The Rt Hon Margaret Hodge MP, Chair of the Committee of Public Accounts, today said:
"The Department for Transport took the right decision in terminating the contract.
However, the Department did not undertake sufficient due diligence on the bid by National Express for the East Coast franchise. Crucially, the Department did not test any of the bids against the impact of an economic downturn.
National Express failed to meet its profit forecasts from the very start, and when the economic downturn hit the losses spiralled.
National Express paid just £120 million – less than they had offered - to walk away from a contract worth £1.4 billion to the taxpayer. The Department turned down the offer of an extra £30 million for a 'no fault' exit in order to send a warning to other holding companies.
But the Department completely undermined its position by making clear that the termination would not be held against National Express in future bids. In doing so, the Department allowed National Express to get away scot free and with its reputation intact.
By its actions in this case, the Department has potentially incentivised other holding companies with loss-making franchises to terminate, rather than renegotiate, their contracts. In future the Department must make clear to such companies that failure to deliver on their obligations will have serious lasting consequences.
The East Coast Mainline's unfortunate recent history may have resulted in under-investment. Under public ownership, investments are being made in new technology and fleet maintenance, and punctuality on the line is starting to improve. This is not only good news for passengers, but should help secure a good deal when the line is returned to the private sector.
The franchise has also recorded better profits than expected. Taxpayers will expect this to continue.”
Margaret Hodge was speaking as the committee published its 21st report of this session which, on the basis of evidence from the Department for Transport and directly operated railways, examined the decision to terminate the contract for National Express to run services on the East Coast Mainline.
Since the mid 1990s, passenger rail services have been delivered through a system of franchises. Each franchise is a competitively procured contract, typically lasting seven to ten years, between the Department for Transport and a private train operating company. Companies bid for franchises on the basis of the amount of subsidy they require, or the premium they would be prepared to pay, to run services on a defined part of the rail network. Bids include each company's forecast of what revenue they can expect, based on assumptions about the number and type of passenger journeys and the prices they can charge.
The InterCity East Coast Mainline is a hugely significant rail service, carrying around 19 million passengers a year between London, the North East and Scotland. The franchise has had a troubled history. In 2005, a contract was awarded to Great North Eastern Railway, but financial difficulties at its holding company meant that the franchise failed 18 months later.
In 2007, a new contract was awarded to National Express to run the franchise on the basis that it would pay the Department £1.4 billion over seven and a half years. At the time, the East Coast franchise was one of three operated by National Express, which also ran passenger services in the South East and East Anglia. As a result of the economic downturn, expected passenger revenues did not materialise and National Express announced in July 2009 that it wanted to opt out of the contract and would not provide the necessary financial support to the East Coast franchise.
Following negotiations with National Express, the Department terminated the contract in November 2009 and transferred services to a new publicly owned company, Directly Operated Railways, until the franchise could be re-tendered. Although other franchises suffered financial difficulties during the economic downturn, East Coast was the only franchise that failed.
In negotiations, the Department turned down an offer worth £150 million from National Express to exit the franchise by mutual consent. Instead the Department chose to terminate the contract, and received £120 million from National Express.
The Department judged that foregoing the extra cash would reduce the risk of other train operating companies with loss-making franchises seeking similar deals, but the taxpayer did forfeit £30 million. The Department allowed National Express to keep their two other franchises, and in December 2010 told National Express that the termination would not be held against the company if it bid for future franchises.
Since the East Coast termination, other franchises have been in financial difficulty and their holding companies have not sought to hand them back. We are, however, concerned that the Department created a moral hazard by allowing National Express to pay a lesser financial penalty through terminating a contract than they would have done by paying £150 million to exit consensually, and by choosing to not hold the termination against National Express in future bids.
The Department have potentially incentivised other holding companies with loss-making franchises to terminate, rather than renegotiate, their contract with the Department, as they know doing so will cost them less and will not affect their ability to compete for other contracts.