | 10:48 am | 9 min. read
Interface agreements are used in private finance initiative (PFI) projects as a means of creating a direct contractual relationship between the building contractor and facilities management (FM) provider. This is done on the basis that these two major subcontractors will have more effective remedies against each other in respect of such risks than Projectco, and that Projectco will not want to be involved in claims between subcontractors wherever possible.
As a reminder, we will be using 'Projectco' to refer to the private sector company or partner created for the sole purpose of owning the project. This type of company is also known as a single purpose vehicle (SPV). We will refer to the contracting local authority entering into the agreement with Projectco as the 'Authority'. For more on the formation of public private partnerships (PPPs), please see our separate Out-Law Guide.
The alternative to an interface agreement is for these issues to be dealt with in each of the subcontracts. In this model, each subcontractor has its separate contractual relationship with Projectco, leaving Projectco to recover what it can from the other subcontractor in the event of any claim. The problems that this causes are:
Despite these drawbacks, as a general commercial approach some building contractors and FM providers do not favour interface agreements. They are essentially a device to protect the interests of the funders and Projectco, and most subcontractors will be wary of owing contractual obligations both vertically (to Projectco) and horizontally (between each other) at the same time. However, the very fact that Projectco's obligations to the Authority - for example, to build or to run the facilities - are stepped down to the two subcontractors means that interface issues will inevitably arise. An interface agreement is a means of resolving these issues.
Equivalent project relief (EPR) is an issue which arises from the way in which Projectco's obligations and liabilities under the project agreement are stepped down into the Facilities Management Agreement or Construction Contract. It is a way of ensuring that Projectco's liability to the relevant subcontractor will not be any greater than the entitlement it has against the Authority under the Project Agreement. In most circumstances Projectco must exercise its rights against the Authority, and the Authority must agree that Projectco does have an entitlement, to trigger the subcontractor's entitlement against Projectco.
In order that the subcontractor is not disadvantaged or put at risk by this arrangement, the subcontractor can generally force Projectco to pursue the Authority for its entitlement. In addition, Projectco cannot generally agree anything with the Authority that may prejudice the subcontractor's entitlement without the subcontractor's consent. This consent must be obtained in writing where the adverse effect would be material.
This 'horizontal' EPR should apply to any subcontractor's entitlement to compensation from Projectco if there is no interface agreement. These provisions will typically form part of both subcontracts in as near as possible to identical terms. Where there is an interface agreement, the subcontracts will usually exclude Projectco from liability in respect of acts, omissions or breaches of the other subcontractor - the interface agreement being intended to provide the sole focus for such claims and liabilities.
Where there is an interface agreement, the principal subcontractors may try to apply EPR provisions in respect of liabilities to the other subcontractors where the issues are caused by sub-subcontractors. There is also no reason why, where there are several key sub-subcontractors, there should not be an interface agreement between those sub-subcontractors to exclude the main subcontractors from liability in respect of the actions of those sub-subcontractors.
Although a number of interface issues commonly occur in virtually all PFI projects, their relative importance will differ depending on the overall project structure. Some of the more important and commonly occurring interface issues are detailed below.
Delay: Usually the term of the project will be fixed from the date the works begin or the target date for the commencement of the services, rather than the actual date the services begin. If completion is delayed this means that the service period will be shorter and the service payments over the life of the project will be less than originally anticipated. This means that Projectco, and therefore the FM provider, will lose an element of revenue to the extent that completion is delayed. The FM provider is also likely to incur additional costs where completion is delayed if it has to stand down staff or its own subcontractors, or if it is bound to pay them during the delay. The FM providers should therefore ensure that to the extent any delay is due to a compensation event, the Authority is obliged to reimburse its losses or expenses.
If there is no interface agreement, provision for any costs and losses the building contractor is liable for will usually be incorporated into the facilities management agreement. Alternatively the parties can, and generally do, agree that the building contractor has two sets of obligations: one to Projectco, to cover its cost of meeting debt repayment obligations and loss of income; and one to the FM provider, to cover its loss of profit and extra costs due to the delay. The FM provider will usually not be entitled to damages where the delay is caused by force majeure or a relief event.
Design development: It will be in Projectco's interest for the FM provider to be involved in the design process because it will want the reassurance that the FM Provider has taken the design into account in its pricing strategy. Typically the FM provider will agree with Projectco and the building contractor in the interface agreement that it can provide the services if the building is built in accordance with the specification. In order to have some recourse if the performance of the services becomes more expensive or more difficult due to the design of the building not being as expected due to variations in for instance the specification of the building, the FM provider would need to have some recourse against the building contractor.
