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West Coast Mainline Procurement Goes Off the Rails

On 29 October, the DfT published[i] the interim report of the independent inquiry into its handling of the franchise process (the “Laidlaw Inquiry”).  This identifies a lack of transparency in the bidding process, non-compliance with published guidance, inconsistencies in the treatment of bidders and technical flaws in the model used to calculate the amount of risk capital bidders were asked to provide to guard against the risk of default.


What was the background to this?
On 15 August, the Government announced that FirstGroup had been awarded preferred bidder status to run the West Coast rail line for up to 15 years[ii].  The route is one of Britain’s most important rail lines, linking London, Manchester and Glasgow.  FirstGroup had bid £5.5 billion and was due to take over the franchise from the incumbent operator, Virgin Trains, in December 2012. 
Virgin Trains expressed surprise at the announcement, alleging that FirstGroup’s figures were unrealistic, unsustainable and significantly underestimated the level of risk involved. On 28 August, Virgin Trains formally challenged the decision in the High Court, submitting an application for judicial review of the Government’s evaluation of the competing bids[iii]. 
It was only in gathering evidence to defend this action that the DfT uncovered significant flaws in how its officials had conducted the procurement[iv].  The decision was then swiftly taken not to contest Virgin Train’s judicial review and to shelve the award of the contract to FirstGroup.
The Secretary of State launched two separate inquiries:
  1. the Laidlaw Inquiry: to identify the lessons to be learned from DfT’s handling of the franchising process.  This is being led by Sam Laidlaw, the DfT’s Non-Executive Board Member and Centrica Chief Executive.  The final report is to be published by the end of November 2012; and
  2. the Brown review: Richard Brown, Chairman of Eurostar, is to lead a review of the Rail Franchising Programme and report back by the end of the year on (a) how to structure risk transfer between the Department for Transport and rail franchisees; (b) how to structure the bidding and evaluation processes to ensure a robust and fair competition, including the evaluation of risk and (c) the timing of the remainder of the franchising programme, so that it can be resumed as soon as possible. 
In what ways was the procurement process technically flawed?
The Laidlaw Inquiry’s preliminary findings identifying major flaws in the DfT’s process for determining the level of any additional financial support (in the form of a Subordinated Loan Facility (“SLF”) backed by a third party guarantee) that bidders would need in order to show they were robust enough to withstand business downturns.  In particular:
  1. DfT had been unable in the time available to develop an appropriate model to calculate a bidder’s SLF requirement. It decided not to share its internal risk modelling tool with bidders, realising that to do so would create a risk of challenge. 
  2. as a result, bidders were not provided with adequate information to predict reliably the likely size of any SLF requirement, making it difficult to determine the optimal capital structure of their bids.  The DfT was aware of this lack of transparency but decided nonetheless to continue with the process and accept the risk of a bidder challenge.
  3. The amount of SLF required by DfT in respect of the FirstGroup and Virgin Trains bids was not determined in compliance with the DfT’s own SLF Guidance.  It was influenced by extraneous factors and this led to inconsistent treatment of the two leading bids.  Moreover, the DfT’s internal model provided numbers in real terms, rather than in nominal terms, and so incorrect figures were used as the basis for the SLF assessment. 
How did this happen?
The Laidlaw Inquiry identifies a number of contributory factors, including:
  1. DfT’s approach to the evaluation of the financial robustness of bids was “developed late, in a hurry, and without proper planning and preparation”, due partly to the late development and clarification of new Government policy;
  2. resources at DfT were stretched: there had been major staff cuts and frequent changes of leadership within the DfT during franchise process, including the loss of senior, experienced civil servants at important stages of the process.  In making the substantial costs savings required of it[v], the DfT had also cut back on external consultants and financial advisers;
  3. a lack of effective governance and a lack of clarity around the functions of the various committees and boards, and no clear mechanisms for escalating concerns.
What are the implications of the decision to cancel this contract?
The entire West Coast Mainline bidding process needs to be rerun using a new set of assumptions.  This re-tendering could take up to 18 months.  The DfT is negotiating with Virgin Trains to continue to run the franchise for a further 9 – 13 months[vi] once its current contract expires on 9 December.  The plan is then to procure a two-year interim franchise agreement which would run until the new long term West Coast franchise commences. 
Meanwhile, the Secretary of State confirmed that he had also “paused” the on-going franchising programme, including live competitions on Essex Thameside, Great Western and Thameslink.  A further 15 franchises are reported to be in the pipeline and these are likely to be pushed back too.  However, earlier contracts do not need to be scrutinised. 
The episode is a significant embarrassment to the Government.  The West Coast franchise was the first to be tendered under the Government’s new policy for rail franchising.  Announced by the DfT in July 2010, it proposed longer franchises with less detailed specifications and greater incentives for operators, plus new options for managing franchise risk and reward.  Specifically, this involved replacing the existing “cap and collar” revenue risk sharing mechanism with a revenue risk sharing mechanism linked to macroeconomic factors.  Recommendations by the Brown review could undermine these reforms. 
In addition to the significant costs of rerunning the tender and securing continued services from Virgin Trains beyond the end of its current contract, the Government will also reimburse all bidders’ wasted costs as a result of the aborted procurement, estimated at £40 million.  FirstGroup could also sue the Government for damages, although that looks unlikely given its continued involvement in the procurement process.  Meanwhile, DfT has suspended three officials while the full facts are established. 
The debacle is a reminder for those running procurements of how essential it is to dedicate adequate time and resources to planning and managing large and often complex tender processes, in order to ensure that the decision stands and complies with all the requirements of EU and UK procurement law.  It also demonstrates the value of even just the threat of a legal challenge where a bidder is unfairly excluded, as well as the usefulness of the EU public procurement rules, without which Virgin may have been in a weaker position to bring its successful legal challenge. 
For more information contact Rachel Iley.
[i] http://assets.dft.gov.uk/publications/laidlaw-report/laidlaw-report.pdf
[ii] http://www.dft.gov.uk/news/press-releases/dft-press-20120815a/
[iii] http://mediaroom.virgintrains.co.uk/2012/08/virgin-trains-limited-commences-court.html
[iv] http://www.dft.gov.uk/news/press-releases/dft-press-20121003a/
[v] The 2010 budget required DfT to make direct savings of £683m, within the context of a 25% cut (£3.4bn) for transport spending overall. 
[vi] http://www.dft.gov.uk/news/press-releases/press-dft-20121015a