The Defence Reform Act 2014 (the Act) received Royal Assent on 14 May 2014. Part 2 of the Act creates a new statutory framework for single-source contracts, to be called the Single Source Contract Regulations (the Regulations). A new non-departmental public body, the Single Source Regulations Office (the SSRO) has been established to provide oversight of that regulatory framework.
The Regulations are still in draft form as of September 2014. This summary is, therefore, an interpretation of the Regulations in their draft form.
The purpose of this bulletin is to raise awareness of the new proposed framework for single-source contracts and the impact that it will have on private sector contractors.
WHY WERE THE DEFENCE REFORM ACT 2014 AND ACCOMPANYING REGULATIONS INTRODUCED?
Since 1968 the UK Ministry of Defence (MOD) had used a non-legally binding system, known as the Yellow Book framework, to price single- source contracts. The Yellow Book framework had not kept pace with significant industrial and technological changes, and the system was regarded by some as giving disproportionate negotiating power to the contractor.
In his 2011 report Lord Currie recommended a fundamental reworking of the existing arrangements. Part 2 of the Act and the Regulations have been drafted in this context and with the shortcomings of the Yellow Book in mind.
THE NEW FRAMEWORK
The new framework has moved the Regulations onto a statutory basis.
This approach will have two principal characteristics:
- The Regulations will ensure that the industry receives what is considered by government as a fair return on single-source work, whilst ensuring that the taxpayer is protected; and
- The new governance regime, supported by the SSRO will help to ensure that the Regulations are applied and adhered to and kept up to date.
QUALIFYING DEFENCE CONTRACTS
The Regulations apply to qualifying defence contracts and qualifying defence sub-contracts.
A qualifying defence contract is a contract between the Secretary of State for Defence and a primary contractor:
- With a value of or above £5 million;
- Which is entered into after 1 October 2014; and
- Which is not the result of a competitive process.
The Regulations also apply to such contracts entered into before 1 October 2014 which are amended on or after 1 October 2014, where the Secretary of State for Defence and the primary contractor agree that these Regulations should apply in the circumstances.
A qualifying defence sub-contract is a contract between a primary contractor and another party:
- Which is necessary to enable the performance of a qualifying defence contract;
- With a value of or above £25 million; and
- Which is not the result of a competitive process.
THE SINGLE SOURCE REGULATIONS OFFICE
The SSRO is a new executive non-departmental government body created under the terms of the Act. The SSRO's broad role is to be an independent expert on MOD single-source procurement and the custodian of the single source procurement framework.
In July 2014, Jeremy Newman was appointed as the first head of the SSRO. As of September 2014, Mr Newman was overseeing the process of recruiting a Board and ensuring the effective establishment of the SSRO.
It is anticipated that the SSRO will employ a staff of approximately 25 at a cost of around £4 million per annum.
This cost will be shared equally between the MOD and the single-source suppliers.
The statutory objectives of the SSRO are to:
- Ensure that good value for money is obtained in government expenditure on single-source defence contracts; and
- Ensure that parties to qualifying defence contracts are paid a fair and reasonable price under those contracts.
WHAT ARE THE KEY FEATURES OF THE REGULATIONS?
Key Issue - Price Negotiation
The Regulations signal a transition from a voluntary code of conduct to a statutory basis for price negotiations. This may provide less flexibility for the MOD and contractors alike.
Qualifying contracts will be required to be priced in accordance with a pricing formula, pursuant to one of the four pricing methods (i.e. firm pricing method, the fixed pricing method, the cost plus pricing method or the target cost incentive fee pricing method). The Regulations also set out the prescribed method for calculating the contract profit rate. This calculation is made by subjecting a baseline profit rate set by the SSRO to adjustments agreed between the private sector contractor and the MOD. The baseline profit rate for the period commencing 1 April 2014, according to publicly available draft information, is 10.70%.
The SSRO will be tasked with conducting annual assessments and issuing guidance in relation to allowable costs and other key pricing considerations.
The new framework may give the MOD a greater ability to re-open the pricing provisions of contracts by referring them to the SSRO for determination.
Key Issue - Reporting Requirements
The new framework will impose more detailed and transparent reporting requirements on contractors and sub-contractors for the duration of the contract.
Within one month of entering into the contract, the contractor must provide a contract reporting plan. This will have the effect of producing a timetable of reporting commitments, which must then be followed strictly by the contractor.
The Regulations will require standard quarterly reports for all single-source contracts above £50 million in order to allow MOD senior and project management to be able to identify costs, performance, schedule risks and opportunities. The report must contain extensive information, including an annual profile of the estimated costs and details of and cost implications arising out of key risk or opportunity events that have occurred during the contract to date.
There will be some new safeguards introduced in order to give industry confidence. For example, unauthorised releases of the most sensitive information will be a criminal office.
Key Issue - Joint Planning on Key Facilities
The new framework will ensure that the MOD is appropriately involved in the long-term planning of facilities where the MOD makes a significant financial contribution. The Regulations will require contractors to submit annually a long-term plan for the key facilities where substantial overhead is (or is planned to be) recovered through MOD single-source work.
Key Issue - Compliance and Contraventions
The Regulations will move to a stricter compliance regime whereby failure to provide the required transparency could result in the name of the supplier being made public and a fine under a civil penalty regime. The SSRO will act as the appeal body for the compliance regime.
Key Issue - SMEs
The MOD is introducing a simplified single- source procurement process for smaller contracts and suppliers. However, the MOD would also like to encourage the use of SMEs in larger supplier's supply chains and will require larger single-source suppliers to produce an annual SME report describing sub-contractor procurement processes and how they have encouraged SMEs to enter their supply chains.
WHAT DOES THIS MEAN FOR PRIVATE SECTOR CONTRACTORS?
The principles at the heart of the Regulations will continue to be achieving good value for money for the MOD and a fair and reasonable price for the contractors. These principles are now given a legislative basis and should be treated accordingly.
Contractors will have to adapt to the new pricing regime. Paying close attention to the SSRO's annual guidance will become increasingly vital in order to ensure compliance.
We can clearly anticipate a more stringent reporting regime, in which more will be expected of the contractor throughout the duration of the contract. This is reinforced by fines and other sanctions for which the contractor may be liable in the event of actionable non-compliance.