Armed Forces (Flexible Working) Bill [HL]

Debate between Lord Tunnicliffe and Baroness Jolly

3rd reading (Hansard): House of Lords
Wednesday 25th October 2017 Lords Chamber

[Lord Tunnicliffe (Lab)]

My Lords, we gathered through the debates that noble and gallant Lords were somewhat uncomfortable with the general thrust of the Bill, but for our part we accepted the Minister’s assurance that the senior management of the Armed Forces was behind it. We did our duty as the Opposition, which is to look at detail, seek assurances and propose amendments to make sure that the Bill will work fairly when it becomes an Act. I thank the noble Earl and his team for their courtesy, for the time he gave us, for wisely giving us some of those assurances and for wisely accepting a couple of our amendments. I also thank my noble friend Lord Touhig, who led our side until recently, for his leadership and I acknowledge the support we received from our own back office.

[Baroness Jolly (LD)]

My Lords, I agree with the noble Lord, Lord Tunnicliffe. I thank the Minister and his team very much for supporting the House and us in our deliberations on the Bill. We are pleased that the Government have accepted the view of the Delegated Powers and Regulatory Reform Committee on parliamentary scrutiny and on the adoption of the affirmative procedure. I worked quite closely on this with the noble Lord, Lord Touhig, and with both spads. We agreed amendments between us: so it is an example where, on occasions, opposition parties can work successfully together, and I wish the noble Lord success in whatever he is doing.

On a personal note, this is my last defence hurrah. I have now moved to health and have come back just for Third Reading. It occurred to me as I was walking into the Chamber that ever since I came into this House I have been either opposite or alongside the noble Earl in my deliberations and those of the House. I thank him very much for his courtesy and consideration; I learned an awful lot from him.

Single Source Contract Regulations 2014

Debate between Lord Tunnicliffe and Baroness Jolly

Tuesday 9th December 2014 Grand Committee

[Baroness Jolly]

I thank the noble Lord for his interesting and valuable comments and I shall address the points he raised as far as I can. We shall be in touch with him on any unaddressed points.

On his comment about the regulations being difficult for a lay audience to understand, and that the way they are laid out bears no relationship to the Act and that the cross-referencing of the two proved quite a challenge, we have done everything we can to make them as clear and comprehensible as possible. However, inevitably, they are highly technical and dry. They relate to a complex and specialist subject and it is necessary that they are accurate and precise. Everything in the regulations addresses specific issues in providing for the new framework for single source procurement.

When we had our meeting last week we discussed the intention that industry would probably not use the regulations but that the SSRO would produce specialist toolkits to guide industry through the morass of legislation and regulation. So, although those of us who enjoy reading these sorts of things might have had a problem, the department is doing all it can to smooth them out.

On the issue of training for industry, extensive briefing material has been provided. We have discussed this extensively in consultation with industry. We are providing workshops, briefing early adopters—including industry—and much of our guidance is on the internet, visible to industry and transparent.

“Mays” and “musts” is a good House of Lords regulation issue. I can confirm that the “may” in Section 18(2)(a) and (b) has not been used in the regulations. “May” does not mean “must”. I hope that the noble Lord is happy about that.

I thank the noble Lord for his comments and I hope that I have answered the main points raised during the debate. I further hope that Members of the Committee appreciate the Government’s commitment to improving this key component of our approach to procurement. This is a fundamental reform to a system which is well overdue for change. We continue to work with the SSRO and industry to ensure that implementation of the new approach is pursued as effectively and smoothly as possible.

Before I finish, I will not only repeat my thanks to the noble Lord, Lord Tunnicliffe, but thank the officials who not only had to teach me the intricacies of single source procurement—

[Lord Tunnicliffe]

Before the noble Baroness sits down, does she have any comments about the future of transparency? I think she does.

[Baroness Jolly]

My Lords, it is important that we should understand how any taxpayers’ money is being spent. How will Parliament know? The SSRO will publish an annual adherence report that will be laid before Parliament—helpfully, the officials, who I am praising to the hilt, have told me this—in the usual way. It may be that the noble Lord and I will have to google for press releases.

[Lord Tunnicliffe]

I know that it is extremely difficult to pick up on this point at the moment. I wonder whether, if the Minister can add a little more, she will write me a letter and place a copy in the Library.

[Baroness Jolly]

I will willingly do that and pop a copy into the Library. Finally, I commend the regulations to the Committee.

Apprenticeships

Debate between Lord Tunnicliffe and Baroness Jolly

Wednesday 26th March 2014 Lords Chamber

[Lord Tunnicliffe (Lab)]

My Lords, by our normal conventions, we would start the QSD but there was wide expectation in the House that there would be a vote now and at least half of our speakers are not present. Perhaps I may put it to the government Whip that she adjourns the House during pleasure for 10 minutes so we can all assemble for the next debate.

[Baroness Jolly (LD)]

I beg to move that the House do now adjourn until 5.49 pm.

Defence Reform Bill

Debate between Lord Tunnicliffe and Baroness Jolly

Monday 24th March 2014 Lords Chamber

[Baroness Jolly (LD)]

My Lords, as the noble Lord, Lord Tunnicliffe, explained, the intent behind the proposed amendment is to increase the independence of the SSRO by giving BIS responsibility for the regulations relating to qualifying defence contracts. As we have made clear on countless occasions during the progress of the Bill, and indeed in positive meetings with noble Lords—we have met quite frequently to discuss this, so I am glad the noble Lord found that helpful—the Government are fully committed to the independence of the SSRO in order to achieve value for money for the taxpayer. The SSRO will succeed only if it is, and is seen to be, fair to both parties. If it is too biased towards the MoD we risk driving the best suppliers out of the market. It is precisely the need for an independent moderating authority that led the MoD to propose the creation of the SSRO in the first place.

In Committee the noble Lord, Lord Tunnicliffe, pointed out that the SSRO chair and other non-executive directors are appointed and potentially reappointed by the Secretary of State. The Secretary of State sets the budget for the SSRO and can abolish it if he, or she in the future, so wishes. The noble Lord considers that that gives the Secretary of State considerable leverage. It would perhaps help if I were to explain in detail the context of our approach to the SSRO. In framing the legislation, we wanted to give the SSRO as much freedom as possible, including the ability to recruit its own staff. We did not want the SSRO to be a servant or agent of the Crown. These requirements have led to it being designated a non-departmental public body—NDPB.

Considerable public attention has been paid to NDPBs over the past few years, and substantial guidance has been developed. This includes the requirement that they must be allocated to a department, and the Secretary of State of that department must appoint the chair and the non-executives of that body. This department must also pay for the NDPB, which is why the MoD must set the budget for the SSRO. As to the ability to abolish the SSRO, this has been included in Clause 40 which relates to the termination of the whole of Part 2. This power will be used only if there is a desire to repeal the entire framework and revert to a non-statutory approach. In either case, the SSRO will no longer have a role, so the power will exert no leverage over the SSRO.

I turn now to what we have done to ensure the independence of the SSRO. The independence of the chair and other board members is essential, so I hope that noble Lords will forgive me if I describe the recruitment process in detail. To ensure that this appointment will result in a suitably independent and unbiased person, we are running the process in full accordance with the guidelines of the Office of the Commissioner of Public Appointments—OCPA. The recruitment panel for the chair is headed by a public appointments assessor, who has been chosen for us by OCPA. Also on the recruitment panel is an independent person suggested by OCPA and approved by the public appointments assessor. There are two others on the panel—one MoD official, and a representative from industry, Mr Paul Everitt, the CEO of ADS, one of the industry trade bodies for the defence sector—so only one of the four members of the interview panel will be from the Government.

