Those who watched the recent mini-series “Pine Gap” on the ABC will remember that one of the central themes running through the show was the property settlement dispute between two of the main characters, Kath and Jacob. Which of the protagonists was going to end up getting custody of “Bruce” the cat? In the end, the fact that Jacob brought the cat into the relationship seemed irrelevant. Now you may be wondering what cats and contracts have in common, but it reminded me that many contractors and sub-contractors make significant investments in contracts without sufficiently contemplating what might happen to their investment if the contractual relationship comes to a premature end.

What is your contract investment?

Investment in a contract can take various forms, including time, materials, operating costs, tools, equipment and performance security. Some contracts require a significant up-front capital investment, such as the purchase of new vehicles or equipment to be used solely or primarily in performing obligations under the contract or putting up a substantial amount of cash to obtain a large performance guarantee.

What could cause a contractual relationship to end prematurely?

Non-performance by the contractor springs to mind, but just as Gough Whitlam’s Family Law Act of 1975 introduced no-fault divorce, contracts can also be terminated without any fault on the part of the contractor. Examples include insolvency (albeit somewhat curtailed by the recent “Ipso Facto” reforms), force majeure and terminations for convenience. Termination for convenience clauses are par for the course these days and almost always one-sided in favour of the principal. Most people would agree that if you fail to perform as a contractor you deserve what you get (i.e. commit the crime, do the time), but what happens when your contract is terminated through no fault of your own? What if the principal gives notice under the termination for convenience clause? And if you think that because your principal is a large, long-established and reputable company, the chances of it becoming insolvent are slim, spare a thought for those who had contracts with RCR Tomlinson, the 120-year old engineering group with approximately 3,400 employees that recently went into voluntary administration.

What aspects of the contract might put your contract investment at risk?

1. Termination for Convenience Clauses: Until the High Court declares that a duty of good faith is implied into every contract, these clauses can be triggered by a principal for any reason and without having to give a reason. It could just be that the principal has been offered a better price. The longer the contract term, the greater the risk, because the capital investment in the contract is usually factored into the contract price, spread over the term of the contract. Let’s say the contract is for a 5-year term and the scope of works requires you to install on site for the term of the contract a purpose-built item of equipment that costs you in excess of $100,000 to acquire. You build this cost into the contract price either in the form of a monthly rental component or as part of the overall service fee to be charged over the life of the contract. In this scenario, you expect to recover the cost of the equipment (plus a margin) by the end of the 5-year term. But what happens if the principal decides to terminate the contract for convenience after only 2 years? The nature of the equipment could make it difficult, if not impossible, to reallocate it to another contract (see Tender Monster #4: “White Elephant”).
2. Problematic payment clauses: Standard contract templates designed for lump-sum, fixed-scope projects are often used for schedule of rates fixed-term contracts. The contractor expects to submit monthly invoices or progress claims, but the contract only allows for an invoice, “upon completion of the services”. That could arguably mean all services over the entire term of the contract. What happens if the contract is terminated early (i.e. before “all” of the services have been provided)? Are you are entitled to submit an invoice after the contract has been terminated?
3. Rights on Termination: Clauses requiring the contractor to hand possession or ownership of its assets to the principal or to forfeit money that would otherwise be owing to the contractor (see Tender Monster #5: “Bad Divorce”). The worst case I have seen didn’t discriminate between terminations for breach and no-fault terminations. So, even if the principal terminated the contract for convenience, the principal was allowed to keep the contractor’s equipment and the contractor forfeited its right to payment for any work performed but not paid for as at the date of termination. True story!
4. Step-in/Take-out rights: This is really just a specific example of the above, where the contract allows the principal to “step-in” and make its own arrangements to complete the contract works. In some cases the contract allows the principal to take possession of and use the contractor’s equipment, often without having to compensate the contractor. Also, step-in clauses often require the contractor to indemnify the principal for the costs incurred by the principal in completing the contract works. A reasonable clause will apply only in the case of a fault-based termination and will require the contractor to cover only the difference between the actual cost of completion compared to the amount that the principal would have paid to the contractor to complete the work under the contract. Unfortunately, not all step-in clauses are reasonable.
5. Broad intellectual property licences: Many businesses don’t seem to realise that they invest intellectual property in every service contract they enter into. Most contracts require the contractor to give a licence to the principal to use the contractor’s “background intellectual property”, so that the principal can enjoy the full benefit of the services. This is problematic where the scope of the licence is too broad (see Tender Monster #25: “Prodigal Son”) and the contract comes to a premature end, but the principal remains free to use the contractor’s intellectual property for any purpose.
6. Inappropriate transfer of title clauses: This can work both ways. If you’re selling goods under the contract, then ideally you want to retain title in those goods until payment has been made. On the flip side, many generic contracts for supply of goods and/or services contain standard clauses stating that title in “goods” passes on the earlier of delivery or payment. Equipment that you are required to deliver and store on site for the term of the contract can often fall within the definition of “goods” under the contract, resulting in title to that equipment inadvertently passing to the principal when those goods are delivered to the site. While the principal is unlikely to take the point, it’s not a gift that you want to hand to your principal’s liquidator on a silver platter.
7. Ignoring the PPSA: Many supply contracts give rise to “security interests” as defined by the Personal Property Securities Act (PPSA). The PPSA provides a mechanism for registering these “security interests”. In certain circumstances, including insolvency of the principal, failure to register could result in loss of entitlement to the security interest. Examples of this include (a) “rental” of equipment to the principal or placing equipment on site under a contract for a term of 2 or more years or where the contract term is unspecified; and (b) selling goods under a retention of title clause in the contract.

