The silk purse
Julian Blake outlines why the operation of public sector contracts remains a minefield and suggests some solutions
KEY POINTS
- Contracts between the public and third sector are still problematic
- Distinguish a grant from a contract
- Contracts should be easy to understand – not shrouded in legal speak
- Identify what is important and what isn’t
Only 20 years ago, a new development for charities from my perspective as a charity lawyer, was ‘the coming of the contract culture’. This described a public policy shift at community level, away from local authority grant funding, towards commissioned contracts, in respect of the same public services. It was also part of a more general sense that charities should become less dependent on subsidy and more self-sustaining. This mood has since acquired momentum with the recent concept of social enterprise.
Back then, a public services contract, issued by a certain county council, came across my desk and, innocent in my assumption that real contracts would follow the fine principles learnt at law college, I was shocked to see such an incoherent, incomprehensible and worthless document.
Social enterprise is here to stay, but the contract culture has not arrived properly – another contract I received from the verysame council confirmed that nothing had changed their end in the intervening period.
Of course good public sector commissioning practice does exist – often where there are problems these can be caused as much by poor supplier practice as issues on the commissioning side. Nevertheless, it cannot be denied that the public sector commissioning environment is often seriously and unnecessarily problematic. At worst, as it was once resonantly put, it is an environment in which ‘the seller does not know how to sell and the buyer does not know how to buy’.
With the current funding constraints the situation is unlikely to change for the better. There are unfortunate signs of commissioners not only retrenching, but exploiting their local impunity within unequal relationships. A more enlightened, liberalised approach to public sector contracts could form part of a drive for true efficiency savings.
Reform initiatives
Many efforts have been made to improve things, including the campaign for ‘full cost recovery’, the government’s ‘Compact with the Community and Voluntary Sector’1 in its various manifestations and a model contract my firm drafted for the Department of Health Third Sector Commissioning Taskforce. 2 However, each of those initiatives illustrated the problems they sought to resolve: an agreed payment for a service, not merely costs being covered, is a proper contract price. The Compact articulates fair principles to counter the grossly distorting effect of the inequality of bargaining power between public sector commissioners and suppliers; and the model contract has not come into common usage.
What can we do? Well we can at least learn those, reasonably straightforward, law college principles thoroughly and then, much more importantly, learn to utilise them in the context of the real imperfect world.
What is the difference between a grant and contract?
We do still need to ask the basic question of "what is the difference between a grant and a contract?" In particular, because many public service funding documents, in supposedly moving to the contract culture, have retained grant principles (and the instincts of departmental direction) and created confused hybrid documents. In summary:
- A contract is a legally binding bargain; a payment in return for a service. A grant is a unilateral payment; a subsidy to assist in the provision of the service.
- Contracts create reciprocal rights – if the service is delivered the price must be paid and vice versa. A grant creates only expectations.
- A contract is given on terms and conditions defining proper performance of the service. A grant is given on conditions that it is applied as intended.
- A breach of contract gives rise to a right to be compensated for consequent loss. A breach of a grant condition triggers an obligation to repay the grant for not having been used as specified.
In practice a contract or grant agreement in respect of the same service can look similar and operate similarly. But most understand the big trap where a supplier believes it is receiving a grant and HMRC determines the basis of funding to be a contract in relation to a business supply and VAT is demanded, out of the received payment, which is then deemed to have been VAT inclusive. Grants do not bear VAT, as there is no supply of any kind to the funder. Contracts are subject to the VAT rules (although with the registration threshold and exempt and zero rates, that does not necessarily equate to VAT payments). The best answer is to be clear on the proper legal basis of the relationship and for the documentation to reflect that. Although it is an important second-best safety precaution always to agree payments to be ‘exclusive of any applicable VAT’, where there is any ambiguity concerning, or doubt about, the status of a grant payment.3
The main point, however, is that there is a logic to the distinctions between a contract and a grant relationship and the more that is recognised and applied, the clearer and more satisfactory the operating relationships will be.
The ‘service level agreement’ (SLA) is an obstacle to such clarity. It is widely treated as if it is a third form of legal relationship. It is not. It may be the description given to a contract, or, more inaccurately, a description given to a grant. It may be the description given to a specification within a contract, or again, more inaccurately, a set of conditions attached to a grant.
