Background to the life jacket repair and maintenance arrangements

Defence Force personnel involvement with a commercial entity - Miltech

Since 2011, the Air Force had been carrying out scheduled servicing of life jackets, not only for the Air Force but also for the Army and Navy. This arrangement was to create efficiencies. NZDF believed it made savings by having life jackets serviced by Air Force personnel instead of by external servicing agents.

Between 2011 and 2013, an increasing demand for lifejacket servicing, an increase in operational tasks by Air Force personnel, and a reduction in Air Force Safety and Surface personnel qualified to service lifejackets led the Air Force to conclude that the arrangement was not sustainable. By June 2013, it had become apparent that the Air Force would not have the capacity to service life jackets for the Army or Navy; NZDF saw the demand for life jacket servicing increasing in the near future, and there was a backlog of Navy life jackets requiring servicing.

Defence Logistics Command was notified in June 2013 that the Air Force would not continue servicing Army and Navy life jackets. Logistics Command was briefed on options for the short term (up to 12 months) and the long term (beginning mid-2014). The proposed short-term solution was:

  • Navy outsource the servicing to an external provider;
  • Army had already engaged an external provider; and
  • Air Force continue to service its own life jackets.

Logistics Command was also alerted to the need for a long-term solution, involving a life jacket procurement contract with maintenance and support services included.

NZDF commissioned an independent study in November 2013. The report of the study confirmed that the supply of Air Force personnel to service Army and Navy life jackets was insufficient to match the demand, and this was overloading the Safety and Surface bays. Air Force’s lack of capacity had already led Army to outsource all of its life jacket servicing to an external provider. The report provided NZDF with options and recommended outsourcing life jacket servicing to a single provider, combined with the Air Force retaining its capability due to unique airworthiness requirements.

In December 2013, Logistics Command (Air) recommended adopting the independent study’s preferred option and that the Air Force stop servicing Army and Navy life jackets.

Before pursuing a long-term solution for the supply and servicing of life jackets, NZDF wished to complete its PFD1 Rationalisation Project, which sought to rationalise the types of life jackets. It was expected that the outcome of the independent study would affect decisions about the long-term solution. By this time, it was envisaged that new life jackets (under a long-term contract) would be purchased in about October 2014.

NZDF needed to outsource the servicing of Navy life jackets in the meantime. The two main brands requiring servicing were the RFD and the SOS Marine life jackets.

In our view, an interim solution for Navy life jacket repair and maintenance was genuinely needed and, for operational reasons, the need was urgent. From February 2014, Navy outsourced the servicing of SOS Marine Navy life jackets to Miltech as part of a short-term, interim arrangement while it prepared to go to tender for the long-term supply and maintenance of life jackets.

Our findings on secondary employment

Miltech proposal to repair and maintain life jackets

What happened?

An Air Force Flight Sergeant based at Whenuapai (Person A) ran a hobby business on his private premises through his company, Miltech, for which he was shareholder and director. Miltech was incorporated on 31 October 2011, and the hobby business included painting and refinishing work as well as repairing life jackets for civilian businesses.2 We saw no evidence that any formal request was made or approved at that time for engaging in secondary employment.
Person A had experience in life jacket servicing work as part of his job in the Air Force. Through his Air Force work in the Safety and Surface trade, he had developed expertise in maintaining safety equipment, such as life jackets, and was aware of the Air Force’s capacity issue with continuing life jacket maintenance and repair.

Person A told us he approached his commanding officers in early 2013, with a proposal for meeting the Navy life jacket servicing demand. He suggested that he and others with the relevant expertise could service the Navy’s life jackets outside work hours, on his own premises, through his private company. He told us that his commanding officers were supportive of the suggestion although, at that time, NZDF was not considering outsourcing lifejacket servicing. Emails confirm Air Force command’s willingness to put forward the Miltech proposal to NZDF’s Logistics Command.

On 3 June 2013, Person A emailed the final version of the proposal document to Air Force command. The proposal was in the name of Miltech Survival Equipment (incorporated on 7 May 2013) and named Person A as its Director. The proposal document said that all Miltech technical employees had a background as senior Safety and Surface tradesmen. The proposal document did not explicitly disclose that Person A was a current serving member of the Air Force, although this fact was known by members of Air Force command. Person A emailed the final proposal document from his NZDF email account to one of his commanding officers; the commanding officer acknowledged the email and advised Person A that he had forwarded it to the office of the Commander Logistics. The proposal was noted by the Logistics Leadership Board. NZDF told us that it was forwarded to NZDF’s defence commercial services for potential future use.

