Part 4: Managing the contract

Achieving public sector outcomes with private sector partners.

According to the Australian National Audit Office:

Competent management of the contract is the public sector entity’s key means of control over its outputs and their contribution to outcomes.36

The public entity needs to be aware that its responsibilities for contract management do not end once the contract has been awarded. It will be very important for the public and private sector parties to establish and maintain effective contract management throughout the term of a partnering arrangement, since inadequate contract management by either or both parties can have adverse consequences:

  • for the public sector party – from additional costs affecting the financial viability of the project and, thus, the value-for-money outcome; and
  • for the private sector party – from less than optimal performance and profitability.

Inadequate contract management could also result in risks being inadvertently transferred back to the public sector party.

Managing the contract over its term requires a different set of responsibilities and processes, which should be considered and planned for from the beginning of the procurement exercise. The contract management roles and responsibilities of both parties should be fully specified in the contract documentation.37

How the public entity manages the contract will depend on the type of partnering arrangement being entered into. For example, in the case of a DBMO contract, the public entity will need to set up its own contract management arrangements independently of the private sector party. In the case of a project alliance or joint venture, many of the contract management activities will be shared between the parties, but it is important that the public entity ensures that it has ongoing oversight of the project, and that it meets its public accountability requirements.

The public entity will need to identify adequate resources to manage the contract. This includes experienced personnel who can manage relationships with the private sector party, service users, and other stakeholders; systems and processes; and an appropriate budget. It is good practice to designate a contract manager and staff for contract management early on in the procurement process, to ensure continuity. The contract manager may or may not be the project manager responsible for managing the procurement.

Different contract management activities will be required at each stage of the delivery of the contract, such as design and construction, service delivery (including preparing for, and settling in, service delivery), and contract expiry.38 Contract management staff will need to understand the business and have an in-depth knowledge of the project and contract documentation. Staff could also be required to have skills in design and construction, facilities and services management, and legal and financial matters, and have an understanding of statutory safety, regulatory, accounting, and accountability responsibilities.

Objectives of contract management

Contract management objectives that should be addressed in the contract documentation will include good governance and accountability, and sound management of performance, risks, assets, relationships, payments, and changes to the contract.

Contingency plans are also required for the possibility of failure of service delivery – for example, as a result of emergency events or through failure on the part of the private sector party. These should include clearly documented procedures for dealing with defaults and exercising step-in rights (see paragraphs 4.58-4.61).

Good governance and accountability

An appropriate governance structure for managing the contract once it has been awarded needs to be considered at an early stage of the decision-making process, and addressed in the business case (see paragraphs 3.11-3.14). This will probably be different from the governance structure used for identifying the project.

Roles and responsibilities of all public and private sector personnel involved in contract management (including responsibilities for decision-making) should be clearly defined, and individuals should be given appropriate authority to carry out their tasks effectively.

The long-term nature of many partnering arrangements means that it is inevitable that personnel managing the contract will change. Consequently, it is important that both public and private sector parties have arrangements for succession planning and the retention of knowledge. This is an important lesson highlighted in the case of Wellington City Council’s Clear Water project, where the Council has recognised that its internal succession arrangements need to be improved for the future (see Appendix 3).

Governance arrangements will also need to cover interaction with other public sector agencies that may have an interest in the contract.

The public and private sector parties are contractually accountable to each other for the performance of their respective obligations under the contract. The public sector party is also publicly accountable for choosing, designing, and implementing the partnering arrangement, including monitoring the private sector party’s performance and achieving the project’s desired outcomes. Achieving both forms of accountability requires careful and precise contractual stipulation of the rights of each party to information, including reporting requirements, as well as the limits of commercial confidentiality.

In finalising the contract, the public sector party should have specific regard for the requirements for access to information – such as are contained in the Official Information Act 1982 and Local Government Official Information and Meetings Act 1987 – and audit and other public accountability requirements – such as those in the Public Audit Act 2001.

Managing risks

Risk allocation should have been negotiated and specified in the contract documentation. Risks are likely to change as the project progresses, and it will be essential for the public sector party to ensure that risks are regularly monitored and reviewed, not least because it may find that it inadvertently becomes responsible for risks previously not allocated to it.