Completion certificates and commissioning/familiarisation: Before a completion certificate can be issued, the FM provider will need to make sure that it is adequately protected in respect of the standard of works and their compliance with relevant consents or legal requirements. These terms should be included as a prerequisite for such a certificate in the facilities management agreement and any interface agreements. The FM provider may also need the building contractor's cooperation in terms of demonstration or training in the operation of the facilities and any equipment installed in the building as well as the timing of completion. The building contractor will want to ensure that it is entitled to claim against the FM provider during the commissioning/familiarisation process where the FM provider in some way hinders the building contractor or delays completion. In addition the building contractor will be under an obligation to notify the FM provider of any problems and potential delays to the construction programme.
Liability for deductions caused by defects: This and the issue of responsibility for the rectification of those defects are generally the key issues arising out of interface agreements. The facilities management agreement will generally provide that the FM provider is initially liable for all deductions, even those caused by construction defects, and that the FM provider must recover those deductions under the interface agreement. The interface agreement will impose an obligation on the building contractor not to cause defects, generally by obliging it to comply with the building contract, and must have provisions dealing with the manner in which the FM provider and the building contractor should remedy those defects. It will also impose a duty on the FM provider to notify the building contractor of defects as soon as is practical after it becomes aware of a defect.
Rectification of defects: Typically the building contractor will have both the right and the obligation to carry out defects rectification during a 'defects liability period', usually of 12 months. During that period the FM provider will be obliged to provide notification of matters it considers may be a defect and the building contractor will have obligations to investigate and remedy.
Given that the FM provider's income stream is at risk, there will be a commercial incentive for it to attend to and remedy all maintenance problems including defects immediately. Any right for the building contractor to remedy defects during the defects liability period will be an impediment on the FM provider's ability to meet its performance standards under the facilities management agreement, but this needs to be balanced with the building contractor's ability to control its ultimate liability. It is likely that the FM provider will not have the know-how to manage rectification itself.
Lifecycle issues: The interface agreement will impose an obligation to build or install specific assets set out in the design and build specification, but it would not be usual for the building contractor to take the risk that these assets need replacing earlier than expected. This risk will usually be borne by Projectco or the FM provider. It will be up to Projectco and the FM provider to balance their interest in making the assets last as long as possible, and having them replaced before they become a burden to maintain or affect the FM provider's revenue.
ICT issues: On projects with a significant ICT aspect, there may be a principal ICT subcontract between Projectco and an ICT subcontractor. Similar issues of delay, impediment and cross default will arise. An ICT subcontractor will often need access to the works to carry out some element of its contract, giving rise to some risk of damage or delay. Detailed protocols will generally be developed to govern such access and the risks arising from this. Careful consideration of available insurance proceeds in relation to physical damage and related delays can help resolve some of these issues.
Covenants between subcontractors: One of the key features of an interface agreement is the mutual obligations of the subcontractors to comply with their respective subcontracts, which will usually include reimbursement or indemnity obligations. It is this covenant that will allow Projectco to exclude liability to its subcontractors under their subcontract in respect of the acts or omissions of other subcontractors.
Limitation of liability: The interface agreement could limit the parties' liability in a number of possible ways. It is likely to state that the subcontractors' aggregate liability in relation to the project is no greater than the liability cap in the main subcontracts. It could also, for example, provide that there will be no liability for indirect losses suffered by the subcontractor under the agreement including loss of profit, business opportunity or goodwill, or set a minimum monetary value for claims, to prevent frivolous claims being made by either party. It is not uncommon in these agreements for there to be individual caps on liability relating to either a particular party or particular issues. Projectco and the FM provider will also have to agree what to do with residual liability for defects after the building contractor's latent liability period expires. These discussions will also involve the funders.
Replacement of a subcontractor: The project agreement should address the consequences of one subcontractor being terminated and replaced. Typically, the surviving subcontractor may have to enter into a replacement interface agreement on terms substantially the same as the existing agreement. As subcontractors will typically be uncomfortable binding themselves to contract on these terms with unknown entities, they will generally seek to achieve some sort of protection through the subcontract - for example, an agreement that they are only obliged to enter into a replacement interface agreement with replacement subcontractors who meet certain minimum financial and technical requirements. Subcontractors will also be wary of accepting liability where the other subcontractor becomes insolvent, and may try to push this commercial risk on to Projectco.
Claims under the interface agreement: A party is only liable to pursue a claim if they give notice to the other party, setting out the relevant facts, basis of liability and amount or likely amount of the claim, within a set period of time – usually 15-20 business days.
Dispute resolution: The interface agreement normally provides for a number of levels of dispute resolution. All of them will provide for adjudication, and should provide for related or connected disputes.
Pinsent Masons advises Photon Energy N.V. and Bankhaus Scheich Wertpapierspezialist AG on EUR 55m GREEN bonds