The UK case of Mid Essex Hospital Services NHS Trust v Medirestprovides some timely lessons for governments around Australia as they pursue partnering and outsourcing arrangements with the private sector, particularly in the hospital and health services space.

The case highlights how a failure by parties to an outsourcing arrangement to cooperate in good faith, together with a confrontational approach to strict contractual performance and an overly complex service level regime, can result in the breakdown of a productive commercial relationship.

Transitioning to “services enabler” – governments seeking value for money

Governments in Australia continue to examine ways to improve service delivery to their communities in challenging economic times.  The Queensland government in particular is moving to implement its April 2013 Better Services for Queensland plan, issued in response to the Independent Commission of Audit Final Report of February 2013.  This movement is also coming into sharp focus across other States and Territories along with the Federal Government making clear its intentions to explore contestability and increase competition and value for money in delivery of Government services to assist in returning the budget to surplus and improving the quality of services to Australians.

Catering services in Essex public hospitals – what went wrong?

In 2008, Mid Essex Hospital Services NHS Trust contracted Medirest to provide facilities management including catering and cleaning services for two of its public hospitals.  The contract was for seven years with an option for extension.  

If Medirest failed to meet the service levels specified in the contract, the Trust was entitled, by a complicated system of service failure points and service credit points, to reduce the fees payable to Medirest.  The Trust also had a right to terminate if Medirest exceeded a certain number of service failure points in a specified period.

The contract also required the parties co-operate with each other in good faith, limited to the efficient transmission of information and enabling the Trust to obtain the full benefit of the contract.

Services began in April 2008 and, despite some early teething problems, by early 2009 both parties agreed that the service level requirements were being satisfied.  Feedback indicated that patients were pleased with the food quality and hospital staff were happy with the cleaning standards.

However, the Trust had issued a formal warning notice under the contract at the end of 2008 for earlier performance failures (e.g. chocolate mousse was one day out of date, a fridge was set to the wrong temperature), requiring Medirest to prepare a services improvement plan.  Evidence showed that the Trust behaved in a confrontational manner and instructed its staff to review the plan and “pull it to bits”. 

The Trust sent its calculation of the number of service points accrued and services credits outstanding, and sought to deduct £587,207.67 from the amount payable to Medirest for the second half of 2008 (more than half the amount invoiced).  In contrast, Medirest calculated that £37,665 should be deducted.  Both parties ultimately served contract termination notices on each other.

High Court and Court of Appeal decisions – good faith and common sense

In the initial decision2, the High Court held that in the context of a long term contract of this kind, which could have significant ramifications for patient well-being, there was a general obligation to cooperate in good faith pursuant to the good faith clause in the contract, and this was consistent with commercial common sense.  This obligation included a duty on the part of both parties to work together to resolve any problems which cropped up as part of that long term relationship. 

The High Court found the Trust had breached its duty to cooperate with Medirest in good faith by being unreasonable in enforcing its remedy of penalising service failure points on Medirest by deductions to the amounts payable to Medirest.  As both parties were entitled to terminate the contract, neither could succeed in their claims for substantial post-termination losses.

The Trust successfully appealed the High Court’s decision, and the Court of Appeal3 held unanimously that the Trust was entitled to terminate the contract and claim for damages.  It also narrowed the High Court’s interpretation of the contract clause requiring good faith cooperation, and found there was no implied contractual obligation that the Trust would not act arbitrarily, irrationally or capriciously in assessing Medirest.

Some useful lessons in the Australia context

It is important to note that English courts have commonly been reluctant to recognise an implied contractual duty of good faith in commercial contracts – and for this reason English commercial contracts (such as the contract between Medirest and the Trust) often include an express duty of good faith on the contracting parties. 

In contrast, Australian courts have generally recognised an implied contractual duty of good faith in commercial contracts – an obligation of good faith and reasonableness in the performance of a contractual obligation or the exercise of a contractual power.  Of course, contracting parties can also contract out of the duty of good faith by an express provision.

In this context, the UK experience holds several lessons for governments in Australia considering similar outsourcing arrangements.

Have your outsourcing contract properly drafted

The terms of any outsourcing contract, including the all-important service level regime, should be specific and relevant to the category of services being provided.  Sounds simple doesn’t it?  However in this case, the fact that the contract between the Trust and Medirest had been “cobbled together” (as the Court put it) from a PFI project precedent contributed to the conflict between the parties.

Consider allowing for a “bedding down” period

Transitioning the provision of services from the customer to the service provider under a large scale outsourcing contract involves significant change to the operations of both parties and can take time.  Inevitably there will be services hiccups in the early days, particularly where an outsource arrangement involves the transfer of customer staff to the service provider.  

For this reason the service provider may seek an initial period during which service levels apply on the basis that no service credits are deductable from service fees or are capped. 

Contract interpretation – apply commercial common sense

If parties contest the interpretation of a contract, a court will prefer the interpretation that most closely aligns with commercial common sense.  In this case, the court rejected the Trust’s claim that each kitchen appliance was a separate “area” to be cleaned (so a single failure to clean a kitchen could lead to multiple service level breaches), because that was not consistent with business practice.  In another example, the Trust’s deductions (e.g. £84,540 for out-of-date chocolate mousse, £46,320 for a box of out-of-date ketchup sachets and £96,060 for three-day-old-bagels) were characterised by the court as “confrontational” and “patently absurd”.

Exercise discretion reasonably

When a contract gives a party discretion when making a decision, even absolute discretion, the party should exercise it reasonably.  In this case, the contract required Medirest to demonstrate to the Trust’s satisfaction that a performance failure had been remedied in order for service points deductions to stop. 

Even though a number of Medirest’s performance failures were remedied in the presence of Trust staff, the Trust insisted it couldn’t be satisfied a failure had been remedied unless it received a written communication to that effect from Medirest, and that because it hadn’t received such a communication it continued to calculate service points against Medirest. 

The High Court found the Trust acted unreasonably.  Under Australian law, with an implied duty of good faith in commercial contracts, there will likely be an obligation to exercise discretion given under a contract reasonably and honestly. 

Make sure a service level regime works and use it appropriately

The main objective of a contractual service level regime should be to drive appropriate behaviour and services performance on the part of the service provider, and to help the parties identify areas for improvement and achieve the desired outcomes of the contract. 

For this reason, service levels need to be clearly drafted and unambiguous, measureable, and also allow for appropriate action to address failures.  In this case, the service level regime allowed for multiple penalties for the same failure accruing daily.  This allowed the Trust to calculate such large services fee deductions – and the court queried the appropriateness of this.

If a termination right arises once service level failures reach a certain number or level, parties should take care to set the trigger at the appropriate point.  Too low will mean it is triggered inappropriately by trivial failures, but too high will mean serious and persistent non-performance will need to occur before a right of termination can be exercised.  In this case, the Trust had a right to terminate because the relevant threshold was reached, but the facts of the case suggest the threshold was too low.