Proportionate protections

In their first article on the impact of supplier insolvency, Kirsten Maslen and David Rawson discussed the definition of insolvency and what steps a local authority creditor can take to anticipate problems in advance of an insolvency situation and what options are open to the authority to recover its money. This article looks at how the authority can support businesses that may be feeling the effects of the credit crunch, and also how authorities can protect themselves from supplier insolvency.

How a local authority can support struggling businesses

Local authorities are often keen to support business, especially local businesses. At its most unsophisticated, such support consists of little more than turning a blind eye to the difficulties of the company in question, so that the local authority is one less thing for the company to worry about. Such an approach may have a short-term benefit to a struggling company, but is unlikely to help the company address its fundamental problems.

A local authority that has spotted the warning signs of financial difficulty and has brokered an open dialogue with a struggling company has the potential to offer significant support to a business. There is a strong argument in favour of such support taking the form of "tough love" (for example, coupling any supportive measures with the creation of wider contractual termination provisions), but local authorities can support business by, for example:

• Speeding up internal processes to settle invoices as quickly as possible
• Where the authority is owed money, extending payment terms (but beware of offering what could amount to an overdraft for the company, allowing it to pay other creditors before the authority)
• Relaxing service level agreement targets or suspending the payment of service credits
• Agreeing to make lump sum payments on account of services (this can be a valuable source of additional cash flow for a struggling business, especially if the advance payments are calculated to allow the company to pay key suppliers)
• Using the local authorities’ contacts in the wider business community to source advice and assistance, and
• Holding off from enforcing its termination provisions, providing this does not expose the authority to disproportionate risk.

But what steps can the authority take to prevent its exposure to supplier insolvency in the first place? And how can it balance its need to protect itself without excluding smaller suppliers from bidding for its contracts?

Building in protection at the tender stage

The counsel of perfection is to factor the risk of eventual supplier failure into your thinking at the tender stage. However, local authorities should ensure that any hurdles to selling to the authority are necessary and proportionate. If the authority’s terms of business are too onerous, some, particularly smaller, suppliers may be unable to bid for work.

Think about:

• Making sure you carry out a thorough review of the company's finances and future prospects at the outset, to assure yourself that the company is capable of carrying out its obligations over the length of the contract
• Advertise all contracts as widely as possible
• Consider whether work can be divided into smaller packages, and
• Ensuring bidding terms do not cripple the company before it starts.

Assessing economic and financial standing

Under the Public Contracts Regulations 2006, local authorities can de-select bidders from a tender process if they fail to satisfy the authority’s minimum standards of economic or financial standing. Typically, the authority will state that income from the authority, in aggregate across all its contracts, must not exceed a certain percentage of the company’s turnover, ensuring that it is not too dependent on the authority for its income.

This is a very sensible precaution given that a company’s need to protect its reputation with other buyers is a valuable tool to an authority. Also, if the authority is its only customer, if the company loses that business it may cease trading (and possibly enter liquidation or seek voluntary dissolution) which would remove any indemnities the authority may wish to rely on, for example in relation to any transferring employees.

However, often authorities will use a uniform percentage figure across all contracts, irrespective of their nature and the level of risk. Authorities should ensure that any minimum standards imposed are proportionate to the risk involved.

Authorities should also ensure that it checks the terms of any parent company guarantees or bond agreements and ensures they are in place, and are renewed as necessary, during the life of the contract. The best time to set terms for such agreements is during the competitive process when bidders are eager to please!

Advertising opportunities

Even when the value of local authority contracts fall below the thresholds, or otherwise fall outside, the Public Contracts Regulations, they must be advertised. There is no set value at which contracts must be advertised; just a requirement that all local authority contracting is transparent, non-discriminatory and treats all bidders equally.

Although this can be a hard-sell to busy officers in cash-strapped times, wide advertising is one of the key ways a local authority can achieve better value for money and support businesses by ensuring new or smaller businesses hear about opportunities to tender for work. The requirements can be met by internet advertising on the authority’s website or through a portal, for example, Supply2Gov.

If the tender calls for the bidders to carry out a lot of preparatory work, the earliest such opportunities are advertised the better. Most businesses will not have bid teams to fill out tenders.

Ensuring contractual and bidding terms are proportionate

Local authority contracting has changed a lot over the last 10 years. Contracts are more balanced and risk is allocated is a more proportionate manner. The key contract terms for authorities in the credit crunch are:

• Payment: Many local authorities still pay suppliers in advance for certain services. This may be a justifiable risk in some markets, but unless the service calls for capital investment up-front, such payments should be drip fed wherever possible.
• Termination: Ideally the authority will have the right to terminate on notice for no fault. However, if it is disproportionately expensive to include such a provision, the authority should consider including the right to terminate for persistent minor breaches. It should also be able to terminate for insolvency, which should be defined by reference to the economic fact of insolvency (both balance sheet and cash flow) as well as the entry of a company into formal insolvency.
• Performance management: The authority should ensure the management information the supplier is required to return provides an early-warning system of supplier distress. Any contractual levers to manage poor performance should be applied to avoid affirming breaches.
• Parent Company Guarantees and bonds: The authority should note any expiry dates for these and ensure they chase up renewals well in advance.

It is common practice for local authorities which carry out many hundreds of tenders to use standard tender documents which are re-cycled for each tender. While a systematised approach makes sense, some of the requirements can be onerous to bidders, particularly if the subject of the contract is low risk and low value. For example, insurance levels are often set at the same level for every contract which may exclude some bidders. The length of some tender documents may also be disproportionately long and include irrelevant information. Stripping out unnecessary requirements should attract more bids.

Block vs framework agreements

Efficiency reviews point to the benefits of aggregating spend within and across local authorities and other statutory bodies. The effect of aggregation can be to exclude smaller, local businesses from bidding for the contracts. It can also mean the authority has all its eggs in one basket. Unless the particular service lends itself to scalable efficiencies, the authority may choose to parcel the work up into smaller chunks to enable a wider supplier pool to bid.

Framework agreements are becoming more common in local authority contracting. They mean the authority has a readily procured supplier pool that it can call off from or carry out mini competitions as and when required, a valuable contingency plan should one of the suppliers fail. This benefit should be balanced against the loss of economies of scale and certainty for suppliers, as none of the suppliers has any guarantee that the authority will buy from them.

Kirsten Maslen is an Editor in the PLC Public Sector team and David Rawson is an Editor in the PLC Restructuring and Insolvency team.