A similar recruitment panel, with the addition of the chair, will be used to select the other non-executive directors. There are additional requirements for suitable candidates. They must not have come recently from the MoD or a defence supplier. Together they must represent a balance of private and public sector experience. They must have between them a variety of relevant experience: for example, legal or regulatory expertise, and experience of acquisition within the price sector. This is a rigorous appointment process, and I am confident that the result will be an independent SSRO board.

Having a suitably independent and strong chair will safeguard the independence of the framework, and we have tried our best to achieve this. This is further backed up by guaranteed freedoms. The SSRO is largely free to determine its own procedures, including making committees. The exceptions to this are where procedures are laid out in the Bill, and the requirement to run a full public consultation in support of the quinquennial review, which will be included in the framework document between the MoD and the SSRO.

In addition, the SSRO, like all public bodies, will be subject to external scrutiny by organisations such as the Competition and Markets Authority and the National Audit Office. Moreover, the SSRO chair can be brought before a parliamentary committee at any time. All these points highlight the considerable efforts we have made to ensure that the SSRO will be independent and subject to appropriate public and parliamentary scrutiny. The fact that the Secretary of State appoints the chair and that he can dissolve it are not what will determine the independence and impartiality of the SSRO. While we fully share with the noble Lord his aspiration of protecting the independence of the SSRO and the framework, we do not believe that this amendment is a necessary or effective means of achieving it.

In terms of practicalities, the Ministry of Defence will be the sole government user of the single-source procurement framework. It already has the technical expertise, the understanding and the necessary contacts with the defence industry to understand how the framework will operate in the real world. While the Department for Business, Innovation and Skills would undoubtedly be able to develop the required level of knowledge and expertise, it would take considerable time, effort and cost to create and would, in effect, duplicate the existing capability of the Ministry of Defence.

Moreover, it is normally the case that a single government department acts as the sponsor for a regulatory authority. This amendment would have the effect of splitting this between BIS, which would be responsible for the regulations relating to qualifying defence contracts, and the Ministry of Defence, which would be responsible for all other aspects, including the application of civil penalties. This would create an unhelpful degree of confusion and inconsistency, especially with regard to relations between the Government and the SSRO.

By creating the SSRO, we will increase the number of parties involved in single-source procurement from two—the MoD and the supplier—to three. Adding BIS as a fourth party would add confusion. For example, a supplier might lobby BIS for a change rather than the SSRO, and BIS might seek the MoD’s opinion on a matter rather than trust the SSRO’s recommendations. It is true that BIS has a similar role with regard to other regulators, such as Ofcom, but in such cases BIS is acting as a moderating body between the privatised suppliers and the public. In the case of the SSRO, however, the proposed amendment would place BIS in the position of setting statutory pricing and procurement rules of which the MoD is the sole user. BIS would thereby become the moderating body between private industry and another government department. This would create a potentially unhelpful relationship.

I will make a final point on premises and the issue of independence. I reaffirm what I said in Committee, which was that the SSRO, although it will be on government estate, will not be co-located within the Ministry of Defence. In developing this piece of legislation, the MoD has consulted extensively with industry over a prolonged period. There has been no suggestion from industry that it would see any advantage in having BIS own these regulations. Indeed, the Minister for Defence Equipment, Support and Technology, Mr Philip Dunne, recently met with Mr Paul Everitt of ADS, who said that industry no longer had any concerns over the independence of the SSRO.

The noble Lord, Lord Tunnicliffe, asked about a couple of points, including performance targets. Targets are there to ensure the efficient operation of the framework and the organisation. They are likely to relate to how quickly the SSRO responds to opinions or determinations made by the MoD or the supplier. He requested clarification on communications between the Secretary of State and the SSRO. If they are not on ruling, what sort of communications will they be? The SSRO will be responsible for keeping the framework under review and this will require communication with the Secretary of State or his officials to discuss any matters relating to the performance of the framework of the SSRO. The SSRO will have similar communications with industry.

On Amendment 3, as I stated, the purpose behind Part 2 is to ensure that in exchange for providing suppliers with a fair and reasonable price, the MoD will receive value for money for the goods and services it obtains through single-source procurement. Here we are in complete agreement. This works in two ways. First, it does this by establishing pricing rules that must be followed by the MoD and suppliers and by giving the SSRO the power to adjust the contract price if these rules are not complied with. This places a direct obligation on suppliers to use only appropriate and reasonable pricing assumptions.

Secondly, the Bill imposes transparency requirements which will allow the MoD to monitor suppliers’ costs: for example, ensuring that cost increases are highlighted in good time. These transparency provisions will allow the department, over time, to generate pricing benchmarks for goods and services. In turn, this will help the MoD to negotiate with industry over prices and to press for tough but reasonable efficiency targets. As it is in the interests of the MoD that these two features are applied as widely as possible, we fully expect that the Secretary of State for Defence will use the powers of exemption set out in Clause 14(7) only on an infrequent basis.

In Committee, I provided examples of where we envisage that the use of exemptions might be justified. However, I will summarise them again for the benefit of the House. The first circumstance is where there is no market failure. The framework addresses the situation where a contract price is not subject to the competitive pressures of the market. If those pressures are evident in the contract price, the framework is not required. An example is the purchase of additional items that are already available in the civil market, such as computers.

The second circumstance is one of national security. The Bill provides for some categories of contracts to be automatically excluded from the framework. One of the categories identified in the draft regulations is when the contract is for the purpose of intelligence activities. These exclusions apply only if the whole contract is covered by one or other of the excluded categories. So in the case where a significant part, but not all, of the contract is for intelligence activities, the contract would not be automatically excluded from the framework. As transparency is a significant part of the framework this is unlikely to be appropriate, so the whole contract may require exemption by the Secretary of State.

The third circumstance concerns our relations with other nations. Some of the standard reports would give us sight of a supplier’s plans for the key industrial sites sustained by MoD’s single-source procurement, which could result in a supplier having to reveal the forecast throughput assumptions of facilities that are used predominantly by a foreign Government, thereby exposing that country’s defence planning assumptions. This is likely to be treated with considerable reluctance by the foreign Government and therefore may require use of the exemption.

These are strong, valid reasons for the Secretary of State requiring this exemption power. However, not all the potential cases might be classed as being exceptional, as set out in the proposed amendment. Let us take, for example, the case where the market failures addressed by the framework are not present. It might be useful if I quoted the hypothetical but plausible example of where the department wishes to buy additional desktop computers. In the interests of operating only a single type, an open competition might be undesirable. However, in this example we do not need the full protections Part 2 offers to confirm that the price being offered to the department is fair and reasonable; we can simply compare it with the market price. This may be an unusual case as it requires a contract to be single-sourced yet fully priced using market prices. There would be a valid case for using the exemption powers, but it would be hard to argue that this constitutes exceptional circumstances.

We do not wish the Secretary of State to be constrained by how the new regime is applied in this way, but given that it is in the department’s interests that as much single-source procurement activity as possible is covered by the framework, the fewer exemptions there are, the greater the benefits there will be to the MoD.

I hope that this explains our position and therefore I urge the noble Lord to withdraw his amendment.