In mid-May 2013, NZDF received another unsolicited proposal, from a company that had previously serviced SOS Marine Navy life jackets for NZDF. This company was also aware of the Navy life jacket situation and offered its repair and maintenance services to NZDF.

Both proposals were attached to a June 2013 briefing note to the Commander of Logistics about life jacket maintenance and support options.

During the independent study carried out toward the end of 2013, Person A (among others) was given life jacket data from NZDF’s system and asked to comment on it. Person A is listed in the report as one of 32 people the independent consultants spoke with when preparing the report. Person A told us he did not take part in the decision making on the options presented in the resulting report. Although the report of the independent study noted Miltech as a potential life jacket servicing provider, at no time had Person A been asked to declare his private interests in any formal, written manner.

Expectations

We expect public sector agencies to have formal policies and processes to deal with employees who wish to take up secondary employment. The Air Force’s Defence Force Order section on personnel covers conditions of service and employment. It envisages that members of the Air Force might accept temporary employment when on leave or engage in secondary employment outside duty hours, be self-employed, or be a director or shareholder of a limited company. This Order requires members to submit an application for approval through the command chain and to understand that:

  • their private business or part-time employment is in no way to interfere with their Service duties,
  • they are to take no part in any activities connected with any enterprise or business which may give rise to the least suspicion, however ill-founded, that they can use their position as a member of the Armed Forces to further their private interests,
  • they are to take no part in any transaction between the [private] business and NZDF, the New Zealand or any foreign government, or any semi-public organisation … brought into being by the New Zealand Government.

Approving officers can approve secondary employment applications only if they ascertain certain matters, including that:

  • The activity does not involve the use of Service Time, or affect the individual’s efficiency as a member of the Armed Forces.
  • The activity will not bring the NZDF into disrepute.
  • The time spent engaged in the activity does not exceed 15 hours per week.

As well as adhering to formal rules and policies, we expect public entities to:

  • identify where the employee’s private interests overlap with their duties or interests in their official capacity;
  • identify whether this could give rise to an actual or perceived conflict of interest; and
  • manage that situation appropriately.

As well as identifying and managing conflicts of interest, we expect public entities to be mindful of other risks and considerations, for example, the actual or perceived ability of an employee to further their private interests through having access to “inside information” or to influence decisions in their favour (as distinct from having the power to make such decisions).

Findings

We found no evidence that Person A offered, or was asked, to submit a formal declaration of secondary employment in 2011 when Miltech was incorporated or when the formal proposal document was passed through Air Force command in 2013. Person A told us that members of his command were aware of his involvement with Miltech, from its beginning as a hobby enterprise through to when he was directed to relinquish his interest in it. As we note above, emails confirm Air Force command’s willingness to put forward the Miltech proposal to NZDF’s Logistics Command and it was attached to a June 2013 briefing note to the Commander of Logistics.

The investigation into the arrangements with Miltech carried out by NZDF’s Director of Risk and Assurance found that Air Force command had not requested or received a formal declaration of secondary employment from Person A until 28 May 2014. It concluded that Person A’s interest had been “disclosed in general terms” – that he had “disclosed his interest in Miltech” in the unsolicited proposal of May 2013 but that it was not “formally declared in the prescribed format”. As such, NZDF considered that Person A’s business interest in Miltech had been “indirectly declared” by submitting the proposal.

Air Force command was aware of Person A’s business interest, but the receipt of the Miltech proposal did not prompt any of the commanding officers to request a formal declaration from Person A. Air Force command’s approval was therefore informal.

When Person A (and two other serving Air Force members with companies related to Miltech) did formally request permission to undertake secondary employment on 28 May 2014, the requests were initially approved by Air Force command, on 9 June 2014. Air Force command initially concluded that there was no conflict of interest in terms of the Defence Force Order that covered secondary employment because Person A’s activities in Miltech would not affect his responsibilities and performance of his work duties. Person A also considered there was no conflict of interest because he had no decision-making authority on NZDF contracting with Miltech and no ability to commit Navy finances to a business arrangement with Miltech.

