Sarah Guminski
Urban Institute
UI Associate

How early contract termination clauses help launch PFS projects

August 15, 2016 - 1:26pm

Last year, evaluators for the Adolescent Behavioral Learning Experience (ABLE) Program at Rikers Island—the first pay for success (PFS) project in the United States—determined that the program did not lead to reductions in recidivism for its participants.

Goldman Sachs, the senior lender, subsequently terminated the program early in accordance with the project’s contract. Because even evidence-based interventions may not always achieve desired outcomes, termination clauses can be an integral part of designing effective PFS projects and protecting a key feature of the model: that stakeholders will only pay for a program that works.

Including an early termination clause doesn’t mean the PFS financing model is flawed. Instead, termination clauses are simply a way to mitigate the risk that the project will miss its outcome targets, causing investors to lose their principal. In the event that a project’s early results indicate it has been unsuccessful, early termination allows investors to “cut their losses.” A PFS contract can outline terms for early exit, such as whether there is an associated fee and what evidence is needed to justify termination. 

Of the ten PFS contracts examined in Nonprofit Finance Fund’s Pay for Success: The First Generation report, seven have provisions for non-standard contract termination events. In most of these contracts, clauses detail termination or replacement of evaluators and service providers in the event that one of the parties does not fulfil their agreed upon responsibilities. But, a few contracts have more project-specific provisions.

For example, the contract for the Cuyahoga County Partnering for Family Success Project outlines termination procedures if sufficient housing resources are unavailable as the project progresses. This contract also allows for early termination if the Department of Child and Family Services does not make a sufficient number of eligible referrals from the target population to the service provider.

If the group of program participants is small, or there are not enough places to adequately house them, these provisions suggest that the probability of the program meeting its outcome targets is low. Instead of waiting until the end of the project, these termination clauses prevent further investment into a program that is likely to fall short of expected success.

Some PFS projects that utilize Medicaid reimbursements also have unique contract termination clauses. In the Denver Housing to Health Initiative, the project contract permits early exit if there is a change to Medicaid funding such that the service provider “cannot access the Medicaid resources assumed in the Project Budget.”

Because every PFS project will have different target outcomes and timelines for evaluations and outcome payments, there is no simple checklist of termination considerations. Therefore, including an early termination clause should be considered on a case-by-case basis. Additionally, political considerations could impact the government’s willingness to include a termination clause and, on the other side, funders may or may not demand such clauses depending on their risk preferences.

Early exit is part of what makes PFS work for both project partners and program clients. Exercising a termination clause is not inherently a failure for a PFS project; in fact, terminating a project that is missing its targets indicates a well-functioning plan that stops money from going to ineffective programs. It is, however, important to carefully construct these clauses because minor variations from projected intermediate measures are not a guarantee that the long term outcomes will not be met.

Since this is the broader goal of PFS and other outcomes-based financing mechanisms, it can be as important for policymakers to know what doesn’t work as it is to know what does. In the Rikers Island project, partners learned important information about a potentially promising program for a challenging population, and departed from the status quo in government contracting where programs often continue irrespective of whether or not they’re effective.

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