[Lord Tunnicliffe]

My Lords, I thank all Peers who took part in this debate, and in particular the Minister for her various assurances. I have faith that the people currently in the Ministry of Defence will undoubtedly use the right mechanisms to select the chairman of the SSRO and the individuals who are its non-executive directors. The pressure, which I am sure the present Administration would not bring to bear on the SSRO, will nevertheless come from all the subtleties. I speak as somebody who has chaired a nationalised industry, and who has been the chief executive of one and therefore on its board. The most subtle pressure comes from something that is entirely within the discretion of the appropriate Secretary of State. The Commissioner for Public Appointments, whom the Minister quoted, stated in a recent press release:

“The Public Appointments Commissioner plays no part in a decision not to re-appoint someone at the end of their term of office. That is a matter for Government”.

As we have seen recently in the case of Ofsted, the Government exercised that privilege without recourse to any mechanisms or checks. Everybody will try to do the right thing in these circumstances, but at the end of the day “not being reappointed” is a code for being fired, and being fired can engage the mind rather firmly. I believe that we should do more to distance the SSRO from the Ministry of Defence; the solution that we have chosen is the best one, and because it is important that the Government understand the wisdom of our words, I beg leave to test the opinion of the House.

Defence Reform Bill

Debate between Lord Tunnicliffe and Baroness Jolly

Monday 24th March 2014 Lords Chamber

[Baroness Jolly (LD)]

My Lords, this amendment seeks to remove Clause 16 of the Bill.

The clause is essential to ensure the consistent and widespread application of the new framework to all types of contracts used by the Government in single-source procurement. The purpose of Clause 16 is to allow for qualifying defence contracts that use a target price rather than a fixed price. These target-price contracts include sharing arrangements in the event of cost overruns or underruns. The benefits of any cost reductions are shared by the MoD and the supplier, as are the risks of costs being greater than anticipated. They are usually referred to as target-price incentive fee contracts, as the noble Lord has said. This kind of contracting approach is a model often used in high- value single-source MoD procurements where there is insufficient pricing certainty to make a firm or fixed-price contract a sensible option. In the past they have accounted for approximately 40% of our single-source contracts by value.

The Typhoon-availability contract, which provides support to the RAF’s Typhoon fleet, is one such contract. We want to retain the ability to use these target-cost contracts. We also do not want these contracts to be excluded from all the protections offered to both parties by Part 2. Clause 16 ensures that such target-cost incentive fee contracts, or indeed any other pain/gain share models based on a target price, can benefit from all the protections of the new regime.

Target-cost contracts are typically used when it is not reasonable for either party to take the risk of a firm price at the outset of the contract. This risk may be so great that in order to accept it a supplier would have to price in a very large contingency. This does not represent value for money. In this case, the price at the outset is deemed to be a target price. The final price is determined by comparing actual incurred allowable costs with those used to set the target price. Contractually agreed terms specify the share each party takes, whether 50:50 or some other split. Clause 16 ensures that the allowable costs included in the target price, and the allowable costs later agreed as the actual costs, must conform to all the pricing rules within the Bill. It is possible that there might be a disagreement at the end of a contract over what the actual costs were. In this case Clause 16 allows one or both of the contracting parties to ask the independent SSRO to make an expert determination. This helps ensure that disagreements are not overly prolonged.

Clause 16 also specifies that Clause 21—“Final price adjustment”—does not apply to target-cost incentive fee contracts. This requires a little explanation. The purpose of Clause 21 is to deal with any excessive profits or losses that might apply to firm- and fixed-price contracts. Most of our single-source contracts—approximately 60% by value—are such firm- or fixed-price contracts. A fixed price is typically used for contracts that are not risky enough to justify the use of a target-cost approach. They provide suppliers with the strongest incentive to become more efficient, as any cost reduction will improve their bottom line. This, in turn, will create better value for money for the taxpayer in lower follow-on prices.

However, when profits become excessively high, we do not want to have to wait until we engage in a follow-on contract. Indeed, it is possible that there will not be any follow-on contract at all. That is why we want to ensure that we get a share of these profits even if we have agreed a fixed price. Equally, we do not want to force a supplier to be subject to potentially crippling losses simply because they agreed to a fixed-price contract. For cutting-edge defence equipment, a contract that did not appear risky at first may turn out to be just that, which is why Clause 21 also provides a minimum protection for suppliers in the event of excessive losses. Because Clauses 16 and 21 both include profit-sharing arrangements, they cannot run simultaneously. That is why Clause 21 is excluded from target-price contracts.

Turning back to the amendment, we would like to maintain both options: the option to agree a fixed- or firm-price contract, with suitable protections for excessive profits and losses, as set out in Clause 21; and the option to agree target-price contracts if the contract is clearly high-risk and a fixed-price contract would not give us value for money. Clause 16 is what allows us to do this. The clauses have clearly distinct purposes and will be used in different cases.

Target-price contracts typically account for more than £2 billion worth of contracts per annum. This clause is therefore essential to the overall functioning of the new framework and must remain within the Bill if the substantial financial benefits expected under Part 2 are to be realised. I hope that this explains our position, and I therefore urge the noble Lord to withdraw his amendment.

[Lord Tunnicliffe]

I thank the noble Baroness for that explanation. But, as she knows, I do not need that explanation because I agree with everything she said. What I am challenging is the use of Clause 16 to explain an agreement where the share is 100% of the losses to the Government and 0% to the contractor. That seems incompatible with the spirit of Clause 16. I do not want Clause 16 to be removed and the noble Baroness knows that I will withdraw my amendment, but I would like at least some assurance that such a deal will not be done in the future. It makes a mockery of the target-price sharing if the so-called share is 0% versus 100%.

[Baroness Jolly]

I thank the noble Lord for his patience. I would rather not give him inaccurate information. How an agreement works out is very much due to commercial judgment, assured for value for money by the Ministry of Defence or HMT—the Treasury. That is the answer that I have. It is determined as a result of judgment, assured for value for money by the MoD or HMT.

--- Later in debate ---

[Lord Tunnicliffe]

My Lords, Amendments 5 and 6 seek to bring out the relative weight given by the Bill to the contract profit rate and allowable costs. The contract profit rate is the subject of Clauses 17, 18 and 19; allowable costs are the subject of Clause 20. The split between profit and allowable costs is typically that more than 90% of the final price will be allowable costs and less than 10% will be profits.

Clause 17(1) states:

“Single source contract regulations must make provision for determining the contract profit rate for a qualifying defence contract”.

Since it is a regulation, it will be made by statutory instrument, with all the parliamentary attention that that will enjoy. Clause 20, which is about much, much more money—nine or 10 times as much money—simply says that the SSRO,

“must issue guidance about determining whether costs are allowable costs under qualifying defence contracts”.

The essence of our concern is that the real potential for profit and loss in a defence contract comes from how the allowable costs are set. They are the much bigger proportion, and once the deal is set—unless it is a profit-sharing contract such as we have just discussed, and even there, the allowable costs are set—every pound by which the contractor is able to produce the goods cheaper than the allowable cost converts to profit on their account. It may not be under the profit part of the pricing deal, but it drops to profit. One has to realise that a substantial amount of the allowable costs—sometimes more than half—are allocated overheads. If you are the finance director of this large conglomerate, you are probably more concerned about making sure that you can—I was about to use a very unparliamentary word—get as much of your overheads into the allowable cost as possible. If one were negotiating this deal, one would not worry about the profit; everybody knows that it is going to be about 10%, as it is laid out by statute and all that sort of thing. The concentration would be to get as much into the allowable costs as possible, both in terms of the original price setting and in terms of taking advantage of some of the price adjustment mechanisms.