Air Force command subsequently reconsidered and then declined Person A’s request to undertake secondary employment (on 16 June 2014). This was because the arrangement between Miltech and the Navy did not comply with the Defence Force Order that prohibits a serving person from involvement in a transaction between their secondary employment business and NZDF.

Our conclusions

The Defence Force Orders clearly envisaged that members of NZDF might wish to take up secondary employment or hold private business interests while still in service. However, that possibility did not extend to members taking part in transactions with NZDF in their private capacity. It is clear that NZDF initially failed to apply its own rules for permitting secondary employment by not:

  • requesting Person A to submit a formal application for approval of secondary employment but instead giving informal approval; or
  • applying the prohibition on taking part in a transaction between the private business and NZDF.

Air Force’s Defence Force Order on secondary employment was designed partly to prevent situations such as the business arrangement with Miltech, and its associated risks to NZDF, from happening. Had Person A’s commanding officers applied the existing rules and required a formal approval process, the interim arrangement with Miltech should not have arisen.

NZDF also needed to consider wider questions about the probity of considering the Miltech proposal. It is clear that Person A’s private business interests overlapped with his military role. Person A and NZDF’s interests were mutually beneficial, because Miltech could provide a service that NZDF needed. Air Force command considered there was no conflict of interest but failed to consider the risk that Person A might be perceived to have used his workplace knowledge or connections for his own advantage.

By virtue of his employment, Person A was aware of opportunities to create or advance his own private business interests. At least one other external provider was also aware of the life jacket situation and the potential business opportunity it presented. The situation risked creating an appearance that Person A might have been able to influence the chance of obtaining a private business benefit from contracting with NZDF. That is why arrangements such as this can create a problem and need to be managed formally and transparently. It is also why there are rules in the Defence Force Order that prohibit not only situations that create a conflict of interest but also situations that could give rise to the “least suspicion” of inappropriate conduct.

We acknowledge that, once NZDF investigated the business arrangement between NZDF and Miltech, it applied its Defence Force Order by declining permission for Person A (and others) to engage in secondary employment so long as they remained connected to Miltech and its associated companies.

Our findings on the procurement process

Procurement of Navy life jacket repair and maintenance services (interim arrangement)

What happened?

After advice from Air Force and Logistics Command that the Air Force would no longer be servicing Navy life jackets, the Naval Supply Depot began seeking external servicing agents in early 2014. It was planning to call for tenders for a longer-term contract for the supply of new life jackets, with maintenance conditions included. This meant that a short-term arrangement was needed in the interim. The interim arrangement was thought, at that time, to be needed for about six months, after which the long-term contract was expected to be in place. Navy estimated the cost for dealing with the life jacket maintenance backlog and short-term servicing (that is, the “interim arrangement”) at $80,500, which was below NZDF’s threshold for requiring a formal tender process (according to NZDF’s Defence Force Order 52).

By early 2014, the Naval Supply Depot was aware of the unsolicited proposals received in May 2013 from Miltech and one other servicing agent.

The Naval Supply Depot came to an arrangement with an external provider for servicing its RFD life jackets but still needed to find a servicing agent for the SOS Marine life jackets. It held discussions in early 2014 with the other servicing agent that had provided the unsolicited proposal in May 2013. On 5 February 2014, it emailed a third company to request an expression of interest.

On 11-12 February 2014, NZDF approved and processed Miltech as a new vendor in its system. By 12 February 2014, before the third company had replied, the Naval Supply Depot had awarded the SOS Marine life jacket interim servicing work to Miltech.

Neither we nor NZDF’s Director of Risk and Assurance were provided with any documentation relating to seeking an expression of interest from Miltech. We have seen no evidence that any information was sought from Miltech, or provided by Miltech after May 2013, to seek or support its specific interest in carrying out the work under the interim arrangement. We were told that the Naval Supply Depot’s Technical Manager Maritime contacted Person A to ask if he (operating as Miltech) was still able to perform the work. Communication was by telephone and email. There was no formal, written contract between NZDF and Miltech for the life jacket repair work. This account of events is supported by investigations later commissioned by NZDF, which found that the arrangements leading to awarding the work to Miltech were informal.

