Procurement in the Australian infrastructure sector: Protecting against insolvency risk in uncertain times

Introduction

In these uncertain times it is important for the government and businesses to ensure that their procurement policies and procedures support and enable business continuity, and to protect their rights and interests in case any of their contractors and partners suffer insolvency events. The economic impact of COVID-19 on the infrastructure sector is vast and, whilst helpful, the Australian Government’s recently introduced temporary relief for financially distressed businesses will not be enough to ensure the ongoing viability of many businesses. Accordingly, preparation is vital.

Key takeaways

• The ability of parties to terminate or take other action upon a counterparty suffering a specified insolvency event is limited – learn any exceptions that may apply to your business and activities.
• Improve your business’ financial health by:

• Proactively reviewing existing procurement policies and procedures
• Reviewing existing tender conditions and standard form contracts to ensure you have adequate protections against counterparty insolvency and the ability to terminate or take other actions for other reasons

• Invest in training for project managers and contract administrators to improve project delivery outcomes.

The ipso facto regime

Contracts are often drafted to enable a principal to take certain actions if a counterparty suffers an insolvency event, including:

• Termination of the contract
• Suspension of works
• Calling on security
• Exercising step in rights
• Exercising set-off rights
• Engaging others to perform the works

Following the introduction of the ‘ipso facto’ legislative reforms in July 2018, the ability of parties to terminate or take other action upon a counterparty suffering a specified insolvency event is limited, with a stay being placed on the ability of a party to exercise certain rights where:

• The rights have arisen due to:

• A party entering into administration or receivership
• A scheme of arrangement being proposed
• A party’s financial position if it is in administration, receivership or subject to a scheme or arrangement

• The reason for exercising such rights is, in substance, contrary to the ipso facto legislation

There are, however, numerous exceptions to the ipso facto stay. The most relevant of these for the infrastructure sector include:

• Arrangements involving special purpose vehicles, in circumstances where the arrangement provides for securitisation, private-public partnerships and certain project financing arrangements
• Building work, construction work or related goods and services arrangements in circumstances where the total payments under all such related contracts is at least $1 billion (this exception only applies to such arrangements entered into before 1 July 2023)
• Arrangements relating to Australia's national security, border protection or defence capabilities
• Step-in rights
• Contracts entered into before 1 July 2018, but varied, novated or assigned prior to 1 July 2023
• Rights to indemnities for costs, liabilities and loss incurred when preserving or enforcing rights
• Arrangements for the supply of:

• Essential or critical IT or communications technology, products or services to the government, its authorities or local governing bodies
• Goods or services to, by, or on behalf of, a public hospital or a public health service
• Essential or critical IT or communications technology, products or services to the government, its authorities or local governing bodies

In circumstances where a known exception applies, it may be helpful to articulate that the exception applies at the outset.

Using procurement policies and procedures to guard against insolvency risk

Managing insolvency risk effectively involves revising and improving existing procurement processes and policies as well as contractual arrangements. Robust procurement procedures minimise the chance of a problem being encountered during the tendering or delivery of a project.

It is advisable for organisations to conduct robust financial due diligence before entering into arrangements with contractors or partners and their related entities. Importantly, and particularly given current uncertainty, there should be regular reviews of all previously ‘approved’ and existing suppliers and business partners (including under standing offer arrangements and the like) so that changes in financial position can be readily identified. To ensure robust processes, we recommend that at a minimum all existing, new and proposed contractors and their related entities be required to provide:

• Evidence of current insurances held with reputable and solvent insurers
• Current financial information on a regular basis and as part of any tender submission process
• Evidence of holding relevant licences, e.g. QBCC licence for those performing building work in Queensland, and any action taken against the contractor by applicable regulators (e.g. building legislation compliance, health and safety breaches, Fair Work Australia investigations and any environmental breaches)
• Details of financial structure, including financial reports
• Notification upon any changes in financial position or structure
• Details of key subcontractors and supply chain, with financial information about those subcontractors and suppliers who are critical to the outcome

Contractual protections for principals

It is recommended that tender conditions and contracts be revised in order to assist with the effective management of counterparty insolvency risk.