It is therefore our contention—and Amendments 5 and 6 give effect to this contention—that the allowable costs rules should be set out in regulations and that there should be a framework of regulations setting out the criteria for allowable costs, recognising that the actual detail of allowable costs will be extensive and that those criteria should go on, as Amendment 6 proposes, to be the subject of guidance from the SSRO. It is a very simple idea, but, we think, a very important one: to give the debate on the most important part of the price a higher profile in the public domain, and to try to persuade the Government that they should be as accountable—indeed, more accountable—for the criteria setting allowable costs as they are for those setting profit.

The Government will no doubt come back and point to Clause 20(2), which sets out criteria. I was somewhat scathing about the criteria in Committee, so I shall try to be less so now. The three criteria are that the cost should be,

“appropriate … attributable to the contract, and … reasonable in the circumstances”.

Working backwards through them, my general understanding of administrative law is that things have to be reasonable in the circumstances. I would not quibble at throwing “reasonable” into the Bill, but it is not a particularly heavy or precise definition.

The next criterion is “attributable to the contract”. It does not seem to me a very exciting idea that the cost should be attributable to the contract; I think that the average lay person would expect allowable costs to be attributable to the contract. Nevertheless, that is what is set down.

The only criterion that seems to have any substance is that the cost should be appropriate. I have a very low opinion of the word “appropriate”. I used to stand on the opposite side of this Chamber and read the stuff that the officials produced for me. Whenever I saw “appropriate”, I knew it meant that they could not find a better argument—I fear that that is what “appropriate” means.

The overarching framework of allowable costs should be set out in regulations so that they can come before Parliament and be widely developed. The SSRO’s guidance should be developed from those fundamentals and should be in the public domain. I beg to move.

[Baroness Jolly]

My Lords, I will consider Amendments 5 and 6 together. They concern the statutory guidance that the SSRO must issue for determining whether costs are allowable costs under qualifying defence contracts. The allowable costs make up the bulk of the price, and we agree with the noble Lord, Lord Tunnicliffe, that it is important that there should be clear and comprehensive rules that help ensure value for money.

Amendment 5 would introduce an additional step requiring the Secretary of State to set out in the single-source contract regulations principles governing the treatment of allowable costs. The SSRO would be required to have regard to those principles in the regulations when issuing its statutory guidance. Amendment 6 would require the parties to a qualifying contract—that is, the MoD and the supplier—to have regard to those principles as well as to the SSRO’s guidance.

It is in the interests of both the MoD and our suppliers that the rules determining allowable costs should be clear. These costs will typically account for around 90% of the value of a qualifying contract. The SSRO’s guidance must be sufficiently detailed to ensure that inappropriate costs are excluded and to avoid unnecessary ambiguity. The guidance must be enforceable. The Bill provides a strong enforcement mechanism underpinning the SSRO’s statutory guidance on allowable costs. This ensures that its guidance will be adhered to unless there is good reason not to do so, and it is achieved through several provisions.

Clause 20 provides three high-level principles that are binding on the parties to the contract. The noble Lord listed them. Costs must be reasonable in the circumstances, appropriate in nature and attributable to the contract. However, the noble Lord must know that, in the past, costs have not always been attributable to contracts. That has been unavoidable, but it has always been found to be the case after the event. Clause 20 also requires the SSRO to issue statutory guidance.

The guidance issued by the SSRO will have effect in several ways. First, both parties to a qualifying defence contract must have regard to the guidance when agreeing the price. Secondly, the Secretary of State can require a supplier to demonstrate how they have followed the statutory guidance at any time. Thirdly, the SSRO may make a binding determination on the extent to which a cost is or is not allowable.

If either party feels that the guidance was not followed, they can appeal to the SSRO, which can change the price. Any deviation from the SSRO’s guidance carries with it a significant risk. Following an appeal, the SSRO has the power to adjust the price back to what it would have been had the guidance been properly applied—and it is likely to do so unless there were good reasons not to follow its guidance, supported by a robust audit trail. Therefore, although it is called guidance, it is enforceable guidance.

Turning to the content of the guidance, we are confident that the statutory guidance will be substantial. We have agreed with industry that we will jointly recommend to the SSRO that its initial guidance should be heavily based on the existing government accounting conventions. These make up a substantial part of the current “Yellow Book”. For example, there is substantial and detailed guidance on the treatment of costs such as research and development, rationalisation and redundancy, and other such cost categories. These conventions can be imported into the initial statutory guidance, and will be expanded on to include areas not yet covered. Producing this guidance will be one of the first duties of the SSRO, which it will do in consultation with the MoD and industry. MoD officials are already working on the material we intend to provide to the SSRO in support of its consultation, and we know that industry is doing likewise.

The statutory guidance will also continue to evolve as new circumstances are considered. This will happen through the SSRO’s ongoing reviews and consultations on the framework, where the MoD and industry will suggest amendments. The SSRO will also make amendments following opinions or determinations that it is asked to make in relation to allowable costs. For example, if there is any ambiguity in the case of a particular contract, one or other party is likely to raise this with the SSRO for an opinion. After the SSRO has considered the matter, it will be likely to amend the guidance at the next appropriate point so that all parties have the clarity they need. Therefore, the existing provisions of the Bill contain everything required for substantial guidance backed by a strong enforcement mechanism.

In issuing its guidance, the SSRO is acting in its role as an independent expert charged with regulating the framework. The SSRO’s aim is to ensure value for money for the taxpayer and a fair and reasonable price for suppliers. This aim is provided for in the Bill under Clause 13. We do not consider that there is any need to limit the SSRO’s power in relation to providing detailed guidance consistent with that aim. In the event that the MoD objects to the SSRO’s guidance, it can make that case to the SSRO. However, we consider that a strong and independent SSRO will provide the best outcome for the new framework, and it should be fully empowered to fulfil its aim, as with other regulators, without unnecessary constraints.

There may also be an unintended consequence to these amendments. One of the parties to qualifying contracts—the Secretary of State—would be allowed to limit the power of the SSRO to independently set guidance on the allowable costs of those contracts. This may be perceived as introducing a partisan element to the regime, which we do not want.

There is one final point I wish to make. These amendments would lead to there being three tiers to the rules that determine allowable costs: primary legislation, regulations, and statutory guidance. This would add an additional level of complexity to the framework. MoD commercial officers and their industrial counterparts would have to follow and have regard to all three. There are cases where it may be appropriate to have three levels of rules, but clearly it should be avoided unless absolutely necessary. In this case we do not consider it necessary. We have taken the simpler approach of having three high-level principles in primary legislation, supported by substantial detailed guidance issued by the independent SSRO.

In summary, we want a framework that provides clear guidance on allowable costs, supported by a strong enforcement process, and for the SSRO to be able to act as a strong and independent regulator. The Bill as drafted does this, and we do not consider that these amendments are required. They will unnecessarily constrain the power of the SSRO and may introduce uncertainty for contractors. I hope this explains our position. I urge the noble Lord to withdraw his Amendment 5.