On 12 February 2014, the Naval Supply Depot’s Technical Manager Maritime advised SOS Marine (the Australian company that manufactures SOS Marine navy life jackets) that it had contracted Miltech to service its life jackets. The Technical Manager told SOS Marine he had previously visited the Miltech premises and was satisfied with their facilities and capabilities.3 The next day, SOS Marine formally confirmed its appointment of Miltech as its New Zealand service agent. SOS Marine told us that it approved Miltech based on the Navy’s recommendation and photographic evidence of the workshop facility. SOS Marine followed this approval up with a site visit a few months later. Also on 12 February 2014, Maritime New Zealand certified Miltech as a life jacket servicing agent, after its audit of Miltech on 27 January 2014.

Expectations

Our expectations are based on three sources of guidance.

NZDF’s Defence Force Order DFO 52 (DFO 52) outlines its procurement policy and procedures. Chapter 8, section 4, requires a formal tendering process for purchases of more than $100,000. For purchases between $5,000 and $100,000, the Order requires “Market Testing to be carried out appropriate to value and type of purchase”.

Importantly, the Order also states that, “Sensitive and/or complex purchases that in the view of the sponsor may generate external attention or may be subject to challenge may be referred to a Tenders Board for review or guidance”.

As well as NZDF’s requirements, the five principles for government procurement are:

  1. plan and manage for great results;
  2. be fair to all suppliers (including encouraging capable suppliers to respond and clearly explaining how proposals will be assessed);
  3. get the right supplier;
  4. get the best deal for everyone; and
  5. play by the rules (including being accountable, transparent, and reasonable; and staying impartial, identifying and managing conflicts of interest).4

Further, our guidance on procurement for public entities lists good practice principles that govern all public spending. These reinforce the Government’s procurement principles, and include accountability, openness, value for money, lawfulness, fairness, and integrity.5 Applying all of these principles should avoid what could be perceived as preference by “mate-ship”.

Findings

The Director of Risk and Assurance’s investigation concluded that the Naval Supply Depot correctly established the potential demand and estimated value of work at the time. The value of the work was initially anticipated to be less than $100,000, so a tender process was not required under DFO 52. Under that assumption, some lesser form of market testing, such as seeking expressions of interest from selected parties, was appropriate.

The Director of Risk and Assurance’s investigation also found that the Naval Supply Depot:

  • did not refer to the Maritime New Zealand approved list of life jacket repairers;
  • did not request a formal expression of interest in February 2014 from the servicing agent that sent in the unsolicited expression of interest to NZDF in May 2013;
  • gave one potential service agent only two working days to respond to a request for expression of interest; and
  • did not establish any evaluation criteria or document any analysis to determine which company should be awarded the work.

Naval Supply Depot personnel told the Director of Risk and Assurance’s investigation that Miltech “met all the criteria” for the work. NZDF initially told us that Miltech was “an established vendor used by NZDF previously”. However, up until 11 February 2014, Miltech:

  • was not on NZDF’s list of approved vendors;
  • was not on any preferred supplier listing or standing supply contract; and
  • was not an approved agent of, or certified by, SOS Marine to service SOS Marine life jackets.

The process to appoint a service agent under an interim arrangement to service the SOS Marine life jackets was hurried. This appears to be in response to an urgent demand from the Navy for life jackets that were necessary to sustain operations. It was complicated by the need to find a service agent acceptable to the original manufacturer of the life jacket (that is, SOS Marine). Market testing was minimal, and a decision was made before the market testing process had been finished.

It is difficult to argue that there was a proper market testing process.

In such circumstances, it is essential that the rationale for taking action is clearly stated and recorded. However, the process for awarding the work under the interim arrangement was informal and undocumented and, in our view, inadequate. The lack of formal documentation did not make the decision transparent enough and, therefore, did not provide the necessary evidence or reasoning to justify awarding the work to Miltech.

We are not questioning the quality of work carried out by Miltech. From information we have received as part of our inquiry, we also have no reason to question the Navy’s judgement that the services provided by Miltech offered the best value for NZDF under the circumstances in terms of timeliness and quality of workmanship. However, the way in which the procurement process was carried out failed to demonstrate the reason for the decision or the reasonableness of the price.

