Old Contracts, New Climate: The PFI Handback Challenge

Introduction

For over 20 years, PFI was used in the UK to procure, finance and operate numerous public infrastructure projects. Many of the original contracts are nearing their 25-30 year expiry date, raising important practical and legal consequences for what comes next. This is increasingly the subject of public discussion and debate following the UK Infrastructure and Projects Authority commissioned White Fraiser Report published in July 2023.[1]

The origins of PFI, its central characteristics and a summary of key legal issues which may arise from PFI handback were discussed in an article by Katherine Apps KC and David Sawtell, PFI handback – identifying potential disputes (30 May 2024). One issue raised concerned the complications but also opportunities of PFI handback and Net Zero.

The need to consider the decarbonisation of PFI projects is a matter which has relatively recently been considered in depth by the Infrastructure and Projects Authority, which on 5 July 2023, provided a handbook of recommended good practice for PFI contracting authorities for the preparation and delivery of decarbonisation interventions, though this concerned operational PFI projects.[2]

Therein, it is noted at the outset of the Executive Summary “Up to 42% of the UK’s total carbon footprint comes from the built environment. Decarbonisation of public built environment assets is an essential part of meeting the legal commitment to decarbonisation that has been made in the Climate Change Act and successive Carbon Budgets.”[3]

In respect of handback specifically, as noted within the Infrastructure and Projects Authority Guidance dated February 2022, ‘Preparing for PFI contract expiry’, “At the point of contract expiry, the assets will typically be 20 to 30 years old. It is inevitable that the authority’s requirements, guidance (for example, Building Bulletins) and policy/ legislation (for example, net zero carbon obligations) will have changed in this period. The authority should therefore review the handback criteria to determine whether they align with future needs.”

This issue was also briefly considered in the White Fraiser Report, which considered the importance of behaviours and relationships, including to net zero policy aims.

This article will consider the impact of legislation and policies applicable to public body decision-making, and to the built environment, and consider how this will affect PFI projects, in particular after handback.

Obligations under PFI contracts and upon PFI companies specifically

PFI contracts

A significant proportion of PFI contracts were created over 20 years ago, well before the Climate Change Act 2008, and are therefore unlikely to have express contractual commitments regarding Net Zero related considerations.

As noted in the February 2022 IPA guidance, to comply with handback criteria, the PFI private sector companies will need to complete a wide range of lifecycle works in the latter years of the contract. However, the public authorities’ future needs may no longer be aligned with this handback criteria, given net zero obligations. An example given in the IPA guidance is whether to replace boilers, which might be required under the handback criteria, and whether the public authority may instead agree to vary the criteria for installation of heat pumps. 

ESOS

The Energy Savings Opportunity Scheme (“ESOS”) is a mandatory assessment scheme for large UK businesses (defined as those employing more than 250 people or having a certain annual turnover/annual balance sheet total), though this excludes public bodies, administered by the Environment Agency. It came into force on 17 July 2024, pursuant to the Energy Savings Opportunity Scheme Regulations 2014. Organisations that qualify for ESOS must carry out ESOS assessments every four years, including an audit of all energy used, which would include energy used by their buildings. It is possible that ESOS may apply to certain PFI entities, albeit many will be excluded if they are smaller SPVs.

Net Zero legislation and policy applicable to public body decision-making

The Climate Change Act (CCA) 2008 is the cornerstone of the UK’s domestic legal framework for tackling climate change. The CCA 2008 sets the framework for the UK’s long-term climate mitigation targets, adaptation processes, and the associated governance mechanisms enabling a transition to a low carbon UK economy. At its core is the ‘net zero’ commitment – a commitment to reduce greenhouse gas emissions to ‘ensure that the net UK carbon account for the year 2050 is at least 100% lower than the 1990 baseline’ (section 1 CCA 2008). This is to be brought about through cyclical, legally-binding ‘carbon budgets’ to ensure the net zero target is met.

Most PFI contracts were entered into before the Climate Change Act 2008 came into force, meaning that the original handback criteria were set without consideration of what are now legally binding carbon reduction requirements. These requirements mean that an authority will most likely need to (re)shape its PFI handback policy, including its policy for providing services and managing its estate, with a view to reducing greenhouse gas emissions.  Some of the ways that these requirements may directly bear on PFI handback are as follows.

The Greening Government Commitments

The greening government commitments (GGCs) are a framework of actions which UK government departments and their partner organisations will follow to reduce their greenhouse gas emissions and other impacts on the environment.

As set out in DEFRA’s ‘Greening government commitments 2021 to 2025’ policy paper (15 December 2022), “The commitments apply to the office and non-office estate of central government departments and their executive agencies (EAs), non-ministerial departments (NMDs) and executive non-departmental public bodies (NDPBs), unless specifically exempted. With the exception of greenhouse gas emissions, the targets are aggregate central government targets and not bespoke minimum performance targets for individual departments. They should, nonetheless, act as a guide for departments to work to.” The commitments include specific greenhouse gas emission reduction targets, as well as minimising waste and promoting resource efficiency, reducing water waste, and procuring sustainable products and services.

