If the pot of gold at a contract’s end is realised savings, why do so few contracts provide adequate cover for completion delays and overspend? It’s time for the public sector to get serious about damages.
In procurement we are no strangers to contracts overrunning or budgets being exceeded. As hard as procurement professionals try, sometimes it’s just not possible to get a contract placed in time, have works completed to schedule, or stay within the original budget.
In the public sector, the negative outcomes associated with these contracts are magnified. After all, they are usually delivering public services or infrastructure, and spending public money. The root cause for delays and overspend this can frequently be tracked to poor contract or relationship management, scope creep or unrealistic cost or project estimates at the outset.
While many of the issues can be attributed to internal process, with the public sector very much its own worst enemy, sometimes external suppliers and contractors are at fault. However, in many cases, the contracts that have been agreed and signed lack the clauses that would help protect procurement and the wider organisations against the costs associated with the delays.
As the challenge of delivering projects on time and in budget increases, we have to asked the question – why is public sector procurement so bad at using liquidated damage or penalty clauses in contracts?
High Profile Failures
Before taking a closer look at the clauses that could assist the public sector in their contracts, let’s have a look at some of the most high profile examples of projects that have suffered colossal overruns or budgetary overspends.
It won’t take you very long to find some examples in the media of these projects. What these 4 have in common is that even though some of the fault lay or lies with contractors, the public sector (and therefore the taxpayer) was and are the one to shoulder the burden of additional costs.
In 1997, a plan was put in place to build a new home for the recently re-established Scottish Executive (to become the Scottish Government). Initial estimates for the project were a total budget of £10-40m and an opening date of January 2004. By the time the building opened in October 2004, the total cost had risen to £414.1m (a figure confirmed in 2007).
Despite an enquiry stating that the wrong type of construction contracts had been used at the outset, and claims of contractors overcharging, no legal action was taken against contractors to recoup any costs.
- London Olympics and Paralympics
Although the Games frequently have Olympic-sized budgetary overruns, the London Olympics and Paralympics in 2012 took the gold medal for the most expensive summer games ever. When London won the right to host in 2005, the budget was estimated at £2.4 billion. By the time the games were completed, the total cost ran to over £8.7 billion.
The London Organising Committee of the Olympic Games (Locog), essentially a private company, were criticised for the contracts it put in place, particularly for security for the Games. However, in the end, the UK taxpayer ended up footing the bill for the new budget.
Another project that looked to re-introduce a service that had been lost to the City of Edinburgh, the trams were originally budgeted at £545 million and be completed by 2011. In the end, the network delivered was only a third of what was originally planned, cost £776 million and didn’t start operating until 2014.
Again the finger was pointed at the contracts being used and courts found against Transport Initiatives Edinburgh (TIE), the public company responsible for project delivery, on a number of dispute with the main contractor. However, there was never any money recovered from contractors, leaving the taxpayer out of pocket again.
The most recent and still incomplete example of the group. At the time of writing, the project is already 9 months delayed to start operating, received 3 bailouts in 2018 totalling over £2 billion, and is already £600 million over budget. Even these estimates may prove to be lower than the actual final cost, and currently there is no agreement on who will shoulder this burden.
It’s all very well saying that contracts were at fault for these delays and budget issues, but the specifics of this are rarely highlighted. For example, were clauses put in place in the contract to help return money to the Local Authority or Government where delays occurred? This brings us round to our focus – Liquidated Damages.
Your Contract Shield
Liquidated Damages – A fixed or determined sum agreed by the parties to a contract to be payable on breach by one of the parties.
Before we do anything else, let’s caveat that in the examples above, and in many other cases, the fault may lie with the contracting authority in part or wholly. In this case, Liquidated Damages would be as much use as a chocolate fireguard. But where it can be proven that the contractor is at fault, then we’re in business.
The important part of the definition above is that the damages are a fixed sum, agreed by both parties up front. Damages which aren’t agreed in advance and have no set value are classed as penalty clauses, and are unenforceable in most contracts.
The key is for work to be done up front on this between the contracting parties. This means that levels of damages are agreed and aren’t subject to challenge further down the line. The damages also have to be realistic in line with estimates of the costs of a breach of contract, including delays to completion or commissioning.
For example, if you have a construction project, you might look at the day rate being charged by the contractor and agreed that this will be the rate used for damages per day in the event of delays. For the most part, Liquidated Damages will likely be capped at a certain value (say 20 per cent of the total contract value), providing a level of fairness for both sides.
Setting Up Your Clauses
Clearly, given the intricacies of the laws surrounding contracts, this isn’t something that procurement should be approaching in isolation. If you do feel that your contract would benefit from a Liquidated Damages clause, then you should engage at the earliest opportunity with your Legal department.
Make sure the clauses are set up correctly and called out clearly in the contract. Once you have awarded your tender, you should take time to speak to the successful supplier. This will ensure that the clause is agreed to and everyone is aware of the full implications of it.
No-one wants to use these clauses in contracts – it suggests that something has gone wrong in the contract management, plus the damages aren’t going to cover the full extent of the costs too. But by having them in place to begin with, procurement can help to limit the possible damage to their organisation in the event that budgets or schedules go awry.
I’d love to hear your thoughts on this article and the series of articles on the challenges facing public sector procurement in 2019. Leave your comments below, or get in touch directly, I’m always happy to chat!