However, the range of risks that must be considered for contract management purposes is broader than the range of risks considered by the procurement team for contractual risk allocation purposes. The Contract Management Guide prepared by Partnerships Victoria refers to some important contract risks:

  • Project risks contractually allocated to the public sector party, including risks expressly allocated in the contract, contractual obligations implied by law, and consequences arising from statute or common law.
  • Risks arising from issues not resolved at contract execution. These risks may not have been identified, or may have been identified but not resolved.
  • The risk of the private sector party failing to adequately control and mitigate risks it has been allocated.
  • Risks arising from poor contract management by the public sector party. Mismanagement of the contract by the public sector party might not have an effect on the delivery of services, but might compromise the value-for-money outcomes of the project, damage the reputation of the public sector party or government, or affect the public entity’s ability to be fully accountable to the public.
  • The risk that poor performance or financial failure on the part of the private sector party will affect the ability of the public sector party to deliver core or essential public services, especially if the public sector party cannot delegate a duty of care or other statutory obligation to people receiving these services.
  • Risks associated with proposed changes to the contractual arrangements.

As far as possible, the contract documentation should address how these risks will be managed, such as through default remedies available to the public sector party. The parties should also include these risks in risk registers to be monitored and reviewed throughout the life of the contract.

An issue often raised with partnering arrangements involving private financing is that private sector parties might make additional gains from refinancing after the contract has been entered into. Examples have occurred in the United Kingdom of considerable adverse publicity arising from what have appeared to be huge “windfall gains” for private sector parties resulting from their benefiting from lower borrowing cost premiums through refinancing. It is now a requirement in the United Kingdom that PFI contracts should provide for sharing refinancing gains.

Managing performance and contract review

Performance measures that are meaningful, and arrangements for reporting on them, should be considered at an early stage in the procurement process, and written into the draft and executed contracts. The Contract Management Guide by Partnerships Victoria recommends that performance monitoring and reporting arrangements should be based on the premise that the public sector party understands:

  • The business environment and objectives for entering into the contract in the first place. Performance measures should therefore be linked to strategic objectives and outcomes.
  • The private sector party’s internal operating environment. This should enable the public sector party to derive an awareness of the sustainability of the contract, as indicated by the private sector party’s strengths and weaknesses, including financial performance.

Performance monitoring will focus primarily on outputs, compared with traditional procurement approaches where there may also be a need to monitor inputs and processes. Inappropriate monitoring of inputs and processes (for example, availability of expert staff and technology employed) may result in risks being inadvertently transferred back to the public sector party.40

United Kingdom guidance is that management and monitoring procedures should be kept as simple as possible, since over-complex systems are likely to be costly to run and difficult to enforce:

The essence is only to monitor essentials (based on the potential significance of impact on the service and risk of occurrence of events) and to avoid being inundated with information which is not strictly relevant for the purpose of assessing service delivery.41

Performance measures and standards should be both quantitative and qualitative, using both hard and soft data. Hard data is quantifiable and measurable data that can be used to make comparisons against past performance or benchmarks. Soft data is not easily quantifiable, and will probably depend on the expertise of contract management staff. A good example of soft data is the quality of the private sector party’s management and operating personnel, which could provide an indication of future problems.

In the case of Deer Park Women’s Prison, Victoria, a failed build, own, operate contract, the Auditor-General found that performance measures were primarily quantitative in nature, and focused on short-term achievements. This meant they failed to address some key qualitative areas of prison operations, such as the adequacy of the rehabilitation programme.42

The contract documentation should specify arrangements for reporting performance, including the performance data to be provided by the private sector party and the reporting intervals. It is important that the private sector party has adequate performance monitoring systems in place to meet its obligations. The contract documentation should describe the arrangements for the public sector party to audit the private sector party’s performance reporting systems, so as to provide assurance that performance is being measured and reported accurately.