The process carried out by the Naval Supply Depot did not demonstrate that the principles of fairness and integrity had been satisfied. The Naval Supply Depot issued purchase orders for life jacket servicing to a company that was owned and directed by a serving member of the Air Force (Person A). This fact was known to the Technical Manager Maritime (who contacted Person A on his internal NZDF email address and had visited Miltech’s premises) and at least one other employee in the Naval Supply Depot. The awarding of work to a fellow serving officer, together with the hurried and minimal testing of the market, leaves NZDF open to claims of bias for a commercial contract. NZDF failed to identify and manage the risk, real or perceived, of concerns arising from this arrangement.

DFO 52 clearly foresees the risk posed by such an arrangement and advises consideration by a Tenders Board for review or guidance. Naval Supply Depot staff failed to identify the risk and follow the advice set out in the Order. Had they done so, the arrangement with Miltech might not have eventuated. The Naval Supply Depot’s Supply Chain Manager, who authorised the arrangement, stated that he was “under the impression at the time that Miltech was ex-Air Force employees”.

Our conclusion

In our view, the procurement process was inadequate and, given the involvement of NZDF personnel in the vendor company, inappropriate. NZDF’s own rules on secondary employment prohibit an employee from taking part in any transaction between their private company and NZDF.

Events since February 2014

The service and repair work carried out under the “interim arrangement” was extended beyond the initially envisaged period to ensure that Navy vessels would meet their life jacket servicing requirements. NZDF informed us that the last purchase order was issued to Miltech on 8 January 2015, and work continued to fill that order until April 2015. The total cost of servicing under the interim arrangement was $114,000. The extension was because of the delay in the long-term contract process, covered below.

The total amount paid to Miltech crossed the threshold requiring a formal tender process. However, there is no evidence that the Tenders Board endorsed the arrangements before or after the $100,000 threshold was exceeded.

In about April 2014, NZDF began its tender process for a separate, long-term contract for the supply of life jackets. This was a closed, competitive tender, which was managed by NZDF’s Tenders Board. A key requirement of the long-term contract is for “through-life support”, which includes repair and maintenance. The tender was issued on 1 May 2014 and closed on 2 June 2014.

On or about 30 May 2014, NZDF received a tender for the long-term supply of life jackets from SOS Marine. SOS Marine advised that “through-life support” for its life jackets would be provided by its New Zealand agent, Miltech, which was by that time its preferred service agent in New Zealand. At Person A’s request, SOS Marine stipulated in its tender submission that its service agent, Miltech, was owned by a current member of NZDF.

In June 2014, questions were raised in Parliament about NZDF’s contractual relationship with Miltech. NZDF inquired internally into the matter and, later that month, Person A relinquished his business interests in Miltech. His shareholding and directorship were taken over by Person B (a former member of the Air Force and former Flight Commander of Person A) to help ensure that the remaining orders could be fulfilled. Miltech continued to operate from Person A’s residential address because the Maritime NZ certification was tied to the existing premises.

At the same time as the change of ownership of Miltech shares, Miltech relinquished ownership of its three associated companies. Companies Office records show that the three companies, Miltech Survival Equipment Limited, Miltech Refinishing Limited, and Miltech Parachute Rigging Limited, ceased to be related to Miltech as of 19 June 2014 and changed their names to Phoenix Survival Equipment Limited, Phoenix Refinishing Limited, and Phoenix Parachute Rigging Limited on 30 June 2014. Person A, who remains in service with NZDF, kept his ownership and directorship interests in these companies.

We asked NZDF if it was able to provide assurance that there was no continuing association between serving personnel and Miltech and that there are no business arrangements between NZDF and the Phoenix group of companies. In response, NZDF initiated a further investigation. It confirmed that NZDF had no business relationships with the Phoenix group and that any continuing association between Person A and Miltech was restricted to the use of Person A’s workshop premises, mentioned above.

NZDF made its final selection in the tender process for the long-term contract in September 2014. The SOS Marine tender (naming Miltech as its service agent) was not successful.

1: Personal Flotation Device (lifejacket).

2: Several other Air Force servicemen were also using Person A’s workshop for their own hobby businesses, which they operated through companies associated with Miltech.

3: The Technical Manager Maritime had been certified to service SOS Marine life jackets in the past.

4: Ministry of Business, Innovation and Employment (April 2013), Government Rules of Sourcing, First Edition, page 6.

5: Controller and Auditor-General (2008), Procurement guidance for public entities, Wellington, pages 11-12.