These commitments are likely to have significant consequences for PFI handback. The GGCs mean that authorities with PFI contracts approaching expiry cannot simply accept handback of assets which no longer align with these commitments. Many PFI assets will be 20-30 years old at handback and likely to have, for example, poor energy performance by current standards. Energy-inefficient buildings without a plan to bring them into compliance with these targets may pose a problem. They may require departments to negotiate contract variations for energy efficiency improvements before handback, or to budget for significant post-handback retrofitting works. Similarly, as noted above, the GGCs also require departments to procure sustainable products and services, which should factor into decisions about whether to extend PFI maintenance contracts or bring services in-house.

Local Authorities

While not bound by the Greening Government Commitments, many local authorities have declared climate emergencies (including Buckinghamshire Council, Oxfordshire County Council and Cambridgeshire County Council, among many others) and set their own net zero or environmental targets that may be more ambitious or specific than national requirements. This may create particular challenges for local authority PFI handback, where the handback of carbon-intensive PFI assets conflicts with net zero commitments.

A further challenge will be funding constraints. Unlike central government, local authorities typically have more limited access to capital funding for post-handback improvements, making the condition and energy performance of handed-back assets more critical to their ability to meet climate commitments.

However, net zero policies and schemes do not only present a challenge in relation to PFI – they may also provide valuable opportunities, as follows.

Capital grant programmes

The UK government has introduced capital grant programmes aimed at accelerating the transition to Net Zero. These initiatives provide critical funding to support infrastructure needs such as energy efficiency upgrades, low-carbon heating systems, and strategic decarbonisation planning across public buildings, and may be leveraged to support interventions at the point of handback.

The Public Sector Decarbonisation Scheme (PSDS) provides grants for public sector bodies to fund heat decarbonisation and energy efficiency measures by, for example, enabling public sector bodies to replace fossil fuel-based heating systems with low-carbon alternatives such as heat pumps and district heating networks. These programmes may present a valuable source of funding to enable authorities to retrofit PFI assets with low-carbon technologies.

Relatedly, the Public Sector Low Carbon Skills Fund (LCSF) provides grants for public sector bodies to engage the specialist and expert advice and skills required to develop a heat decarbonisation plan, which in turn will put them in a stronger position regarding future applications to the PSDS. By enabling a more informed and proactive approach to decarbonisation and estate management, and by providing critical funding, LCSF and PSDS may allow authorities to embrace the opportunities presented by PFI handback.

The Net Zero Estate Playbook & Construction Playbook

The Net Zero Estate Playbook, developed by the Government Property Function, offers guidance for decarbonising public sector property, setting out a step-by-step framework for achieving Net Zero across the government estate. Although not explicitly aimed at PFI, it provides a strategic framework for managing public assets in a way that aligns with Net Zero goals. For authorities preparing for PFI handback, the Playbook therefore provides essential guidance on how to assess, upgrade, and operate inherited buildings sustainably. Along with the Government’s Construction Playbook, this will be useful to authorities post-handback, when authorities have the opportunity to reframe asset management around sustainability, resilience, and long-term value. The playbooks should therefore be useful to authorities in ensuring that PFI handback is not merely a contractual milestone, but a launchpad for decarbonisation.

Net Zero legislation and policy applicable to the built environment

Outside of public sector specific policies discussed above, various other policies and legislation may apply to PFI assets and/or PFI entities and may be relevant before or upon handback.

EPC Regulations

The Energy Performance of Buildings (England and Wales) Regulations 2012 (“EPC Regulations”) (consolidating the previous Energy Performance of Buildings (Certificates and Inspections (England and Wales) Regulations 2007), imposes various duties relating to the production, provision and display of energy certificates for almost all buildings except for those excepted, applying to both non-dwellings and residential properties from 1 October 2008.

The main feature of these regulations was the creation of Energy Performance Certificates (“EPC”) and requirements to display those certificates. Assets are inspected and assessed and provided with an asset rating (1 to 100) and a corresponding band (A+ to G), the EPC must also contain narrative recommendations on how energy efficiency of that property may be improved.

EPCs are required to be produced when properties are built, sold or let.

Accordingly, for PFI assets which completed construction (or were sub-let) after 1 October 2008 (unless they are excepted buildings), the EPC Regulations apply.

The requirement to display energy certificates (see Part 3 of the EPC Regulations) applies to certain larger public buildings (area of 250 square metres or more), frequently visited by members of the public, and these must show actual energy consumption of a building over at least the preceding 12 months.

However, the EPC Regulations do not introduce new standards or oblige property owners to increase the energy efficiency of their buildings.

MEES Regulations

The Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 were introduced for this purpose, namely to improve energy efficiency of rented residential and commercial property (“MEES Regulations”). The MEES Regulations have various different provisions, but central to these regulations, is a prohibition on landlords letting out property below a certain rating (unless it makes energy efficiency improvements or avails itself of an exemption). Presently this rating is an “E” rating. Under the Conservative government, there were proposals to increase this rating requirement, which were subsequently scrapped by Rishi Sunak on 20 September 2023. However, the current Labour government is looking into whether to re-introduce the increases in ratings requirement in the near future. These requirements only apply to landlords letting out private property, and as such are unlikely to apply to a significant proportion of PFI assets, but may apply to some.