Where we should be
If the contract culture ever comes, it will be clear that the supplier charges a reasonable price for a defined service which the commissioner agrees and that the agreed price is paid on delivery of the agreed service, without any concern, or basis, to analyse how the money represented by the price was actually applied. ‘Eligible expenditure’ is a grant concept. It arises from money being given on condition that it is used in particular ways and the eligible uses being verified.
If the compact principles are ever applied, it will be clear that inequality of bargaining power needs to be corrected by fairness principles so that the commissioner will pay a fair price, including an element of reasonable surplus, to cover, for example, development costs and reserves, as any business supplier would charge. The current financial crisis has significantly undermined progress on this principle, so that again it is considered appropriate, for charities, in effect, to subsidise their services through under-charged contract prices being determined only by public sector budgets.Significant progress has been made, up to a point, on one of the other most important Compact principles: that service contracts should be agreed on a cycle of three years, rather than one year in line with the public sector budgetary cycle. The obvious point is that service providers need the security of a reasonable contract period to be able to commit to and invest in effective service delivery. Unfortunately, this Compact principle, once accepted, can itself become entrenched, so where the necessary contract period is actually longer than three years, there is still a problem. Again, with the financial crisis, although contract periods may still be for three years, there are other ways in which commissioners are able to assert their will, in a manner contrary to the intent and/or express provisions of the contract. This might mean exercising inappropriately reserved unilateral rights of variation, or simply requiring variation, or even termination, without the legal right, but with the practical power to do so.
Such scenarios are a long way from how a contract should work. It should be a formal expression of a clear agreed working relationship and put in those terms the true value of understanding contract principles becomes clearer. A genuinely mutual arrangement, genuinely understood by both parties and genuinely focused on the purpose of both – efficient and effective service delivery to the relevant beneficiary group – becomes desirable for both parties as a business case. The popular idea of contract negotiation as a legal battleground with each party seeking to win preferential terms, if a worthwhile way of proceeding in any circumstance, is not so in relation to charities delivering public services. Each party has the same public benefit purpose and the same interest in putting in place the arrangements that will best deliver to beneficiaries. The value in that common purpose is severely underestimated. More important than the legal protections and way more important than the reams of standard contractual provisions, are the practical arrangements: a clear, agreed service specification; a clear standard of service delivery; straightforward monitoring, liaison, review, renewal and variation arrangements and easily workable dispute resolution provisions. Representatives of the two parties sitting down and agreeing matters under these headings, without any reference to the law, would produce a much better contract than their lawyers sitting down with their standard structural documents as the starting point.
Form over substance
Lawyers are certainly partly to blame for the poor condition of public sector contracts, because the traditional closed shop has created and sustained the idea that a contract must be a formal document, in formalised language and the associated risk – averse approach means no one is prepared to query anything they do not understand. Every contract should be easy to read in its own terms without training in the lawyers’ code and most provisions could do with a some rationalising, restoring them to their original purpose. If a clause in a public service contract does not make sense to any interested reader on its first, or even its second reading, it needs rewriting.
But it is not just the lawyers – contract officers have similar characteristics and tendencies. These are based on keeping to the standard familiar bloated documents emanating from the legal department and keeping to standard policy which nobody has the authority to change. This is the depressing culture where form repeatedly takes priority over substance.
This can reach the level of absurdity where a small community charity is required to purchase a performance bond to give a public authority security against failed contractual performance.
Some practical approaches
While this lack of progress is acknowledged in many quarters, it has to be asked how can improvements be made within a system of tenacious imperfection
Reasonable care and skill
In principle, it is established that every contract service must be delivered with ‘reasonable care and skill’ and that this objective standard can be tested against prevailing standards, if necessary by the ultimate objective authority, the courts. This understanding is helpful in formulating and agreeing the more precise descriptions of contract standards, all of which are applications of this basic principle.
Reasonable endeavours
Another example is the much maligned phrase ‘reasonable endeavours’. This is helpful in distinguishing between an absolute obligation that must be fulfilled and an intended outcome that cannot be guaranteed, but which can be pursued with appropriate effort and resource. Again what endeavours are reasonable in a particular case may be judged objectively.
