Commercial approaches in contracts

The NSW Procurement Board recommends the following standard commercial approaches to key contract terms, where an agency does not use the standard form contract templates.  These should be reflected in Government contracts, unless the circumstances of the procurement require otherwise.

Types and levels of insurance

Agencies are required to impose requirements for necessary insurances only and to carefully consider the type of insurance being sought in light of what goods or services are being procured. Professional indemnity insurance is only to be sought, where there are professional services being supplied.

The suggested default levels of insurance are $10m for public liability and, where it is included, $10m for product liability. 

Indemnities

An indemnity given by a supplier is to be capped, on the basis that uncapped liability by a supplier in favour of the State is not considered reasonable. The cap is to be determined in consideration of the goods or services involved. 

The default position is for there to be a multiple of the per annum contract value, for example, five times the value. This indemnity complements the insurance arrangements that are made so that there are a number of relevant tools for dealing with risk under the contract. The general rule is that government agencies should not give indemnities. Agencies should seek to limit their liability to one times (1x) the contract value.

Dispute resolution

Mediation is the preferred method of dispute resolution following attempts to resolve differences between the agency and the supplier in good faith. Expert determination should be avoided, especially where the goods or services are of low risk or low value nature.

Intellectual property

Existing ownership of intellectual property should be undisturbed by the contract so that whichever party owns existing intellectual property at the start of the contract will continue to own it. The default position is that intellectual property in new contract material is to be owned by the supplier and the agency is to be given a perpetual, transferable, royalty free licence to use it. This default position may be disturbed, where the nature of the goods or services warrant it.

Guarantees

The use of financial securities, bank guarantees or performance guarantees is to be limited to necessary circumstances. If goods or services are low risk and paid for in arrears, the use of guarantees should be clearly justified. Where there is a sole supplier appointed, a guarantee may be appropriate even for low risk goods to ensure continuity of supplier in the event of supplier breach.

Termination

Agencies may require the right to terminate for convenience. However, provision should be made for the supplier to be fairly compensated if this occurs. Agencies should agree with the basis of compensation in advance.

Proportionate liability

The proportionate liability provisions of NSW Civil Liability Act 2002 apply to situations, where a person suffers economic loss or property damage as a result of the acts or omissions of two or more wrongdoers. Under these provisions, liability for the loss is apportioned between defendants according to their respective responsibility for the loss. They replaced the common law rule of joint and several liability, under which the plaintiff could recover the whole of its loss from one defendant. 

However, except for personal injury matters, the Act permits contracting parties to make provision for their own rights, obligations and liabilities.  This enables, for example, parties to “contract out” of proportionate liability provisions, and instead agree that one party may recover all of its loss from the other party to the contract. 

Subject to government policy, NSW agencies are entitled to contract out of proportionate liability provisions, when undertaking procurement. However, agencies need to be mindful of not exercising their rights in this regard in an inflexible manner, without proper assessment of whether the circumstances justify contracting out. Contracting out can pose potential disadvantages to both suppliers and government. For example, as contracting out can expose suppliers to significant liability regardless of the size of their actual contribution to the loss, it potentially limits competition among suppliers because of increased insurance costs, thereby reducing the range of suppliers with whom the government may deal. Further, such costs may be passed on to government agencies through higher prices for services. 

The government current procurement reforms, which are aimed at promoting competition, achieving better value for money and delivering better services to the community, underscore the need for agencies to look carefully at whether contracting out is warranted in a procurement situation. Moving away from fixed, rigid methods of procurement to more flexible, commercial and innovative approaches that are tailored to the characteristics of the particular procurement (ie the nature of the goods being procured, risk, timing requirements etc) is integral to the achievement of the reforms. 

Therefore, without limiting agencies’ discretion in deciding whether to contract out of proportionate liability provisions, agencies: 

  • should not as a matter of routine insist on contracting out of proportionate liability
  • should consider various factors in determining whether contracting out of proportionate liability is warranted, including:
    • the size, cost, complexity and risk of the procurement
    • the extent to which the agency is able to manage risks associated with the procurement through means other than contracting out of proportionate liability, including assessing suppliers’ respective expertise, skills and financial resourcing
    • the extent to which contracting out of proportionate liability potentially reduces competition and value for money for a given procurement activity
    • the potential flow-on costs to the agency in contracting out
    • any other relevant circumstances.
  • should listen to any concerns raised by suppliers in relation to contracting out of proportionate liability, and consider them in any final determination on whether contracting out is warranted.

NSW Procurement Board Direction PBD 2017-03 Civil Liability Act 2002 – proportionate liability sets out factors that an agency should consider before excluding application of proportionate liability provisions in the Civil Liability Act 2002. The Board Direction also directs all agencies to submit a report to the Department of Finance, Services and Innovation when they enter into a construction contract that excludes or modifies the operation of the Civil Liability Act 2002. This report must include information on the nature and value of the contract, and the circumstances justifying the exclusion of the proportionate liability provisions.

Price refresh mechanisms

There are a number of mechanisms available for adjusting price. A careful examination of the individual circumstances of the product or service needs to be undertaken to determine whether or not a price adjustment mechanism is needed and, if so, what mechanism should be used. That examination should consider the following principles:

  • the risk of price adjustment should be carried by the party best able to manage it
    If a supplier is exposed to uncontrollable price adjustments (ie. commodity spot prices, regulated labour costs etc.) then the purchaser may be best positioned to manage price increases by, for example, controlling demand. Alternatively, if the supplier is highly vertically integrated and controls much of the supply chain, then it may be in the best position to bear the risk.
  • any price adjustment mechanism should only apply to that portion of the price influenced by the factors covered by that mechanism
    If the price mechanism chosen is a labour index, then only that portion of the total cost that is made up of labour should be subject to adjustment. Similarly, if movement in foreign exchange rates is chosen, then only those parts of the product or service that is produced overseas should be subject to adjustment. It may also be appropriate to use multiple mechanisms for complex products or services.
  • allow for price decreases
    Any mechanism should allow for the price to decrease as well as increase. Price decreases may not only be influenced by external factors, but also factors internal to the supplier such as efficiency gains through becoming more familiar with the purchaser’s business, systems or processes. 
  • select the most appropriate mechanism(s) for the product or service
    This involves understanding what are the major components of the product or service that are subject to price fluctuation, what factors affect the price, how those factors can be measured, and what is the most appropriate way to measure and accordingly adjust price.

The potential range of mechanisms that can be considered include:

  • price indices (such as a Primary Producers Index, or Labour Price Index)
  • foreign exchange rates (based on average movement over a period)
  • commodity prices
  • pre-agreed changes (increases or decreases)
  • benchmarking.

Consideration should also be given to price increase caps or minimum levels of increases before a price adjustment is triggered.