Scope management is essential to ensure that the project actually delivers that which the ultimate users of the project works require. The output specifications, which are set out in the PPP agreement, should take into account the government’s current, as well as future, requirements to the extent that these are identifiable and quantifiable. Variations to the output specifications may, however, be necessary to cater for changes in the government’s requirements, which could not be anticipated or quantified at the commencement of the contract. Variations may also be necessary for changes imposed by external factors for which the government has retained responsibility (for example, a change of policy). The government must be notified of all variations prior to their implementation.
It is necessary to differentiate between changes to the scope of work by the source of the change (that is, the private partner, government, or some external event), the timing, and the size and impact of the change. In all cases, changes to the scope must be dealt with systematically and in terms of the PPP contract.
The likelihood of scope changes originating either from the private partner or the government is greatest in the Construction Phase, as the best means of achieving the output specifications in the context of actual conditions becomes apparent. Regardless of the source of the change, there must be a formal process of scoping and reaching agreement on such changes. The most common means of doing so is a variation notice issued by one party to another, setting out the costs and risk implications and also the formal changes to the specification. The cost implications must be clearly identified, and approvals should be sought from the appropriate decision-makers, depending on the quantum of the change.
There is significant value to be derived through establishing dynamic and empowered committees with representatives from the private partner and government to consider proposed changes, particularly to apply specifications in a manner that drives efficiency in public facilities such as hospitals. Where minor changes to the specifications have no cost implications, these committees are a valuable tool to manage the agreement processes.
Changes with minor cost implications may be approved by the contract management team. Larger changes by the government and private partner executives, and significant changes (expressed as a percentage of the overall construction capital cost, or where there is a material change in the risk allocation or project scope) should be approved by the appropriate approval authority under the project’s governance arrangements. These approving entities may be a central PPP unit or a committee of representative government departments.
On the private partner’s side, the shareholders and lenders have an interest in managing and approving changes. Approval processes, similar to those of the government, should be established where shareholders and lenders are notified of changes and their approval is required, and in some instances, where cost exceeds a certain threshold.
8.3.1. Managing Government-Initiated Changes
Where the government seeks to change the contract specification, it must issue a formal variation notice. It is generally good practice to provide the variation notice in the contract that the private partner is obliged to respond to; the notice should have detailed information in relation to the impact of the proposed variation.
The private partner must be permitted to identify the costs and risks of implementing the variation, notifying the government of such costs through a variation proposal. The costs should be compared to the original or base case capital costs. Where such costs exceed a specified amount, the private partner should be required to tender out such variation in an open market. Where the costs are relatively minor, the private partner should implement the variation using its existing sub-contractors, as this will be the most cost and time efficient.
The government must decide to accept or decline the variation proposal. It is extremely useful for the PPP contract to have a method by which the various overhead costs and mark-ups of the private partner are identified for variations, so that the decision to implement the variation depends on the base costs that the private partner receives from its contractors rather than the mark-ups that the private party seeks to cover for its costs and risks.
The variation is then formally signed off between the parties and implemented as such.
The private party must be obliged to implement the variation unless any of the following conditions are met:
- The variation would, if implemented, give rise to a breach of any legal requirement or good industry practice. Alternatively, if the variation would adversely affect the ability of the private partner to exercise its rights and powers to perform its obligations under the PPP contract;
- The private partner does not have the legal capacity to implement the variation;
- The variation would, if implemented, make any insurance effected or to be effected unavailable on reasonable commercial terms;
- The variation is not technically feasible on reasonable commercial terms; and
- It would place the private partner in breach of its loan agreements.
The costs for the variation must be financed by the government. There are a number of ways in which this can be achieved. The easiest to implement is a capital grant paid as a lump sum to the private partner upon implementation of the variation. Since this change may also involve consistent operating and maintenance costs that were not included in the PPP contract and the financial model, there must be a mechanism by which these can be reimbursed by the government. In cases of a government-pays PPP, the payments can be increased to cover the costs (and risks) of the variation post-implementation. For user-pays PPPs, the cost recovery might be effected by way of an increase in user fees, although this is not common.
The variation in its entirety might also be funded with capital raised by the private party. This is more common in government-pays PPPs where the capital and funding costs can be received from an increase in the payments.
8.3.2. Managing Private Partner-Initiated Changes
There are likely to be many private partner-initiated changes. The majority of these should be changes to the means by which the output specification is achieved and should be at the cost and risk of the private partner. Nevertheless, the government has a significant interest in reviewing and approving these changes so that the output specification continues to reflect the needs of the government. This is because the government remains the owner of the asset created in most cases, and it has an interest that the asset performs over a period much longer than the term of the PPP contract.
In this case, the private partner issues the variation notice and confirms the detail of the change to the specification and that there is no cost to the government. There may be some cases where the government is willing to make a cost contribution to a private partner variation in the interest of increasing Value for Money, but these should be the exception.
The government then issues some form of no objection to the variation. It is then formalized and signed off on by the parties and then implemented.
The government must be sensitive to the concept of value engineering by the private party. Value engineering is where costs are reduced by the use of some innovative implementation method and is common in construction and system development. Cost reductions may well be shared between the parties in the variation agreement, but care must be taken to examine the risk that comes with such value engineering.
An example in a rail system could be reducing the amount of derailment containment to a level that is consistent with good industry practice, but below that set out in the original output specification. An actual derailment in an area where the containment was omitted as part of a value engineering that the government shared in, would lead to some interesting liability issues in the civil and even criminal legal proceedings that would be sure to follow.