The public sector party will also require financial information to reassure itself of the continuing financial viability of the private sector party. In addition, the contract should provide for the public sector party to undertake audits of the private sector party’s quality management and management information systems to provide assurance that the contract continues to be sustainable. The public sector party will need to address how the requirements of the Official Information Act 1982 will be applied to the private sector party, including the type of access to be granted to both the public sector party’s internal and external auditors.

In the case of Wellington City Council’s Clear Water project (see Appendix 3), the Council considers that during the first few years it took a very arm’s-length approach to contract management. However, since 2002 the Council has been in regular operational liaison with the contractor, and more physical inspections have been undertaken. The contractor’s performance is benchmarked, and the Regional Council is involved because of its interest in compliance with resource consents. There is also a Community Liaison Group that meets regularly, which provides feedback on service delivery. The contractor has been instructed to commission independent reports as a means of providing assurance over the reliability of performance information.

The public sector party needs to keep in mind that it may have to increase its contract management and monitoring capability in circumstances of continued underperformance by the private sector party.

The contract documentation should also include specific arrangements for taking action in the event of substandard performance or failure by the private sector party, and the process by which the public sector party exercises any rights of intervention. These may include default provisions and step-in rights (see paragraphs 4.60-4.61).

An example of the consequences of failing to review performance information, even though it was available, is the contract to construct the Channel Tunnel Rail Link and operate the United Kingdom arm of the Eurostar train service. The contract had to be restructured after it became clear that overly optimistic forecasts for the operation of Eurostar UK had affected the ability of the private sector party to raise all the money from private investors it needed to build the Link. The National Audit Office in the United Kingdom found that the public sector party had not demanded all the information it was entitled to under the original contract, which had both hampered the ability of the public sector party to monitor progress and denied external financiers the opportunity to bring private sector financial disciplines to the project at an early stage.43

There are a number of examples of projects in other jurisdictions where serious failures on the part of the private sector party have resulted in the public sector party having to resume responsibility for the delivery of services at a significant cost. Examples already mentioned are the Deer Park Prison44 and the Latrobe Regional Hospital in Victoria.

There are also examples where projects have failed, but the public sector party has avoided having to bear the financial consequences of the failure. The Sydney Airport Rail Link is often given as an example of this. Patronage of the airport rail link was significantly below expectations. It is said that this was caused by a number of factors, such as inadequate marketing of the new rail link and inflexible ticketing arrangements. However, the risk associated with poor patronage and the resulting poor financial performance was borne entirely by the private sector. The private sector financiers stepped in to ensure that the service continued to operate. The public sector and wider community were largely unaffected, and services continued to be provided with no additional public funding being required.45

An area often neglected in contract management is contract review. Contract milestone reviews are important to determine how well the project is progressing.

Examples of contract performance that should be reviewed include:

  • the extent to which project outcomes and objectives are being achieved;
  • the continuing appropriateness of key performance indicators;
  • the effectiveness of contract management;
  • identifying any difference between each party’s expectations and project outcomes;
  • changes in the project that have happened through specific events or as a result of the project moving from one stage to another in its life cycle;
  • changes in the external environment in which the project operates;
  • changes to the risk profile;
  • community relations; and
  • budget performance.

Managing assets

Public entities need to ensure that assets they own or control are fit to deliver public services to a standard that meets their aims and objectives. In New Zealand, Schedule 10 of the Local Government Act 2002 sets out information about assets that must be included in a local authority’s Long-Term Council Community Plan, and specifies the level of asset management planning required. This includes showing how asset management plans support levels of service.46

The public sector party will need to seek assurance throughout the life of the contract that assets are being properly managed to agreed standards and, if relevant, that assets will be returned to it at the end of the contract in a reasonable condition. As part of the contract, the private sector party should be required to have an asset management plan that includes baseline information (such as a description of the number, type, and condition of assets, and asset life strategies) and a maintenance and renewals programme.

The asset management plan should address how forecast changes in demand and consumption of services will be managed, and specify how any requirements for increased asset capacity in the future will be met. The private sector party should be required to update the plan periodically, including reviewing the plan against changing levels of service.

The asset management plan should include key performance indicators – including targets for improving performance, and a risk management plan.

It is good practice for asset management plans to be independently reviewed by a third party.

