Select Committee on Public Accounts Minutes of Evidence

Examination of Witnesses (Questions 80 - 99)



  80. Can I then assume that the profits made by the two partners, Carillion and Group 4 do not only consist of the shareholders' return in FPSL but also indeed on profits they have made on the various contracts they entered into with that company?
  (Mr Banks) Correct. There are risks and rewards associated with those two contracts.

  81. I am sure you will not give away commercial confidentialities here but can we assume that the profits made by those two companies on this particular contract are substantially greater than those highlighted in this report? Would that be correct?
  (Mr Banks) There is a potential for profit there and the contract has been successful. It has been successful in terms of the services it has delivered and it has met its expectations in terms of the overall financial terms that it has delivered.
  (Sir David Omand) That would not be the case in terms of the rate of return because that would depend on the capital employed by the two companies delivering the services. The high figure is based on the fact that only £100 of capital is actually employed in the business. To get at what I would regard as the rate of return, comparing it with other contracts, I would need to do some rather difficult calculations and I am not sure I have the information on which to do them. They would actually look at the total capital which was employed in the financing of this prison.

  82. Yes, but you would not disagree with the comments made earlier by Mr Williams that they will receive a return of all they put into the company within two and a half years or just slightly under and they now have continuing profits both for FPSL and for the two originating companies through the rest of this contract.
  (Sir David Omand) We want them to have profits throughout.

  83. I am not against profit, it is whether that is reasonable and justifiable in the circumstances that I am trying to get at because that is our job as the Committee of Public Accounts. May I move on to Mr Narey, in relation to the use of your advisers in the negotiations? Two questions arising from that. Do you think that there was any conflict of interest in getting FPSL to pay for your advisers? Since the piper was not calling the tune you may well not have thought there was the possibility that you may not have got entirely objective information from them. Secondly, you only seem to have used them to give you advice, yet according to the report, which is a joint report, they could have amassed quite a lot of evidence for you about the situation faced by both Carillion and Group 4 which would have put you in a stronger bargaining position. Why did you not use them in the negotiation process itself?
  (Mr Narey) In answer to your first question, I am confident that the fact that we got FPSL to refund the cost of our advisers did not in any way diminish the quality of the advice we got or the help we got to try to obtain some leverage from this. The money Rothschild obtained from this particular piece of advice was relatively small. We do much more business with them of a much greater magnitude and I am entirely convinced that they were working as hard as possible to give us the best possible advice. I am not even sure at what point they knew that their bill to us was being refunded by FPSL.
  (Mr Kent) Not until right at the end.
  (Sir David Omand) May I make a general point that we regard it as normal practice that if a company wishes to refinance then they should pay the costs of that. The department, the authority in the contract, would take the advice that we felt it necessary to take and would bill the contractor. They would have no say over either the choice of our advisers or the extent of advice that would be offered.

  84. Did that happen in this case?
  (Sir David Omand) Yes.

  85. On the second question?
  (Mr Narey) I have already indicated that I accept we should consider on future occasions whether we incentivise our advisers and get them perhaps to negotiate direct. The net result of the negotiation on this occasion was a very satisfactory one. The fact is that we got ten times more than FPSL's opening offer. That was a result of careful negotiations conducted by Mr Kent on my left and I think he got a very satisfactory outcome for it.

  86. May I just press you on that? The impact of the report itself would suggest, and I put it as the report put it, that you may have been in a stronger bargaining position than you realised. Would you accept that?
  (Mr Narey) In hindsight, yes, I do accept that. At the time I can say that last April when I reviewed the proposals made by Mr Kent I thought that we got a satisfactory deal.
  (Sir David Omand) May I also add a point about incentivisation of advisers which I think I am expecting to find in the new Treasury guidance as something we would be advised to do. It is common practice but I would advise that it should be done case by case. There could be circumstances in which at a delicate point in a negotiation I would not want to feel that my advisers stood to benefit more by my taking a decision now or deferring a decision or took this decision rather than that decision. Incentivising the advisers only works if you are actually handing to them a discrete task where you have a clear measure of success rather than the cases that both Mr Narey and I have had where the advisers are holding our hands as we go through a negotiation process.

  87. Is there any likelihood that Bridgend or any of the other early contracts will be coming for refinancing?
  (Mr Narey) My understanding is that Bridgend, which is now Parc, indicated some time ago the possibility that they were considering refinancing. They have made no proposals to us to do so. Because the contract with them is slightly different, we have a rather clearer handle on their refinancing proposals than we had for Fazakerley.

  88. I hope you would learn from this experience.
  (Mr Narey) I can promise you we shall.


  89. What is confusing me is the renaming of all the prisons.
  (Mr Narey) It is enormously confusing.

  Chairman: It reminds me of videos of American gangster films where the names have been changed to protect the innocent.

Mr Rendel

  90. I think you said in reply to one of my colleagues that the taxpayer had benefited from this refinancing. Can you tell me in financial terms exactly what you meant by that? What was the financial benefit to the taxpayer?
  (Mr Narey) The contract price remained the same but we had refunded to us the equivalent of £1 million from our payments to FPSL made to us last year. We traded half of that back.

  91. So you are talking about the £1 million as the benefit to the taxpayer.
  (Mr Narey) Yes.

  92. I do not quite understand one thing about how the £1 million was calculated. I assume, Sir David, that you would accept what Mr Narey was saying about the £1 million being the benefit to the taxpayer. Can you perhaps explain something to me? In paragraph 9 of the summary it says that the probability of failure was estimated at about ten per cent maximum. In paragraph 6 it says that the present value of the extra liabilities incurred was £13.5 million. Can you explain why ten per cent is £1 million? Where is the £10 million that £1 million is ten per cent of?
  (Sir David Omand) May I direct you to Figure 5 on page 19 where the National Audit Office have produced a ready reckoner which relates the probability of termination to the expected value of the liabilities? As Mr Narey has said, we are prepared now to say in front of the contractors that we would not see the probability of termination as ten per cent. However, that figure does give us £1 million and that was the basis on which we negotiated with the company and we stand by that.

  93. What is the significance then of the £13.5 million in current value? I have misunderstood something in the finances here obviously.
  (Mr Kent) The two figures are not related. The £13.5 million is an expression of the increase in termination liabilities expressed in today's money. The ten per cent was the probability of termination and it was calculated on the basis that if it is ten per cent over 25 years it is approximately half a per cent per year. When you are doing the calculation of the increase in each year of the lender liabilities, ten per cent works out at about £1 million. It is a cumulative effect; it is a very complicated mathematical calculation. We could write to you.

  94. It is because the increase in liabilities is not the same each year.
  (Mr Kent) Yes, that is right.

  95. If you work it out on a year by year basis it is only £1 million as opposed to £1.3 million.[5]

  (Mr Narey) We could provide a note explaining exactly how that calculation is made if that would be helpful.

  96. That would be helpful, thank you, but I think I now understand what the difference is between the £1.35 million and the £1 million. This was therefore in effect the extra costs incurred by the taxpayer for taking on this risk.
  (Mr Narey) The additional risk; that is right.

  97. The £1 million is effectively the extra costs incurred in the risk.
  (Mr Narey) It does not cover the potential cost, it is a balance of the additional costs set against the risk.

  98. It is the costs done into present value taking into account the probabilities.
  (Mr Narey) That is correct.

  99. But it is actually therefore a cost of that risk.
  (Mr Narey) That is right.

5   Note: See Appendix 1, page 17 (PAC/293). Back

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