Managing under-performing contractors

By Steven Power and Holly McAdam.

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

As government transactions become increasingly complex, it is more important for government agencies to properly manage contractor performance. Traditionally, this has been done through reactive means:

• Damages - suing for damages requires agencies to institute legal proceedings against the contractor which they may be reluctant to do. In addition, identifying the type of loss which can be claimed and proving that loss can be a complex task;
• Equitable remedies - equitable remedies (such as specific performance of the contractor’s obligations) are not always available. For example, equitable remedies are not available where damages would be an appropriate remedy; and
• Termination - termination of the contract is often considered as an option of last resort. Termination may leave an agency without the capability it contracted for. This could be a significant issue where a replacement contractor cannot be readily identified or where the continued provision of the capability is fundamental to the ongoing operation of government. In addition, termination is often a right that is reluctantly exercised given the potential liability associated with a wrongful exercise of that right.

While these remain valuable remedies, in some circumstances they may not be practicable or may be contrary to the outcome you want to achieve.

Complementing these more traditional remedies with more proactive contract management tools and rights can help agencies 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.

• 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 agencies 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 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.
• 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 the agency 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, an agency (whether itself or through a third party) has the right to step into 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 agency to set off from payments to the contractor any debts owing from the contractor to it and losses otherwise claimable from the contractor by it. This can be an effective way for the agency to recover debts and other amounts from the contractor without having to commence legal proceedings against it.
• Security - This is another way for an agency 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 the agency can claim against where the contractor owes a debt to the agency or the agency 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 agency 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 your agency can help ensure you still have the services or capability if the contractor defaults or becomes insolvent. Under these agreements, you are generally entitled to require a novation of the relevant subcontract - this means that the agency 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 you in effectively managing contractor performance.

For further information, please contact Steven Power and Holly McAdam.