Requirements/targets
A similar point can unlock disagreements about required outcomes. The disagreement becomes a workable understanding if baseline obligations are set as absolute requirements. And if more desirable levels of performance are identified as targets, which are not merely an aspiration, but which the supplier will use ‘reasonable endeavours’ to achieve.
These are just three examples and there is clearly a mass of points that can be made about imprecise and confused drafting practice.
Prioritisation
Essential provisions
Better understanding of the principles of distinguishing between what is and is not important is crucial. It is extraordinary how much time is wasted discussing, or negotiating provisions which have a very low likelihood of ever having any application. Or, even if they were invoked, would have no substantive impact. You need to know the specification, the standard, the price (and when it will be paid) and preferably the practical relationship management provisions. It is also then appropriate to engage properly with the important legal clauses which do have a bearing on allocation of responsibility and potential liability. These are:
- warranties (formal contractual promises);
- indemnities (formal contractual promises to cover costs that would not otherwise fall to the party giving the indemnity); and
- limitation of liability, where a reasonable recognition of actual risk and actual capability for meeting risk are required, from both parties, to move any negotiation forward.
This leaves a lot of clauses which merit less attention. For example, a force majeure clause may be summarised in one sentence – the supplier will not be responsible for a breach of contract caused by circumstances beyond its reasonable control. In most cases this is simple principle that can be easily accepted.
Clear and reasoned argument
The basic understanding will also help with using scrupulously clear and reasoned argument as a tactic. Preferably this will make points understood, perhaps even inspiring recognition that improving amendments are in the interests of both parties, because it will result in a better working relationship and better contract delivery. Short of this, it provides an established record for assured defensive responses at a later date if unreasonable actions are proposed by the commissioner. If it has been pointed out in very clear terms that a provision is potentially onerous, even though it survived contractual negotiation, you are in a better position to resume the argument than if you are reacting to the clause for the first time when it is invoked.
There is also the formal legal point that the Unfair Contract Terms Act makes all exclusions and limitations of liability, and all non-negotiated standard terms, subject to a reasonableness test, before they will be held enforceable.
Reasonableness
There is also a point about meeting a commissioner on their own terms, bona fide, or otherwise. Commonly, where unreasonable provisions are highlighted, the response is that as a public authority the commissioner will necessarily act reasonably. An example might be a right to demand the removal of any employee engaged in relation to the service, which often appears in public sector contracts, completely unreasonably and without any rationalising qualification. Some reliance may be placed on intrinsic reasonableness ultimately being a necessary practical approach of the commissioner, giving reasoned persuasion and reasoned resistance in their places, albeit late in the day.
Practical engagement
These points are really about practical engagement with imperfect documentation where the working relationships more or less work, quite apart from the fact that they would work better if the contracting culture were different and the documentation was improved.
Claims
There is a whole other issue about resisting actual claims and considering the enforcement of rights, with the difficult considerations of cost, damage to vital ongoing relationships and potential disadvantage and harm to beneficiaries. In a way, although such issues are so difficult, the principles and the choices could be said to be relatively clear. The parties should ask: Is there a case and is there a basis, on balance, for pursuing it, or rather for pragmatic compromise?
There have been some startling instances of such assertion in recent years, for example in relation to the absence of equality impact assessments, which have had their impact on the form, if not the substance, of general commissioning practice, but the decision to step out with such a claim remains a challenging and courageous one.
Public procurement rules
There is also a whole other issue about the way in which public procurement rules and practice now overlay and compound the difficulties relating to public sector contracts and I will be covering this in the second part of this article to be published in Caritas, issue 46, September 2011.
1. www.cabinetoffice.gov.uk/news/ government-and-voluntary-sector-agree-new-compact
2. www.dh.gov.uk/en/Publicationsand statistics/Publications/PublicationsPolicyAndGuidance/DH_4137145
3. See also The Tax Implications of Charity Trading by Pesh Framjee in the publications section of www.cfdg.org.uk
Author: Julian Blake
Julian Blake is joint head of the specialist charity and social enterprise department at Bates, Wells and Braithwaite solicitors.
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