UK: Transparency And Open Book Accounting - Stephen Kenny - ThinkHouse Public Sector November 2015

Last Updated: 24 June 2016
Article by Stephen C. Kenny

Stephen discusses the what, why and where in respect of open book accounting in public sector contracts. He also considers the practical drafting steps when drafting open book clauses in contracts and the possible remedies to include in the drafting.

Transcript

Mark Greenburgh: I'm now joined by Stephen Kenny, a partner in our Projects practice who's going to discuss transparency and open book accounting mechanisms in public sector contracts.  Stephen, what is meant by transparency?

Stephen Kenny: Well transparency is not a legal term but it refers to a numbers thing - three things really. Firstly, those arrangements that policy that Government has about disclosing information about contracts to the general public. Secondly, I think it refers also to those provisions in a contract between the Government and suppliers about the actual disclosure of information relating to the pricing of the contract, particularly the cost base, and then finally it also relates to the protections you would want to have in the contract to restrict what might happen to the subcontractors' supply chain.  So protection is about not changing subcontracts for example.

Mark: Can you tell us what is meant by open book accounting?

Stephen: Open book accounting is a more specific form of transparency and it really refers to those provisions in a contract that give the public sector buyer access to information about the supplier's cost base.  Typically used in clauses where the information is needed to support payment that could be variable so that the buyer needs to really understand and have a really good breakdown of the way that costs are made up.

Mark: When and why would you use it?

Stephen: Open book accounting is used generally on long term public sector contracts and normally where there's a more collaborative or alliancing type relationship that has been established and it would also be used on contracts where the payment provisions are less in the fixed cost/fixed price type provision but more in the variable cost, variable price provisions, although there are a lot of common provisions particularly on construction contracts where you have target cost incentive fees and the contractor can be rewarded for bringing the costs in below the target and you need to have open book provisions to actually underpin all those payment provisions.

Mark: What challenges does open book accounting bring?

Stephen: I guess their biggest challenges are firstly ensuring that you devise a system that actually works in that most suppliers will say you can have whatever form of open book accounting you want within reason, but it's going to cost you money, so what's really important is actually getting into the room the right people to actually devise mechanisms that are practical and give you the information that you want.  That's the main challenge.  Secondly I think the whole issue of remedies if those provisions are breached is a difficult area mainly around the termination is not going to be a likely remedy and therefore ensuring that those provisions can be enforced where the contract is otherwise in a reasonably healthy state and the services are being delivered in a satisfactory way is one of the biggest challenges.

Mark: So if adopting open book accounting what should you include in your contract?

Stephen: Well the first thing you need to do is to be really clear on the strategic reasons for including open book so there's a degree of analysis that needs to be done to work out very clearly what you want to achieve from it and then we would recommend that what you do in the clause is to set out those broad principles so the parties are clear on what lies behind the open book provisions. You then need to get the drafting on the process accurately right in terms of timing and so on and there's a whole host of issues, particularly around the use of the word "good faith", which can be quite tricky to enforce because of recent cases and then you need to really make sure that those provisions flow into the payment mechanism and the performance regime in terms of giving you the right remedies to actually enforce them. 

Mark: So how is financial data protected?

Stephen: That's always a sensitive topic because clearly there's a tension between on the one hand the public sector buyer needing to have the right financial information from within the supplier's organisation on the one hand versus some natural sensitivities particularly arising around some of the wider financial information that might be relevant to the pricing of the contract but where the supplier will push back on actually disclosing it.  So for example typically where the supplier is part of a large group, which often they are global groups, there will be some resistance about disclosing group overhead or the so called central office charge. So big tension around that but how would it be protected? You would need to define clearly the information and put in place appropriate confidentiality non-disclosure arrangements with the public sector buyer.

Mark: And if things start to go wrong what are the solutions?

Stephen: Well when things go wrong you are likely to look at the contract and conclude fairly swiftly unless it's a really really really serious breach that termination is not likely to be a good remedy although you would want to include a specific termination right in to underpin the fact that this is a really important area in the contract. So, the most likely solutions are primarily I think initially a degree of escalation through the governance arrangement in the contract to take it up to the next level, the board or the Chief Executive level but that also needs to be underpinned by some appropriate remedies though the payment performance regime typically key performance indicators and performance deductions but also often we've seen the use of cash withholding, profit withholding to affect the supplier's cashflow and encourage the right performance.

Mark: If I'm an in-house lawyer is open book accounting optional?

Stephen: No longer optional I'm afraid.  I think if you're a public sector in-house lawyer then the whole direction of travel particularly in the light of some of the other policy statements lately is that open book accounting should be in your contracts and the key thing is to think through strategically why you need to have it in and what you actually need and then to actually make sure that flows down into some really bespoke smart drafting not just rely on standardised provisions. If you're an in-house lawyer in a supplier then I think the key point is that this is now an extremely important area and I think in the past we all used to put in a fairly short standardised clause about audit access, well that's not enough anymore and I think you need to take this really seriously and particularly if you're in a competitive bidding situation think through very carefully about how you could actually help your buyer with appropriate provisions.

Mark: What are the key learning points to take away when adopting open book?

Stephen: Well the key learning points if you are on the public sector buying side is to be really clear strategically why you want to do it and that involves working out whether is it just about value for money or is it actually wider objectives like getting savings and efficiencies or managing risk. And then you need to design provisions that give you the right information to actually deliver on that and also to devise remedies that actually work avoiding some of the sort of vague language like "good faith" which can cause problems. And if you are on the private sector side then I think you need to take this area much much more seriously because our experience is that this is rising up the agenda and you need to work with your public sector buyer to help them devise clauses that actually work and deliver on the objectives and this will play out in competitive dialogue meetings and evaluations in the next few years as it becomes more important.

Mark: Stephen Kenny thank you very much.

Stephen: Thank you very much.

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