Managing under-performing contractors

As Government transactions become increasingly complex, it is more important for Government to properly manage contractor performance. Traditionally this has been done through reactive means: suing for damages for loss suffered, seeking equitable relief (such as specific performance of the contractor’s obligations) or termination for contractor default. While these remain valuable remedies, in some circumstances they may not be practicable or may be contrary to the outcome Government is seeking to achieve.

Complementing these more traditional remedies with more proactive contract management tools and rights can help Government to reduce and manage contractor non-performance, and can play a significant role in ensuring delivery on time, on budget and to the required capability.

In this article we'll look at some of these contract management tools and rights, many drawn from major private sector projects and some already well known to Government.

• Linking payment to performance - Structuring the payment regime so as to link payment to proper performance of the contractor's obligations can provide a natural incentive for the contractor to perform under the contract. For example, where the contractor agrees to provide an agreed capability, Government could ensure that a reasonable portion of the contract price is not paid to the contractor until practical completion or acceptance of that capability.
• Liquidated damages – Another incentive for the contractor to meet deadlines is an obligation to pay liquidated damages where the contractor fails to deliver on time. This avoids the need for Government to sue for the loss suffered as a result of the late delivery and to prove the actual loss suffered. The liquidated damages payable will, however, need to be a genuine pre-estimate of the loss suffered by Government.
• Performance-based contracting regime - This approach involves rewarding the contractor for proper performance under the contract and/or abating or deducting payments to reflect the loss suffered by Government where the contractor fails to perform. The contract will generally include key performance indicators or KPIs against which the performance of the contractor is assessed.
• Step-in rights - Step-in rights are commonly incorporated into contracts to ensure that where contractor performance becomes an issue, Government (whether itself or through a third party) has the right to step in to the shoes of the contractor and perform the contractor's obligations utilising the contractor's relevant assets and facilities. Step-in rights can be particularly important where the contractor provides services using unique assets or unique facilities which cannot readily be obtained elsewhere.
• Set-off - This allows the Government to set off from payments to the contractor any debts owing from the contractor to Government and losses otherwise claimable from the contractor by Government. This can be an effective way for the Government to recover debts and other amounts from the contractor without having to commence legal proceedings against it.
• Security - This is another way for the Government to recover debts and other amounts without going to court. It's normally used in conjunction with a right of set-off, and requires the contractor to provide security in the form of a performance bond or bank guarantee which Government can claim against where the contractor owes a debt to Government or Government suffers loss under the contract.
• Regular reporting and regular team meetings - If the contractor is obliged to provide regular reports and updates on its performance under the contract and hold regular project team meetings, it's easier to identify potential issues so that appropriate strategies can be put in place to manage the issues before they become significant. For example, requiring the contractor to provide regular updates to its delivery schedule will enable the Government to monitor project delivery. A requirement for the contractor to submit a corrective action plan and to implement the plan where it believes project delivery will be delayed will also help manage project delivery.
• Direct agreements with key subcontractors – Requiring the contractor and each key subcontractor to enter into a direct agreement with the Government can help ensure you still have the services or capability if the contractor defaults or becomes insolvent. Under these agreements, the Government is generally entitled to require a novation of the relevant subcontract - this means that the Government or its substituted contractor can take the place of the contractor in the subcontract where the contractor fails to comply with the terms of the subcontract or the contract.

Of course, it is important in every project to properly understand the risks involved to ensure that the contract incorporates appropriate contract management tools and rights.

In conjunction with the more traditional contractual remedies, the right contract management tools and rights will help Government in effectively managing contractor performance.

Holly McAdam and Steven Power, Senior Associates, practise in Clayton Utz’ Government Services Group