Heat networks

Heat networks have been identified as one of the key existing solutions in achieving net zero within buildings and form a core part of the government’s Heat and Buildings Strategy.

A ‘heat network’ is defined in the Energy Act 2023 as:

“A network that, by distributing a liquid or a gas, enables the transfer of thermal energy for the purpose of supplying heating, cooling or hot water to a building or persons in that building (and includes any appliance the main purpose of which is to heat or cool the liquid or gas).”

As part of the Heat and Buildings Strategy, there are various government policies in place in respect of heat networks.[4] These include the Green Heat Network Fund (‘GHNF’), a capital grant programme which provides targeted financial support to organisations in the public, private, and third sectors in England, supporting the development of low and zero carbon (‘LZC’) heat (and cooling) networks. This includes both the commercialisation and construction of new low and zero-carbon heat networks, along with the retrofitting and expansion of existing ones.[5]

Chapter 1 of Part 8 of the Energy Act 2023 now expressly provides for the issuing of regulations in respect of heat networks, and is intended to provide for regulations concerning authorisation and consumer protection. The regulator is Ofgem. The phase-in of regulations is anticipated to start in 2026.

Construction / Retrofitting

There is a range of legislation and policies concerning the construction of new buildings and the retrofitting of existing buildings. The extent and detail of this legislation/these policies is beyond the scope of this article. The following items are highlighted:

• The Construction Playbook is discussed above.
• Certain PAS Standards:
  • PAS2038 – This is a set of guidelines concerning the retrofitting of non-domestic buildings, with the aim of improving energy efficiency, reducing energy demand and ultimately reducing carbon emissions.
  • PAS2035 – This covers retrofitting dwellings, including how to assess dwellings for retrofit, identify improvement options, design and specify Energy Efficiency Measures and monitor retrofit projects.
  • PAS 2030 – This was redeveloped in conjunction with PAS 2035, and covers the installation, commissioning, and handover of retrofit projects. Organisations that trade using the Trustmark Government endorsed Quality scheme are required to comply with PAS 2035.
  • PAS 2080:2023 is a standard which came into effect on 31 March2023 and specifies requirements for the management of whole life carbon in buildings and infrastructure.
• The Building Regulations 2010 (as amended) contain various energy efficiency requirements at Part 6 (e.g. target primary energy rates)[6] (see also updated versions of Approved Documents L, F and O). These regulations apply to the construction of new buildings, but also to a range of retrofitting works (which would be considered ‘building work’), though the application of the different energy efficiency requirements will vary depending upon the nature of the works.
• In September 2024 the pilot version of the UK Net Zero Carbon Buildings Standard was published, this is a 125-page document, produced to define the requirements for buildings in the UK to be Net Zero Carbon.

Before handback

The relatively limited application of Net Zero legislation and policy to existing obligations of the parties is detailed above.

In respect of whether current policy can be implemented into existing agreements, as set out in the Executive Summary to the Decarbonisation of Operational PFI Projects Handbook:

“All public sector organisations are tasked with planning and acting now to reduce their carbon footprint. Those public buildings delivered in partnership with the private sector, through the Private Finance Initiative (PFI), Private Finance 2 (PF2) and other Public Private Partnership (PPP) contractual arrangements should be included in these decarbonisation plans. The rigidity of the long-term contractual commitments that sit behind these arrangements may make it more complex to make changes to the assets, systems and operations delivered by these contracts.”[7]

It is not straightforward for net zero policies to be implemented into ongoing PFI projects, unless there is agreement by both parties, due to the detailed long-term contractual commitments, the majority of which will likely have been entered into prior to the Climate Change Act 2008. However, if there is collaboration between the parties, it is likely that net zero policy can be implemented into a range of ongoing PFI projects. These opportunities are discussed in much greater length in the Government’s handbook of good practice related to decarbonisation of operational PFI projects.[8]

On/After handback

There are two key aspects of public sector decision making in respect of handback which will need to take into account the Net Zero legislation and policy discussed above, namely:

• What to do with the asset itself.
• What to do in terms of further maintenance agreements or similar.

Naturally, each PFI project handback will need to be considered on a case-by-case basis, as to how these two decisions are approached.

As discussed above, Net Zero targets set both nationally and locally will affect government decision-making on PFI handback, in particular with regards to extensions of maintenance and operation agreements, such that the agreements align with decarbonisation requirements.

In respect of the asset itself, consideration will need to be given to retrofitting, and the relevant legislation and policy likely to apply to retrofitting.

If renewal involves the construction of any new buildings, the significant changes in regulation and policy, especially concerning government related projects, will likely have a significant impact in the requirements and execution of such a project.

In respect of future maintenance, considerations will need to be given as to future energy consumption and heating, including whether the asset can be incorporated into any future heat network, alternatively what other sources of low carbon heating may be available.