Defence contract disputes and risk allocation in Australia

Disputes and risk allocation

How are disputes between the government and defence contractor resolved?

Defence’s dispute resolution process encourages the parties to negotiate a resolution to the dispute before commencing litigation, although this does not prevent a party from seeking urgent interlocutory relief. The ASDEFCON template used for strategic materiel procurement contains clauses reflecting this objective. If negotiation fails to resolve the dispute, the parties may agree to use an alternative dispute resolution process (such as mediation or arbitration). If the parties do not agree to an alternative dispute resolution process or such process does not achieve the required outcome, either party may commence legal proceedings.

To what extent is alternative dispute resolution used to resolve conflicts? What is typical for this jurisdiction?

As noted above, alternative dispute resolution (eg, arbitration, expert determination or mediation) is preferred as a means of resolving disputes between Defence and a contractor. There are few recorded court cases of contractual disputes with Defence, indicating that confidential alternative dispute resolution is largely relied on to resolve Defence contractual disputes.

What limits exist on the government’s ability to indemnify the contractor in this jurisdiction and must the contractor indemnify the government in a defence procurement?

Pursuant to a delegation issued under the PGPA Act, the Finance Minister has delegated to Defence the power to indemnify a contractor within stated rules. Approval from the Finance Minister is needed to give an indemnity outside the rules. In granting an indemnity, a Defence official must consider two overarching principles:

• that risks should be borne by the party best placed to manage them; and
• that the benefits to the federal government in relation to the indemnity should outweigh the risks involved.

Additionally, an official can only grant an indemnity to a contractor if the official is satisfied that the likelihood of the event occurring is remote (ie, it has a less than 5 per cent chance of occurring), and that the most probable expenditure if the event occurred is not significant (ie, it would be less than A$30 million). The indemnity cannot apply to certain costs (eg, no indemnity can be given for civil or criminal penalties of the indemnified party). Defence acknowledges in its procurement policy that it may be necessary, where a contractor is exposed to risks over which it has no control, or that would otherwise make the contract uneconomical for the contractor, for Defence to grant an indemnity on behalf of Defence. In practice, Defence will only provide an indemnity to a contractor in exceptional circumstances and after rigorous liability risk assessment, including considering the full potential cost of the liability to the Commonwealth.

Can the government agree to limit the contractor’s liability under the contract? Are there limits to the contractor’s potential recovery against the government for breach?

Defence has a stated preference for a contractor’s liability to be determined according to principles of Australia’s common law. However, Defence is able to agree to limit liability to achieve a value for money outcome. Defence has developed its own guide to capping liability for this purpose. Like other federal government agencies, Defence will not usually accept any limitation on a contractor’s liability in respect of personal injury or death, third-party property damage, breach of intellectual property rights, confidentiality, privacy or security obligations, fraud or dishonesty, unlawful or illegal acts, or indemnities provided by the contractor under the contract. A supplier seeking to cap its liability may be required by Defence to provide a risk assessment to support the requested cap. There are no general statutory or regulatory limits to the contractor’s ability to recover against the government for breach of contract.

There are some statutory rights for the government to use copyright material (and material protected by some other intellectual property rights) without the rights owner’s consent subject to using them for permitted government purposes and paying compensation determined by statutory rules. Such rights could have the effect of limiting a contractor’s ability to recover from the government for breach of licence rights in a contract.

Is there risk of non-payment when the government enters into a contract but does not ensure there are adequate funds to meet the contractual obligations?

There is no material risk of non-payment of any amount that the federal government is required to pay under contract. The Defence budgeting process provides for commitments under existing contracts and planned procurements. On occasion, Defence may wish to commence a contract subject to budget appropriation of funds. This may occur, for example, where Defence enters into a supply contract that has budget funds allocated, but the associated support contract is to start in a later year and may not yet have had funds allocated.

Under what circumstances must a contractor provide a parent guarantee?

In complex or high-value procurements, Defence will usually require that a contractor that is a subsidiary provide a deed of substitution and indemnity from a parent company (or other entity), which allows Defence to request substitution of the contractor for the guarantor if specified events occur. Defence may also consider accepting a conventional parent guarantee, or an unconditional bond to pay on demand issued by a creditworthy financial institution (known colloquially as a ‘bank guarantee’).