How can you structure the contract to protect your contract investment against early termination?

• At the risk of sounding like a broken record, have all of your tenders and contracts reviewed by a specialist tender lawyer prior to submitting your bid, or at the very least, prior to signing the contract;
• Make sure the contract allows you to submit invoices or progress claims at satisfactory intervals so that you don’t get “caught with your pants down” if the contract comes to an early end;
• If your up-front capital investment is significant and incapable of being easily and quickly reallocated to another contract or project, push back against any proposed termination for convenience clause. If you feel you cannot negotiate the clause out of the contract, ask for a compensation clause to be inserted so that, for example, if the principal terminates for convenience the principal is required to pay you the written-down value of the capital investment as at the date of termination;
• If you are selling goods under the contract, insert a retention of title clause to ensure that title in the goods doesn’t pass to the principal until the goods have been paid for. If you are providing equipment to the principal or the principal’s site as part of your service obligations under a contract where these is no intention that title in the equipment should pass to the principal, make sure any transfer of title clauses are removed from the contract or reworded in such a way that they exclude your equipment;
• If the contract contains step-in rights, consider on what terms, if at all, you would be happy for someone else to use your equipment. At the vey least, you should seek to be compensated for the use of your equipment. At best, you might be able to have the step-in right removed;
• Make sure any clauses that talk about rights, entitlements and obligations on termination distinguish between termination for fault (i.e. breach by the contractor) and no-fault terminations (e.g. termination for convenience or force majeure). You should not be penalised for terminations not triggered by fault on your part;
• Don’t agree to forfeit your right to demand payment for work done, whether in the form of work-in-progress or unpaid invoices;
• If the contract requires you to pay the principal’s costs of exercising a “step-in” right, make sure you aren’t required to pay anything more than the difference between the actual cost of completing the work and the amount that the principal would have had to pay you under the contract to complete that work;
• Make sure that the scope of any licence given to the principal to use your IP is limited to the extent reasonably necessary for the principal to enjoy the benefit of the work done or services performed under the contract;
• If the contract requires you to “rent” equipment to the principal or to place equipment on a site beyond your possession or control, seek advice as to whether you should register a security interest on the PPSR. If the answer is yes, there are some clauses that you should ask to be inserted into the proposed contract to make it easier for you to register and enforce your interest.

The above discussion covers some of the common risk factors that appear in tender contracts. The Tender Lawyer refers to these as “Tender Monsters”. For a list of other such risks that might be lurking in that contract you’re about to sign, visit www.thetenderlawyer and download a free copy of “Tender Monsters – An illustrated guide to some of the classic ‘monsters’ that lurk in tender documents, often invisible to the untrained eye”.

Stephen King
The Tender Lawyer
27 November 2018