[Lord Tunnicliffe]

My Lords, I am still not convinced by the argument. The essence of my argument is that there should be symmetry of regard for profit and allowable cost. The allowable costs are so intrinsic to how much defence equipment costs the taxpayer, and so much a part of contracts which, over the years, have received massive—perhaps unfair—public criticism. This part of the Bill—which, as I have already said, is a good try and something that we support—will have the biggest impact on cost and profit, and we are not exposing it to the public scrutiny that having the criteria and framework in regulation would allow and, indeed, insist on.

I am incredibly impressed by my arguments but equally seized of the fact that I would not win a vote, so, with enormous reluctance, I beg leave to withdraw the amendment.

Defence Reform Bill

Debate between Lord Tunnicliffe and Baroness Jolly

Tuesday 25th February 2014 Grand Committee

[Lord Tunnicliffe]

My Lords, I am sorry that I did not make a closing speech because the idea of HMT having performance targets and a bonus culture does not fill me with enthusiasm. I may write to the Minister on that.

In moving Amendment 18J I shall speak also to Amendment 18K and to oppose that Clause 25 should stand part of the Bill. The issue here is essentially one of transparency. The offending subsection in Clause 14 is subsection (7), which states:

“The Secretary of State may direct that a particular contract to which subsection (3) applies is not a qualifying defence contract even though the contract otherwise meets the requirements of subsection (2)”.

One loves legislation that contains such clauses because they mean something like, “Never mind the whole of this document because the Secretary of State can decide it does not apply”, which roughly speaking is what this says. Amendments 18J and 18K recognise that there will be circumstances in which, frankly, this whole part of the Bill is excluded by the Secretary of State. It invites the Secretary of State to bring full details to Parliament and explain why the decision has been made. I should like the Minister to set out the circumstances in which subsection (7) would be used. I have asked the question privately and was given a general answer saying, “It is about the peculiarities of government-to-government contracts”. It seems to me that my amendments are entirely reasonable in those circumstances. It is entirely reasonable where there is some other assurance process, such as, “The Americans are going to do it for us” or that there is a treaty with the French which lays out the provisions to do this. That would be when this clause is used.

The Grand Committee is a small group today and we are discussing a very dry subject, but it is one that concerns the moving about of hundreds of millions and, indeed, billions of pounds. If a chunk of money of that order is moving about, Parliament should know under what circumstances it is being moved about, why the SSRO is not involved, and what assurances the public purse can be given by the Government as to what is being done. I expect that in her response the noble Baroness will talk about government-to-government contracts and I look forward to her touching on the detail of that.

The other area that came to light only when I delved into this with more care is the fascinating area of critical industrial capability. I am not sure whether that is the favourite way of referring to the concept these days, but I am sure that my meaning will emerge. Critical industrial capability is a concept whereby the taxpayer shovels out an awful lot of money to various contractors, a substantial part of which goes to BAE Systems, in order to keep workers on the books who are not doing work so that they are available to do work later. I am not even saying that that is wrong. I can see precisely why it makes sense. A more holistic view of the problem might be to schedule one’s procurement in a smoother way so that they are working continuously, but, conceptually, I can see why the former concept is necessary. However, it is important to realise just how substantial this is. We had a recent Statement on aircraft carriers. I read what the Minister said but the BAE Systems press release is in some ways even more interesting in that it is quite revealing. It states:

“BAE Systems has reached agreement in principle with HM Government on measures to enable the implementation of a restructuring of its UK naval ships business”.

The perception of BAE Systems is that this is about the naval ships business. The press release goes on to say:

“In 2009, BAE Systems entered into a Terms of Business Agreement (ToBA) with the Ministry of Defence that provided an overarching framework for significant naval shipbuilding efficiency improvements in exchange for commitments to fund rationalisation and sustainment of capability in the sector. The agreements announced today, together with an anticipated contract for the design and manufacture of the Type 26 Global Combat Ships programme, will progressively replace that ToBA”.

This is about maintaining capability. A couple of paragraphs later, it states:

“Under the new Target Cost contract the industrial participants’ fee will move to a 50:50 risk share arrangement”—

it is talking about carriers—

“providing greater cost performance incentives. The maximum risk to the industrial participants will continue to be limited to the loss of their profit opportunity”.

This clearly—at least in my view—is not compatible with Part 2 of the Bill. Apparently, Part 2 allows risk-sharing only under Clause 16, as far as I can see, and that in no part talks about limiting the loss to the profit component. It implies that the loss would go down the middle and deeper into it.

The press release refers also to the three offshore patrol vessels. Noble Lords may recall that the Secretary of State’s speech made it clear that these were pretty cheap because, frankly, they were being paid for by the industrial capability budget. The press release goes on:

“Following detailed discussions about how best to sustain the long-term capability to deliver complex warships, BAE Systems has agreed with the UK Ministry of Defence that Glasgow would be the most effective location for the manufacture of the future Type 26 ships”.

We should remember that the press release is written for shareholders, not the public, so it re-emphasises:

“The cost of the restructuring will be borne by the Ministry of Defence”.

It seems to me that these sorts of contracts do not come within the proposed framework that Part 2 talks about. In order for such a contract to be completed or negotiated in the future, Clause 14(7) would have to be invoked. Essentially, I am asking whether I am right in those presumptions. I am very happy to be written to because I accept that I have raised rather a new point. If that subsection is to be invoked, and if this capability and that sort of contract is to be involved, costing hundreds of millions of pounds, and probably the odd billion, it seems to me that the public and government should know about it in a rather more open way. Our amendments would require this to happen: the public should know and Parliament should know.

On Clause 25, essentially I am asking the Minister whether I am right that this is the only reference in the Bill to the issue that I have been talking about. Clause 25 seems to stand out as not being cross-referenced anywhere else in the Bill. It suddenly pops up on the subject of overheads and forward planning. I assume that this relates to the reporting structures. I should have said at the beginning that the reporting structures in the Bill are in many ways the essence of it, and the fact that I have no amendments on them is an acknowledgement that I commend the reporting structures and what they do. However, regarding Clause 25, I ask whether this relates to this concept of critical industrial capability and, if it does, in what circumstances Clause 25(8) would apply. Those of us who are required to study legislation always look for this paragraph:

“The Secretary of State may direct that a particular contract is not to be taken into account in determining whether the ongoing contract condition is met in relation to a financial year”.

In other words, if it gets very difficult, the Secretary of State can determine that it shall not be taken account of.

I hope that the Minister will be able to help with these questions and I am content that she may need to write to me. I beg to move.

[Baroness Jolly]

My Lords, I will consider Amendments 18J and 18K together and then move to the clause stand part debate.

These amendments relate to the Secretary of State’s power to exempt contracts from the new framework, provided for by Clause 14(7). Amendment 18J has no impact in its own right other than to add scope for a limitation to the Secretary of State’s exemption power. That limitation is provided by Amendment 18K. Subsection (7) gives the Secretary of State the power to exempt individual contracts that would otherwise be subject to the new regime. While it is not possible to foresee all future circumstances, this power is considered necessary for a number of reasons.

Before considering the limitation introduced by Amendment 18K, it might be helpful to noble Lords if I outline and give examples of the key circumstances in which we expect this power to be used. The first circumstance is where there is no market failure. The framework addresses the situation where a contract price is not subject to the competitive pressures of the market. If those pressures are evident in the contract price, the framework is not required. An example is the purchase of additional items that are readily available in the civil market, such as computers. To ensure compatibility with our existing infrastructure, we might want to use a particular manufacturer, so the procurement would be a single-source procurement. However, the item might have a price that has been established in a competitive market. In such cases, there would be no requirement for standardised reporting and open book rights to ensure value for money, because it would be self-evident from the marketplace. Applying the framework in such a case would not represent value for money, as the additional costs of making the contract a regulated contract would not be outweighed by the benefits of transparency.

