Contract Management in long term or complex projects

8/11/2019 Contract Management in long term or complex projects

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ProcurementContract Management in long term or complex projects:Key commercial principles to help ensure value for money

Contract Management in long term or

complex projects:Key commercial principles to helpensure value for money

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Departments are encouraged to adhere to these commercial principles and adopt therecommended contractual provisions, where relevant, and subject to both the particularcircumstances of the procurement, and the respective risk allocation between the contractingparties.

Contract Management in long term or complex

projects: Key commercial principles to helpensure value for money

This guidance document provides practical support for those involved inmanaging contracts within a complex project environment. It addresses thekey commercial principles and associated contractual provisions,mechanisms and remedies aimed at helping to ensure value for money inlong term or complex services contracts.

Further detailed practical guidance is also available in OGCs Policy and Standards Framework.Please also refer to the NAO/OGC Contract Management Framework , and the ICT ModelAgreement for non PFI ICT enabled complex contracts. In many cases speciali st advice will alsobe required.

Although these commercial principles relate primarily to non PFI major contractual arrangementsfor services, there is significant alignment with the recommended commercial guidance for PFIprocurements which can be accessed on the HMT website .

How to use the guidance

The guidance is aimed at senior responsible owners, procurers, contract managers, and othersenior commercial staff. It aims to help ensure that their contracts (especially those which arecomplex, of longer duration, or where there is some level of uncertainty), contain provisions whichhelp to ensure value for money during the contract term, and that the provisions are implementedand exercised as appropriate.

The guidance needs to be considered at the following stages of the procurement process:- pre-procurement as part of developing a strategy for the preferred commercial

arrangements; during the development of the ITT or ITP, when contractual terms andconditions, and the commercial aspects of the contract are developed;

- competition - to inform dialogue with bidders (competitive dialogue process only) or tohelp refine the invitation to tender and contract documents

- delivery during the contract management phase, to consider how to optimise use of theprovisions available (e.g. addressing areas of poor performance or incentivising goodperformance) At this stage changes in circumstances also need to be managed, andanticipated benefits tracked.

(Further guidance and tools for a typical complex procurement journey are available on OGCsPolicy and Standards Framework .)

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Key Considerations

Developing the right commercial/VFM provisions and arrangements, aligned with the supplierscapability, is a key opportunity to drive successful delivery of the required outcomes. It alsohelps to maintain value for money throughout the contract term.

A number of general considerations should be taken into account. These are explored furtherin OGCs guide: A Formula for Success .

- Getting the requirement right: Defining the requirement in terms of outputs andoutcomes allows for innovative proposals, but also helps to keep the door open for thepossibility of change. In most cases, the requirements should not define how deliveryshould occur.

- Contract duration: Consideration of the length of the contract is important. A longercontract allows for the potential of a greater investment and more innovation, but may alsobe restrictive, and not suitable where there is high uncertainty or instability and potential forchange. Shorter contracts, or longer contracts with more frequent VFM break points, canoffer a better approach where there is low stability and technology is evolving rapidly; it canalso allow for regular testing of the market or benchmarking. For more guidance on contractduration, refer to OGCs Risk Allocation Model .

- Driving appropriate behaviours and taking a balanced approach: To ensure value formoney, there is a need to understand fully how suppliers intend to deliver the contract. Thiswill allow the commercial arrangements to be constructed in such a way as to drive

appropriate behaviour. The best contracts are flexible and balanced, and are consistentwith the need to foster and maintain good productive relationships. Once the contract hasstarted, the commercial arrangements need to protect the legitimate interests of the

Authority if things go wrong. However, of equal importance is the ability to update thecontract to ensure that rights are preserved throughout the delivery period and that thecontract holds true to the original value for money position.

- Proactive contract management: Complex contracts require proactive management,which involves continuous review of performance and contractual risks by both contractingparties. Where actions are taken by either or both parties that lead to cost reduction,consideration should be given to the Authority and Contractor sharing the benefit. Likewisewhere risks have been found to be underestimated, the risk reward position of the

supplier must be open to review.

- Incentivisation: In this area it is essential that a balanced approach is taken. It is alsoimportant to recognise that if incentivisation measures are employed inappropriately,disproportionately or too extensively, this may lead to dysfunctional behaviour, such as thesupplier neglecting routine delivery, to focus on a more incentivised area of work. Theoverall emphasis should be on successful delivery across the whole service.