Consider whether contracts contain appropriate rights during the performance of a contract to ensure early identification of potential financial distress and insolvency issues before they escalate. This includes rights in respect of:

• Start-up of projects and what documentation is to be provided.
• Ongoing access to updated financial and other information. This includes what reports are to be provided, auditing and verification rights and access to personnel.
• Regular statutory declarations from directors or other appropriate personnel on solvency and compliance with key legislation (e.g. Fair Work Act).
• Intellectual property and data (including native title formats of documents such as programs).
• Set-off rights that apply across multiple contracts with the one counterparty.
• Security and parent or related entity support.
• Step-in to subcontracts and supply contracts in limited circumstances.
• Ownership of unfixed goods and materials.
• Payment and whether it should correlate to milestones or other triggers rather than payment of work done over a period.

These rights will need to reflect both the application of the ipso facto constraints and how building legislation will affect their operation.

There will also need to be greater consideration of default and termination rights, and how contracts can better balance the ipso facto reforms and still provide appropriate protection should there be poor performance. Such considerations include:

• Definition of default and termination triggers beyond the traditional definition of ‘events of insolvency’
• Step-in rights (including rights to take over work) and when these will be triggered, as well what occurs during step-in and how a party can step-out
• Rights to terminate, including for default, convenience and for insolvency

Some of these are discussed in more detailed below.

Step-in, termination and security

Whilst, historically, step-in rights have been more commonly included in contracts for PPP projects, incorporating step-in rights into contracts should now be routine for principals, whether government or private, as step-in rights and the right to engage others to perform the work are expressly excluded from the ipso facto stay. In addition, it is prudent to include express clauses entitling principals to recover the costs associated with preserving and enforcing step-in rights and other costs such as interest and lenders’ fees which may be incurred. It may be that such costs are by indemnities and set-off provisions. Careful drafting of consequential loss definitions can also ensure they are not caught by any consequential loss exclusion.

Great caution must be exercised if terminating a contract which permits a party to terminate by reason of the other party’s insolvency, as there are significant consequences for breaching the ipso facto legislation. One option to assist with risk management is to have guidance notes and training that supports project managers and contract administrators understand the impact of the ipso facto legislation on contractual rights. Additionally, apart from the contractual matters above, consideration can be given to amending contracts so as to comply with the ipso facto legislation. By doing so, project managers and contract administrators may be prompted to ask further questions before pulling the trigger on termination.

As always, it is recommended that principals include a termination for convenience clause in contracts. However, whist termination for convenience is permitted, caution should be exercised so as to not fall foul of the anti-avoidance provisions in the legislation where termination may be considered, in fact to be a result of the other party’s financial position or restructuring process.

Provided that reasons for terminating are not contrary to the ipso facto legislation, parties are still able to terminate contracts and take other actions (e.g. call on security, suspend works) for other reasons in accordance with the terms of the relevant contract – most particularly for non-performance and non-payment. Carefully drafted events of default should include indicators of future troubles, such as:

• Repeated, ongoing delays
• Failing to attend site
• Abandonment
• Failure to comply with key personnel provisions
• Failure to provide financial information or statutory declarations when required or providing such information or declarations that are false or misleading
• Taking steps to utilise ‘safe harbour’ protections (which typically involve notices having to be given by directors)

To ensure performance of contractual obligations, principals may wish to consider whether security arrangements are sufficient. As with termination, it is important to exercise caution if calling on security, even in a situation where there is an unconditional bank guarantee, as there is a risk that taking such action could be considered contrary to the legislation. It may be that some form of parent company or related entity support (e.g. deed of indemnity or other security) will assist with ensuring performance of contractual obligations.