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[Lord Tunnicliffe]

I take it that that was an offer to write to me with the one-and-a-half-page response.

[Baroness Jolly]

I am more than happy to read it to the noble Lord. Would that help?

[Lord Tunnicliffe]

It might help, because the noble Baroness will probably have to put it into the record anyway, on Report.

[Baroness Jolly]

The framework provides for a range of reports to be specified in the single-source contract regulations upon both specific contract costs and upon supplier costs that relate to wider capabilities and capacity. It is estimated that around a third of the costs of single-source contracts relates to so-called overheads. These account for some £2 billion a year of expenditure under single-source contracts. These costs do not relate to any one individual contract but, it is said, represent the costs of providing particular industrial capabilities and capacity. Not all of the costs of this capacity will be reflected in the costs recovered through single-source contracts. Some may be recovered through MoD contracts won competitively, or through non-MoD customers. However, in some sectors where single-source activity is particularly concentrated, these costs may represent the majority, if not all, of the costs of capacity.

The new framework has six reports relating specifically to these costs. These include reports on the estimated costs that are used to price contracts, the assumptions that underpin those estimates and the actual costs that are subsequently incurred. The requirement for suppliers to keep relevant records in relation to costs and the MoD right to examine those records also apply equally to these overhead costs, as they do to any other allowable costs. In addition to these transparency rights, the pricing principles set out in relation to allowable costs also apply to these overhead costs. Such costs must be appropriate in nature and reasonable in value.

The transparency provided by these reports, the access to records supporting them and the requirement to follow the pricing principles will further enhance the ability of the MoD to act as an intelligent customer when considering the cost of the capacity it requires. The single-source contract regulations will also provide for a further report that specifically considers the industrial capacity provided by our key suppliers. This report will supply senior individuals in the department with consistent information across suppliers when considering capacity requirements, contributing to the alignment between requirement and the industrial capacity we have to pay for. I hope that the noble Lord will now consider withdrawing his amendment.

[Lord Tunnicliffe]

My Lords, I thank the noble Baroness for that response. We have used different terms but I think she has gone half way to meeting my concerns over what I have called the critical industrial capability. I did not of course put down a clause stand part debate in order to not have a clause, but to understand it better.

However, one area still concerns me. The sort of deals that I described from the BAE Systems press release are very large, and I have great difficulty in seeing how you would fit them, in future, into Part 2, which is full of pricing mechanisms, profit share and so on. It is quite detailed and there is a framework. I am happy for the Minister to write to me rather than give me an answer now, but one of the questions is whether she envisages that such deals will be fitted into Part 2 or whether it will be necessary to use Clause 14(7) or some other exception—as the Minister has pointed out, there are other exceptions in that clause. Does the Minister envisage there needing to be an exception for those sort of deals or is it envisaged that future deals of this nature will be somehow compatible with Part 2 in ways that, at the moment, I am incapable of understanding? I would be very grateful for a response to that detailed question, although I would not encourage her to give me one now. With that, I am content to withdraw Amendment 18J.

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[Lord Tunnicliffe]

My Lords, I will speak to Clause 21 and to Amendment 23C. I must emphasise that our opposition to Clause 21 standing part of the Bill is not directed at the essence of the clause; it is to explore the clause. However, I fear that we must explore it fairly widely.

The concept in this clause, of a final price adjustment, comes out of the report by the noble Lord, Lord Currie. It addresses the key issue of profit that arises from the outturn. In my view, it is conceptually very sound. It is utterly meaningless without the regulations so I thank the officials and the Minister for sharing the regulations with me. After considerable effort, I think that I understood the early part of the regulations, particularly in relation to Clause 21(2), and they seem very sensible. They have a clawback of excessive profit of up to 75% and they support the supplier in a position of excessive loss at 50%, on the simplistic assumption that the profit rate is 10% of the allowable costs. There is quite a broad band, between 96% and 110%, where all variation falls to the supplier’s bottom line, which is a very strong incentive for the supplier to become more efficient and make more profit. I am not against suppliers increasing profit if that is achieved through efficiency. I am entirely in favour of it in this new open book, multi-reporting regime whereby the MoD can share in that experience through the reporting regime, understand it and help future suppliers understand how they can deliver at lower costs and more efficiently. It is a good regime.

Essentially, Amendment 23C simply argues that the regulations referred to in Clause 21(2) should be approved by Parliament using the affirmative procedure. Having recovered from the effort of understanding subsection (2), I gave up the ghost intellectually at that point and stopped reading the Bill. However, since then, I have started to read it again and I find Clause 21 a little difficult to understand, so I have a series of genuine questions for the Minister.

Clause 21(3) states:

“Provision made under subsection (2) must include provision for the amount of any adjustment to be determined … by agreement between the Secretary of State, or an authorised person, and the primary contractor”.

Does that mean that the regulations set out in subsection (2) may or may not be obeyed? In other words, can the Secretary of State agree to disregard the regulations under subsection (2), in which case it seems that the process of developing and publishing the regulations was valueless; or does it simply mean that the parties agree that the figures are right and so on? Is it a clause which simply invites the parties to agree, and if they do not agree the matter can be referred to the SSRO?

Given the precision of the regulations as I read them—I recognise that many thousands of man hours have gone into crafting them—I had some difficulty in understanding Clause 21(4), which states:

“Provision under this section may be expressed so as to apply … to particular kinds of qualifying defence contracts”.

What would be the differences and how would they apply? I genuinely have trouble envisaging what the different sorts of contracts may be like.

I assume that Clause 21(4)(b) is a simple de minimis provision—namely, that there should be a value below which you do not quibble because it is simply not worth doing so. I was fairly comfortable that it was a de minimis provision until I read Clause 21(5)(a) and (b), at which point I gave up the ghost because I could not understand what subsections (5)(a) and (5)(b) meant if subsection (4)(b) is a simple de minimis provision because subsections (5)(a) and (5)(b) seem to be super de minimis provisions. My general view of Clause 21 is that it is great in so far as I understand it, but I have to confess that I do not fully understand it and I seek enlightenment.

[Baroness Jolly]

My Lords, this is a crucial element of the Bill because it protects the taxpayer against contractors earning excessive profits while also protecting industry from excessive losses.

The basis of the Bill is that contractors should get a fair return on single-source work, and even better returns if they can drive cost efficiencies which deliver long-term benefits to the MoD. However, they should not be entitled to super-profits just because, despite best intentions and efforts, both parties happened to get the pricing wrong. Likewise, in the same circumstances, suppliers should not be expected to suffer losses. This clause offers protection to both parties. The clause enables a final price adjustment on completion of a contract if the actual costs of the contract turn out to be markedly different from those agreed at the time of pricing. The mechanism will be applied to all qualifying defence contracts priced at the outset on the basis of a firm or fixed price.