- Finally, it is essential to ensure that the fundamental principle of obtaining value for money overall is adhered to when such provisions are being adopted and relied upon.

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Key principles and contractual provisions

1. Efficiency processes, gain share and controlling excess profit

It should be noted that mechanisms for sharing efficiency savings, or profits and / or variationmechanisms, or gain sharing in any charging regime should ideally be built into the contract fromthe start. This could be achieved for example, by including a clearly defined review processupfront, setting out the precise steps to be adopted in a range of different circumstances.

1.1 Efficiency Savings and gain/benefit sharing

Objective: The Contractor should be encouraged and incentivised to use its expertise to find andimplement efficiency improvements, where possible and appropriate. Sharing in the benefits/gainsachieved will provide an incentive, but this needs to be consistent with value for money obligations,

and Managing Public Money It is also necessary to impose some limits on the return theContractor is able to achieve from the contract.

A business requirement expressed in output or outcome terms (i.e. one which does not attempt todefine how delivery should occur) can often be a key precursor to achieving efficiency savings. Itis also worth considering for example, if the contract should provide for the Contractor and the

Authority to share in the return made over the contract term or on a periodic basis over an agreedthreshold. That share may take the form of a rebate of service charges or the provision of freeadditional services if required

Depending on the contracts duration, it should provide for an annual service review meeting toconsider amongst other issues - the extent to which any continuous improvement programmehas been successful in finding and implementing savings in the preceding year, investigating futureopportunities, and setting a target saving for the forthcoming year.

In such circumstances the Authority should be prepared to consider changing its own processesor procedures, in order to support the Contractor in providing better overall value (including anyinternal cost changes).

To embed this type of provision, it could be required that a failure by a Contractor 1 to achieve atarget saving would lead either to a cash refund equivalent to the gap, or to allow a market test. Inextreme circumstances, continued failure to achieve such targets could lead to early termination or

contract break at periods so defined. As a way of incentivising the Contractor, consideration should be given to gain sharing, or thesharing of savings/benefits, where this is appropriate, and consistent with value for money 2 ,between the Contractor and the Authority. In a proportion which will be agreed on a case-by-casebasis. A [50/50] share line, for example, might be acceptable.

In contracts where there is a high degree of sub contract provision it will be important to ensurethat such a sharing of benefit is flowed down the supply chain.

1 Care will need to be taken in cases where there are obligations placed upon the department upon which the supplier is reliant to deliver theagreed savings. 2 This means that costs of delivery for the services delivered by the contract are reducing at a rate broadly consistent or better than the market.

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The contract may also include provisions requiring a year-on-year reduction in charges (and/or,more rarely, where this can be shown to deliver business value, targeted increases in servicelevels) throughout the contract term.

1.3 Excess profits

Objective: To ensure that the Contractor does not make excess profits within efficiency or gainsharing initiatives

Care should be taken to prevent the Contractor from making excess profits and separateprovisions can be introduced wherever a gain-share arrangement is used.

To control the level of profit one of two methods could be used the first caps the level of profit ata predetermined level, possibly with a share-line for profits in excess of the cap. It is import ant thatsuch a cap is not set too low low. The second is to have a variable gain-share arrangement, where the share becomes morefavourable to the Authority as the efficiency savings increase.

2. Assessing Value for Money

2.1 Financial Model/Open Book Accounting

Objective: To ensure that it is possible to monitor the financial aspects of the project including theContractor's return.

In many cases, before contract award, the Contractor will submit a financial model of the projectshowing budgeted items of initial set-up, ongoing service delivery costs and assumed profitability.On the basis of the agreed financial model, the Contractor will be required to provide annualaccounts (often in the form of a certificate of costs) in relation to the services. These accounts willexpose the Contractor's actual cost of and return from the service provision over the life of thecontract. This will support gain sharing. The assumed return in the financial model will also formthe basis for estimation of proper cost to the Authority of change under the Change Control(Variations) Procedure.

To ensure that the principle of open accounts is adopted effectively, it is usually necessary toextend it to affiliates of the Contractor and/or other material or key sub-contractors in projectswhere there is substantial dependency on these entities to achieve service delivery. The links

between these accounts and those of the company accounts must be auditable.

2.2 Benchmarking

Objective: In a long term services contract where there is limited scope to compete the services,benchmarking can be a useful means of injecting some continuing competitive pressure.