Contract conditions should provide for the public sector party to have full access to the asset management plan, and to undertake regular monitoring of assets throughout the contract term, including receiving periodic reports from the private sector party. Contract conditions should also provide for full access to the necessary information to enable the public entity to properly account for the assets in accordance with generally accepted accounting practice (see paragraphs 3.58 to 3.60).

End-of-term arrangements for assets owned or controlled by the private sector party should be included in the contract documentation. Several different arrangements are possible, such as the assets transferring to the public sector party, the assets remaining with the private sector party, or the assets being available for the public sector party to acquire through an option arrangement.47 Each arrangement will probably give rise to commercial, accounting, and taxation issues.

Managing relationships

The long-term nature of many partnering contracts means that it is important for the public and private sector parties to maintain a strong relationship of mutual benefit.

It is also likely that a significant cultural shift from a traditional arm’s-length, and possibly adversarial, approach to contracting to one of integration, collaboration, and high-performance teamwork will be needed by all parties. Working collaboratively means understanding each other’s aims and objectives and how they will be met.

The procurement stage:

…should be the time to lay the foundations for the future relationship with the winning bidder. This should lead to the development of proper partnership relations during the development and delivery stages to enhance prospects for the successful provision of the services over the life of the contract. Good relations between the [public and private sector parties] should foster a climate which encourages both [parties] to suggest or make improvements in the quality of services delivered.48

A relationship where both parties are “open, share information fully and work together to solve problems” will also be important to avoid the possibility of early termination of the contract for poor performance.49

Partnerships Victoria’s June 2003 Contract Management Guide identifies the following factors that need to be considered in setting up management structures for the relationship. It is important that these relationships are described in the contract documentation.

  • Senior management support – The relationship should be championed at senior levels in both organisations.
  • Peer-to-peer communication – Working relationships should be conducted between peers. If a timely decision cannot be made at one level, there should be escalation procedures so that it can be referred to a more senior level.
  • Separation of roles – Day-to-day contract management and service delivery should be separated from management of the overall strategic relationship and long-term strategic issues.
  • Appropriate and clear roles and responsibilities, with contract management staff having an appropriate level of authority to carry out their jobs effectively.

There should be agreed mechanisms for parties to notify each other about issues arising from the contract.

Disputes should be dealt with as early as possible and at the appropriate level, and dispute resolution procedures should encourage negotiation and/or mediation between the parties. Providing in the contract documentation for easy access to formal court or arbitration proceedings is unlikely to result in a timely resolution of disputes.

Managing payments

The contract needs to document the process where requests for payments are received, checked, and authorised, including processing times.

In a partnering contract involving long-term provision of services, payments are often not made until facilities have been commissioned and services have begun. The payment mechanism could contain elements that relate to:

  • availability of services;
  • performance of the services;
  • usage of the services; and
  • more widely defined benefits, such as improvements in safety or community access.50

The contract documentation should include conditions governing making payments.

In circumstances where payments are made for services, Partnerships Victoria guidance51 states that:

  • There should be a single charge for the service, not separate charges for elements relating to availability or performance. This reduces the incentive for the private party to cut back on less profitable services.
  • The single charge should only be paid to the extent that the service is available.
  • Payments should never contain a fixed element that the private sector party receives irrespective of performance.52
  • The payment mechanism should seek to make deductions for substandard performance that reflect the severity of failure.
  • The payment mechanism should enable the public sector party to have adequate flexibility to make changes in the nature or volume of services to be delivered over time.

Managing changes

It is very likely that changes will occur during the project. These may have been provided for in the contract, or not anticipated – for example, changes in the law, technical advances, or changes to the requirements of the public sector party. These might entail the need to obtain new resource consents or reviews of consent conditions. Changes are both a source of risk and a potential opportunity to extract additional benefits from the project.

Partnerships Victoria’s June 2003 Contract Management Guide recommends that the following change management processes be incorporated as part of contract management and described in the contract documentation:

  • Appropriate protocols are in place to manage change.
  • Appropriate staff have the authority to request and authorise changes.
  • Potential changes are assessed thoroughly by suitably experienced personnel, and based on consultation with relevant stakeholders.
  • Changes are appropriately prioritised and their implementation properly resourced.
  • The implementation of changes is controlled and tested.
  • Changes are appropriately documented.
  • Changes do not compromise value-for-money outcomes.
  • Changes do not result in the unintended acceptance of risk by the public sector party.