At Second Reading in the House of Commons, statements were made to the effect that provisions such as this are undesirable because an agreed contract price should be an agreed contract price and that clauses like this remove pricing certainty and dampen supplier incentivisation. There is some truth in the observation, but I believe the clause strikes a good and proper balance between incentivising suppliers and protecting the public purse in the way that the noble Lord, Lord Currie, recommended it should. It should also be noted that on a number of occasions in the past when suppliers incurred very substantial losses, such as on the Nimrod programme, they have come back to us for more money. Since we need the capability they provide, it is not in our interest to let a supplier go bankrupt by holding it rigidly to its contract price.

I must also tell the Committee that this clause does not introduce a new idea into single-source contracting. Provisions for a final price adjustment have been in place since 1968 under the existing Yellow Book arrangements, and a mechanism very like Clause 21 has been in place since 2004. It is in many of our single-source contracts and has already been successfully used to recover excess profits from our suppliers on some contracts. However, because the existing mechanism is contractual and needs to be negotiated, sometimes suppliers refuse to agree to its terms. This happened on a recent large maritime maintenance contract where commercial officers had to give it up in exchange for another provision we desired. That is why we want to legislate to provide this protection. If Clause 21 falls, a significant protection for both parties falls with it.

Clause 21 also states that any adjustments to the final price will be determined by the Secretary of State and the contractor. However, if an agreement cannot be reached on whether an adjustment is required or on the amount of that adjustment, the clause enables either of the parties to refer the matter to the SSRO for a binding determination. The clause will be used for particular types of contracts—firm and fixed-price contracts, which account for 60% of our single-source contracts—and the SSCRs will set out the minimum value for applying these provisions.

Finally, the clause gives the Secretary of State a power, on a case-by-case basis, to exempt a QDC from any final price adjustment as long as the value of that QDC is within the range to be specified in the SSCRs, which is expected to be between £5 million and £50 million. When deciding whether to make such an exemption, the Secretary of State must have regard to any matters which will be specified in the regulations. The clause is an important element in protecting both parties in defence contracts: the Government against suppliers’ excessive profits and industry from substantial losses, which ultimately would not be in the MoD’s interest. It is therefore crucial that it remains in the Bill.

Amendment 23C is part of a group of amendments which relate to the regulations that are to be made by statutory instrument under Part 2 and the parliamentary procedure by which those regulations will be made. We have previously discussed this in relation to Clauses 19 and 20 and Amendments 23A, 23C and 23D. Amendment 23C would provide for regulations under Clause 21 to be subject to the affirmative procedure. These regulations are for the final price adjustment and are currently subject to the negative procedure. The final price adjustment is expected to apply to around half of qualifying defence contracts—those which are firm or fixed price—and will have effect only when the costs incurred under these contracts are significantly different from those estimated at the time of pricing. The mechanism provided for by the draft regulations under Clause 21 is a relaxation of an existing mechanism that has been in place since 2004 and follows one of the recommendations by the noble Lord, Lord Currie. The Delegated Powers and Regulatory Reform Committee did not recommend that regulations under Clause 21 need be subject to the affirmative procedure and we, too, do not consider that these regulations warrant it. I urge the noble Lord not to move Amendment 23C.

Clause 21(4)(a) applies only to a particular kind of contract. The final price adjustment applies to all firm and fixed-price contracts, but with “pain and gain share” contracts, where the MoD and industry agree sharing provisions such as 50:50, it would not be appropriate to have two sharing mechanisms running simultaneously. Clause 21(4)(a) allows us to exclude “pain and gain share” contracts from the final price adjustment. The noble Lord queried the effect of Clause 21(4)(b). It is only to provide for a de minimis level. I am advised that the effect of Clause 21(5)(a) and 21(5)(b) is complex, and I will write on that.

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[Lord Tunnicliffe]

My Lords, Amendments 18R, 18S and 18T are prompted by industry, which seeks to argue that there should be a mutuality in obligation and a test of materiality. The industry argues that there should be a mutual obligation on the primary contractor and the Secretary of State to notify the other of events, circumstances and information that are likely to have an effect on, or relevance to, a contract. The MoD will have information that is likely to have an effect in relation to a qualifying defence contract, whether that affects its price or performance. The MoD should have a duty to disclose relevant information to the contractor, which must be reflected in the Bill. I understand that this duty was confirmed by the Government in Committee in the House of Commons but I would value further affirmation.

As a result of the broad scope of events and circumstances that are likely to have an effect on, or relevance to, a contract covered by Clause 26(1), it is realistic that the contractor or the Secretary of State should be required to notify only when they believe there is a likely effect or relevance. Without this restriction, the obligation to notify is extremely broad. Further, it is argued that it is not necessary to refer to the effect on costs per se; the important aspect is whether there is an effect on price, such that Clause 26(3)(a) is unnecessary. I beg to move.

[Baroness Jolly]

My Lords, one of the flaws in the current Yellow Book framework is that it provides little transparency once on contract. A key objective of the new framework is that the MoD should be able to monitor the health of single-source contracts on an ongoing basis, receiving timely information so that it can take fast and effective action. This is very important. There have been too many examples in the past when the MoD has discovered cost or time overruns on single-source contracts far too late for remedial action to be taken. Receiving information throughout the course of a contract will give the MoD the opportunity to work with contractors to take early action to avoid or minimise the impact of issues as they arise. This clause is one of several that provide this transparency.

A supplier will always know more than the MoD about the issues affecting its their delivery of a particular contract. Some of our suppliers share information on an open basis, alerting us as issues arise so that decisions can be taken on a joint understanding of the best information available at the time, but not all of our suppliers do this.

The standardised reports that will be required under Clause 24 will provide periodic snapshots of contract performance. However, for contracts below £50 million in value, a report may be received annually or still less frequently, and even for our largest contracts a standardised report is only required quarterly. These periods are appropriate for standardised reporting, but three months can be a long time in managing a contract, especially complex contracts worth many millions, or billions, of pounds.

Clause 26 therefore supplements the regular contract reporting, placing a duty on contractors to let the MoD know, in a timely fashion, of matters material to the contract. Putting the onus on the contractor in this way means that the new framework can be “lighter touch” than it would otherwise be if the only means by which alarm bells could be sounded on a project was through periodic reporting and the MoD’s monitoring powers.

Amendment 18R would make the Secretary of State subject to the same duty, providing notifications to the contractor. Clause 26 will place a duty upon a contractor to notify the Secretary of State when the contractor becomes aware of the occurrence, or likely occurrence, of “events”, “circumstances”, or “information” that are likely to have a material effect on a qualifying defence contract. Applying this same duty would require the Secretary of State to notify the contractor of events, circumstances or information that are likely to have a material effect on the contractor’s costs—the subject of Amendment 18T—the contract price, or the contractor’s performance.

Let me first be clear that this does not concern changes to our contractual requirements. If the requirements of the MoD change, and this affects an existing contract, then we require a contract amendment to reflect those new requirements. This should be quite separate to the delivery of requirements already contracted for; if we wish to amend the contracted requirement, we will tell the contractor and begin the commercial process of amending the contract, and this is not a matter that requires legislation. The contractor is not forced to make the amendment, and they will charge us for any additional costs that might arise, or amend performance requirements if this is relevant. Until we seek a contract amendment, a contractor should be concerned with managing the existing contract.

For contracts which we are not in the process of amending, this duty would require the Secretary of State to assess the impact of events, circumstances and information across the department upon each contractor’s contracts. This is quite different from the duty placed upon a contractor when they are managing a contract in the normal course of business. It would require the Secretary of State to assess what might, or might not, affect a contractor’s cost or performance, to look beyond the contract and assess whether a contractor’s activities are likely to be affected. This duty would be impossible for any Government to discharge.