Benchmarking is a process whereby service performance and/or the price of services providedunder the contract are compared to the market for such services.

it is important to include principles in the contract that permit fair "like for like" comparisons to bemade. It can also inform price adjustment mechanisms or parameters for future years. VFM

mechanisms such as benchmarking even when designed to add value can, in themselves add tocost which may flow back to the Authority, so care needs to be taken.

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Particular points to consider include:

- Who will carry out the benchmarking? (Independence is usually vital).

- Will the services be benchmarked as a whole or can individual service elements bebenchmarked separately?

- How widely scoped with the benchmarking be? (price, quality (i.e. service levels))

- Is there a a suitable open / readily available industry benchmark?

- What are the Benchmarkers terms of reference?

- How will the results be implemented?

- Who pays the fees of the Benchmarker?

- What happens in the event of a dispute?

Further detailed Benchmarking guidance

3 Performance Management and incentivisation

3.1 Managing Delays (with particular reference to the implementation stage of a project)

Objective: Because in many cases the allocation of responsibility for delay is difficult, progresswith the project must not be held up while the issue is debated and, in normal circumstances, theContractor must be obliged to "fix first and argue later".

In relation to delays to the project timetable, the Authority should ensure that:

- the Contractor's first obligation, regardless of fault, is to notify the Authority and fix the

cause of delay on an agreed basis; and the cost of the Contractor employing additionalresources where the delay is the responsibility of the Contractor does not have the effect oferoding the caps on the Contractor's liability (i.e. where the Contractor is not entitled to becompensated).

- if the delay is due to a breach of Authority obligations, the Contractor should be entitled tocompensation for its proven, additional costs of the delay plus an extension of time, subjectto the Contractor's duty to mitigate such costs and delay.

- the contract contains an obligation on the Contractor to notify the Authority at the time ofthe delay or when it becomes aware that a breach of the Authority's obligations is likely.

- if the delay is due to a Force Majeure Event the Contractor should be entitled to anextension of time but, normally, no compensation. In certain Force Majeure situationshowever, where a contractor agrees to continue with its obligations, it may be

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disproportionate to withhold payment. A Contractors ability to recover payment that isappropriate to the work done may be covered by the equitable principle of quantum meruitand so could not be avoided on a contractual basis.

- Consideration should be given to waiving time delay penalties where the result of such awaiver can improve the overall value for money delivered through the contract. E.g. wherethe costs of demonstrating fault exceed the value of the recovery or where it is better tofocus such effort on future deliverables, which might otherwise be at risk. In suchcircumstances it is important that the authority reserves its rights and makes the waiverexplicit.

3.2 Delay Payments (aka liquidated damages), (with particular reference to where thereis an implementation phase in the project)

Objective: To incentivise the Contractor to meet the project timetable and to compensate the Authority for any failure to do so.

If the Contractor misses a key Milestone Date, the Authority should be entitled to withholdMilestone Payments (until the milestone is achieved) and depending on the criticality of thecommencement date of the Service and the Milestone, may also charge Delay Payments.

The Authority may also charge Delay Payments for failure to achieve interim milestones (that donot attract payment) where the achievement of these is critical. Careful consideration should begiven to how this operates in practice particularly as in some circumstances it may be unfair, e.g. ifdelay in meeting an interim milestone (which is not linked to payment) is due to the Authority or

some other unforeseen / unforeseeable factor and in any event the Contractor is able to meet thefinal milestone for which payment is to be made

Any amount identified as a delay payment should be a genuine pre-estimate of the loss. Care mustbe taken that these payments do not amount to a penalty which would not be lawful.

For more guidance on Delay Payments/Liquidated Damages refer to the Policy and StandardsFramework .

3.3 Service Levels and Service Credits

Objectives: Service credit regimes enable the Authority to ensure that the Contractor will retainthe risk of meeting agreed service levels during the contract term.

Service credits are an abatement of the charges so that the Authority is not paying the full price for poor quality service.

Authorities should normally seek to incorporate service credit regimes in the event that contractorsfail to deliver in line with the contract. Whilst the default position should be that all service levelsmust always be achieved, there may be exceptional circumstances where an Authority decides notto apply its contractual right to service credits. These circumstances may include situations where

there has been a minor or isolated breach of contractual terms in an otherwise good performanceand it is decided that there is a longer term value for money case that outweighs the value ofapplying an isolated service credit. Authorities should think very carefully before deciding not to

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implement service credit clauses and should be satisfied that such a decision will result in longterm value for money . The risk of having a detrimental effect on a contractual relationship shouldnot in itself be a reason to not invoke a service credit.