A procedure for agreeing variations should be included in the contract documentation. Variations in key performance standards or payment arrangements over time should be formalised in variations to the contract. Contract variations may lead to a price variation, and the project no longer being competitive. Partnerships Victoria’s June 2001 Practitioner’s Guide states that, as a general rule, only changes initiated by the public sector party should lead to a change in price.

In a project alliance, the risk-sharing basis of the alliance means that situations that would be treated as variations under a traditional contract are usually not considered to be variations under an alliance. However, it is usual for certain situations to be treated as “scope variations” – for example, if the public sector party changes the fundamental function or design requirements of the contract. Project alliance participants will need to be clear on what should or should not be treated as a scope variation before the target cost is finalised.53

A useful example of a process used to identify scope variations is described in the Grafton Gully case study (see Appendix 2).

Contingency planning

Contingency planning is vital, since it may not be possible to fully transfer responsibility for the risk of service delivery failure to the private sector party. It will be important for the parties to have fully assessed potential situations that might lead to an interruption to service delivery. These situations will include events occurring outside the control of both parties, such as ‘force majeure’.

The parties should ensure that they have business continuity and disaster recovery plans to apply to potential situations that have been identified.

The public sector party should also have a plan for any default by the private sector party, and the contract should include default and remedy provisions to make risk allocation enforceable.

Under partnering contracts where the private sector party has control of facilities and responsibility for delivering services, the public sector party usually has “step-in” rights under which it can elect to take over control of the facilities and assume all or some of the service delivery obligations of the private sector party. These rights require special planning, including how and when to step in,54 and the financial implications of doing so.

36: Public private partnerships – Are there gaps in public sector accountability? (3 February 2003), 7th Biennial Conference of the Australasian Council of Public Accounts Committees.

37: How to Manage the Delivery of Long-Term PFI Contracts, Technical Note No. 6, Private Finance Taskforce, HM Treasury.

38: Partnerships Victoria guidance material, Contract Management Guide, June 2003.

39: Standardisation of PFI Contracts (SoPC), Version 3, April 2004, HM Treasury.

40: Contract Management Guide (June 2003), Partnerships Victoria guidance material.

41: How to Manage the Delivery of Long-Term PFI Contracts, Technical Note No. 6, Private Finance Taskforce, HM Treasury.

42: The Auditor-General of Victoria’s comments are in English and Walker’s article, Australian Accounting Review, Vol. 14, No. 2, 2004.

43: Department of the Environment, Transport and the Regions: The Channel Tunnel Rail Link (2001), National Audit Office, United Kingdom.

44: ‘Risk Weighting and Accounting Choices in Public-Private Partnerships: Case Study of a Failed Prison Contract’ (2004), English and Walker, Australian Accounting Review, Vol. 14, No. 2.

45: ‘A Private-Sector Perspective’ (2004), Lilley and De Giorgio, Australian Accounting Review, Vol. 14, No. 2.

46: Guidance is contained in International Infrastructure Management Manual (2006), Institute of Public Works Engineering Australia. This manual has been written for local government, but provides information about good practice in asset management relevant to all public entities.

47: Practitioners’ Guide (June 2001), Partnerships Victoria guidance material.

48: How to Manage the Delivery of Long-Term PFI Contracts, Technical Note No. 6, Private Finance Taskforce, HM Treasury, United Kingdom.

49: Ibid.

50: Practitioners’ Guide (June 2001), Partnerships Victoria guidance material.

51: Ibid.

52: This principle is also followed in the United Kingdom. There may be some circumstances where a fixed payment for margin-related costs could be appropriate but, as far as possible, this should be avoided.

53: Introduction to Project Alliancing (April 2003), Jim Ross, Project Control International Pty Limited.

54: Contract Management Guide (June 2003), Partnerships Victoria guidance material.

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