We agree that when a contract is being priced, the duty to share information should be reciprocal. Both parties should share their assumptions to ensure that the price agreed for the contract is both fair and reasonable and value for money. However, once a contract has been entered into, it is the contractor who must manage the delivery of the contract, and who is responsible for the performance of its business and costs. It is not the responsibility of the Government to second guess what is likely to have an impact upon how a contractor achieves their contracted requirements. We do not accept that Clause 26 represents an equal duty when placed upon the Secretary of State compared to a contractor. It would be inappropriate to place this duty on the Government and impossible for a Government to fulfil.

Amendment 18S is the second in this group, and it seeks to qualify the duty to notify by adding the requirement that, for each of the three elements under subsection (1), the contractor believes in the existence of the effect or relevance. Each element requiring notification under subsection (1) is expressed as,

“likely to have a material effect”,

or,

“likely to be materially relevant”.

This means that a contractor need only notify the Secretary of State if two tests are met: first, that an effect or relevance is likely; and, secondly, that an effect or relevance is material. If a contractor considers that an effect or relevance is not likely or not material, then no notification is required.

The effect of this amendment would be to add a third test: that an effect must be likely, material, and believed to exist. We do not think that an effect could be considered both likely and material and yet at the same time not be believed to exist. To put it another way, if it were not believed to exist, how could it also be considered likely to have a material effect? Without embarking on a debate on the nature of belief, it is not clear what this third test adds.

Where there is a disagreement between a contractor and the Secretary of State over whether a contractor should have provided a notification under this duty, the Secretary of State may issue a compliance or penalty notice. Ultimately, it will be for the SSRO to determine whether a notification should have been provided and, in doing so, it will consider the two conditions of “likely” and “material”. We consider that the two conditions already required for there to be a duty to notify are sufficient and that the third test of belief proposed by this amendment is unnecessary.

Moving on to Amendment 18T, Clause 26 provides for three matters that are the subject of the duty to notify; these are listed in subsection (3). They are the costs under the contract, the total price payable under the contract, and the contractor’s performance of material obligations under the contract. This amendment seeks to remove the first of these matters—the costs of the contractor under the contract. The effect of this amendment requires some explanation as there is some overlap between the first two matters—the cost and the price payable under the contract. For cost-plus and target-cost contracts, the costs incurred under the contract will directly affect the price payable under the contract, so there is a limited difference between the two matters for these contracts, which represent just under half of the single-source landscape. The rest are firm or fixed-price contracts under which the contractor’s costs may vary while the price payable may not. So it is firm and fixed-price contracts that would primarily be affected by this amendment.

The reason that we wish to be notified in relation to both costs and price under the contract is the same as the overall requirement for Clause 26—to ensure that the MoD receives timely warning of matters affecting contracts. If the costs of a firm or fixed-price contract are likely to materially change, this is still important management information for the MoD. It may indicate a significant risk to the project or signal future performance issues. Just because it may not affect the price payable does not mean that this is not important information. For example, a contractor could manage a contract for a year in between standardised reports being provided to the MoD. In that year, a significant risk could be recognised and material costs could be incurred in trying to manage the risk in the expectation that performance under the contract will not be affected. However, despite the additional costs incurred, it finally becomes apparent that performance is likely to be affected after all, at which point a notification would be required.

It is a characteristic of single-source procurement that there is only one supplier that can provide the capability we require. If the contract fails we lose the capability we need. This has led suppliers in the past to seek price increases even though we have agreed a fixed price. Where the cost increases are very large, this puts the MoD in a difficult position. Seeking to keep to the fixed price can lead a supplier into great financial difficulty, putting not only that contract but others with that supplier at risk. If the supplier fails, then we lose the capability we need. This is a real risk that has arisen in the past, and thus we need the same transparency over the costs of fixed-price contracts as we do for other contract types. We do not see a benefit to applying a different notification requirement to firm and fixed-price contracts, so that for these contracts notification is only required once performance is likely to be affected, while for other contracts notification would be required at the point that costs, and therefore price, are likely to be affected. This is not the early warning that this provision is intended to provide.

For all these reasons, I urge the noble Lord to withdraw the amendment.

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[Lord Tunnicliffe]

My Lords, at this point I have no objection to the government amendments, but that may be partly because I do not understand them. I shall find them easier to read when the Bill is reprinted for the Report stage but, as I say, I have no comment or objection at the moment.

I may be about to contradict myself when speaking to Amendments 22A and 23B. Amendment 22A is prompted by the industry, which has argued that the regulations arising as a result of the review should be made and updated in an open and transparent manner. It argues that an industry-wide consultation should be undertaken, the Secretary of State should have regard to that consultation and the regulations should be laid before Parliament. Amendment 23B argues essentially that the penalties regulations should be passed by the affirmative procedure on every occasion. These are penalties which could have dramatic effects.

I think that this is the last time I will speak, so I should like to congratulate the Minister on her marathon performance. I recall from when I occupied her place that it can seem a bit futile, but I know that what she has read into the record will be held to be of great value by both parliamentarians and those outside. I thank her and her officials for their efforts, and I look forward to reading with great care the products of our discussions. I also look forward to her letters.

[Baroness Jolly]

I thank the noble Lord for his comments and I am sure that I will get my pen out and start writing as soon as I have consulted with the gentlemen sitting behind me. On a slightly more serious note, I am sure that we will have meetings with the Bill team and people from the MoD.

I turn now to the amendments. Amendment 22A would place a statutory duty on the SSRO when performing its review of the single-source framework to consult with industry and to publish the results of the consultation exercise. As noble Lords will be aware, many aspects of the single-source framework under Part 2 will lie in regulations rather than in primary legislation, and many of the clauses in this part give the Secretary of State the power to make those regulations. This is to allow the regulations to be periodically updated to take into account changes in procurement approaches, the defence sector and what is being procured, without the need for primary legislation. I reassure noble Lords that we are aware that the new single-source framework represents an important change to single-source procurement. We have been consulting closely with the industry throughout the development of Part 2, including the Bill and the detail of the regulations.

In October 2011, the noble Lord, Lord Currie, published his report and we subsequently ran a full public consultation which completed in January 2012. In April of that year we started a defence suppliers’ forum subgroup with our top 10 single-source suppliers. These included BAE Systems, Finmeccanica, Rolls-Royce, Babcock, Thales, MBDA, QinetiQ and others. Over the past two years we have met with them more than a dozen times to share our proposed approach and understand their concerns. Beneath this forum we also established a number of technical working groups on specific matters such as confidentiality, the SSRO and risk, and most recently on the regulations themselves. In January alone this year we spent four full days discussing the draft regulations line by line with industry, and we expect further such discussions before the summer. This is a substantial level of consultation, more than is typical for new government policy, and it has resulted in our making some important changes to our framework, such as introducing the new criminal offence to protect industry information.

It is certainly not in our interests to create an unworkable framework. For one thing, we pay for any additional overheads our suppliers will incur, which will be incorporated into their single-source prices, provided that they are reasonable. We also need the capability they provide and have no desire to make it hard to do business with the MoD. Indeed, it is out of a desire to ensure that the framework is as practical as possible that we have consulted with industry to the extent that we have. Industry cannot claim that it has not been consulted prior to the first regulations being made.