The key principles relating to a typical service credit regime are:

- the Contractor is required to meet agreed service levels throughout the contract term;

- in the event of a failure to meet service levels, the first obligation of the Contractor is torestore the service, regardless of fault;

- service credits are payable at a higher rate for more serious or persistent failures to meetservice levels;

- the amount of service credits that apply should vary in accordance with the severity of theContractor's underperformance. Typically this is done through some form of pointsmechanism, however other methods can be employed. Service credits are often mostuseful for the less serious failures where it is unlikely that significant loss to the Authority'sorganisation will result. Accordingly service credits should normally be capped at a certain"threshold" level, allowing critical or chronic failures to be dealt with outside the servicecredits regime. Escalating remedies such as increased monitoring, warning notices,damages (liquidated or general) can then be considered for such failures. Alternativedispute resolution and ultimately termination will also be available in these cases. It is

important to consider how effective these other remedies (short of termination) will be;

- a default may be triggered when the number of Service Credits reach any cap and/or aspecified level over a period specified in the contract;

- there is no "right answer" to the question of what the Contractor's maximum exposure toservice credits should be. Because, compared to a PFI-regime the Contractor is much lessexposed to financing-related risk, there is greater scope for flexibility;

- it may be desirable to allow the Contractor the right to earn back service credits forsatisfactory future performance if appropriate reductions in risk premiums and servicecharges are offered;

- exceptionally, where there is a clear business benefit - for example a saving in the cost of Authority resources - over-performance of certain service levels may justify an additionalpayment but the Authority should consider whether this is justified. Such incentivisationcan divert the Contractor's attention from other aspects of the service, and any paymentmust be affordable within the constraints of departmental priorities. This approach may beappropriate for transaction-based services but is not recommended for availability ofinfrastructure, for example. Furthermore, care should be taken in this area to avoid scopecreep and also the risk that instructions to exceed service requirements during the contractterm are seen as a contract variation, which in itself may be problematic if not consistentwith what was permitted in the original scope of the procurement;

- where Contractors have the primary responsibility for monitoring their own serviceperformance the Authority should have mechanisms in place for auditing or reviewing thismonitoring, and should have remedies available should the Contractor not disclose failure.

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4. Environmental Sustainability

Objective : Authorities are required to seek to promote sustainable development objectives,consistent with value for money, through their procurement, which will be reflected in contractualterms and conditions depending on the particular circumstances of the procurement and specificrequirements

The most effective way to pursue environmental objectives through procurement is to considerthem at the earliest stage of the procurement process. When identifying the need for aprocurement Authorities can include consideration of environmental benefits in the business case.This means that environmental objectives relevant to the procurement can be built into thespecification.

Many energy efficient products incorporated into output based solutions may cost more initially buthave significantly lower running costs, making them cheaper over their lifetime than less efficientproducts. When the respective environmental costs are also taken into account, the value formoney case for the more energy efficient product becomes even stronger. In these circumstances,and provided that the product is otherwise fit for purpose e.g. it provides heat or light to thestandard required - the more energy efficient product would be preferable, it would normally havethe best whole life net cost-benefit.

The sustainability requirements will need to be specified as a key element of the performancemeasurements and quality attributes of the contract. If an objective of the project is to source 20%of energy from a renewable source then this will need to be included as a key performancemeasure in awarding the contract. Key milestones for delivery, and anticipated benefits shouldalso be included and monitored as part of the contract management process. For more informationon incorporating sustainability within procurement refer to the Policy and Standards Framework .

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Glossary of key terms

Authority: Contracting Authority

Contractor: Contractor providing the services

Change Control procedure: The procedure for changing the contract, as set out in the appropriateschedule of the contract

Delay payments: The amounts payable by the contractor to the authority in respect of adelay. Also can be defined as Liquidated Damages

Force Majeure event: Any cause affecting the performance by a party of its obligations arisingfrom acts events omissions happenings or non happenings beyond itsreasonable control, etc

Milestone: An event or task described in the contracts implementation plan, which ifapplicable must be completed by a relevant Milestone Date

Milestone payment: A payment identified in the charges and invoicing section of a contract

made following achievement of a Milestone

PFI: Private Finance Initiative

Service credits: The sums payable in respect of the failure by a contractor to meet one ormore service levels specified


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Contract Management in long term or complex projects