• Test 1

Records, reporting and pricing of sub-contracts

The implementation of the Defence Reform Act’s regulations and statutory guidance has introduced significant changes to the rights and obligations of the parties. All new single source contracts and contractors will be affected by revised arrangements. Only changes to pre-existing contracts and sub-contracts will continue to be priced in accordance with existing DEFCONs (as incorporated in the contract). For qualifying contracts and sub-contracts The Single Source Contract Regulations 2014 (here) will apply and for non-qualifying contracts and sub-contracts the DEFCONs expected to be negotiated and incorporated, the Defence Reform Act is available here and new and revised DEFCONs are accessible on the previous page.

The legislation applicable to qualifying defence contracts and qualifying sub-contracts is not structured in a way that easily and clearly communicates rights and obligations and does not adequately address the full relationship through the contracting line:

  • The regulations do not repeat the content of the Part 2 of the DRA i.e. obligations or rights that are fully expressed in the DRA are not repeated in the regulations
  • In both the DRA and the regulations legal rights and responsibilities relating to sub-contractors mainly have to be derived from DRA and regulation requirements that apply between MOD and prime contractors i.e. the requirements are not clearly and distinctly set out but rather require to be worked through an overly complex structure.
  • The DRA and regulations do not grant any rights to a higher tier contractor to access to a sub-contractor’s records, reports or any other pricing information i.e. the rights to a sub-contractor’s records, reports and pricing information only exists between the MOD and the sub-contractor. This even applies when pricing a change between the prime contractor and its sub-contractor when there is no change to the QDC SOW.
  • It is unclear if a sub-contractor’s failure to price in accordance with the pricing formula or PEPL adjustment is recoverable by MOD through the contracting line or directly between MOD and the sub-contractor. Uncertainty applies to penalties and Schedule 15.3(b) of the Act where re-pricing of the whole contract can be triggered by one party.

The DRA and The Single Source Contract Regulations 2014 gives MOD right to examine and to take copies of relevant records for a verity of defined purposes and provides an obligation upon the contractor not only to make such records available but also to provide MOD further information or explanation reasonably requested i.e. a right for MOD to pull information from a contractor. For new contracts and sub-contracts that are not QDCs or QDSs DEFCON 812  is expected to be negotiated and incorporated into single source contracts where the value exceeds £1m.

In addition to MOD’s rights, contained in the DRA and supporting regulations for qualifying contracts and sub-contracts, to pull information; the contractor has an obligation to issue standard reports to MOD and the SSRO. These reports and supporting obligations are set out in regulations 22 through 30 for contract reports and regulations 31 through 45 for supplier reports. Two of the reports contained within the reporting suite replace the Equality of Information Pricing Statement of the previous Yellow Book single source pricing framework. The regulations include extensive, difficult and detailed requirements. SSRO’s statutory guidance on reporting still need to be further developed e.g. are costs reported as incurred when allocated or when incurred (if the later should these be estimated and if so in what period should the showing up be included; how should authorised but unpriced contract amendments be incorporated into reports; if the contractor’s functional currency is other than GBP what rate should be used for conversion and should this be altered during the duration of the contract? The quality of statutory guidance issued to date; the unrealistic aspirations for defined pricing structure presents risk to early adopters. Lack of adequate definitions, the proposed adoption of the US style 881C product WBS may make implementation difficult for many suppliers. Lack of clarity exists as to the reporting requirements of contracts awarded under enabling arrangements e.g. Post Design Services tasks are to be continuously aggregated to provide a report on the cost of the requirements let to date (no purpose is served) or each contract is to be reported as exemption test under regulation 5(5) is not achieved (a high volume of reports with little utility are required).

In addition to the report formats contractors are required by Section 26 of the Act to report relevant, circumstances and information that is likely to have a material effect to a QDC.

The reports are also applicable to qualifying sub-contractors including those under common control. As the regulations apply to the legal entity contract costs incurred by any of the separate business units within the entity need to be reported at cost within the contract reports.

Prime contractors have no right of access to sub-contractors records or reports issued to MOD/SSRO and therefore unless all pricing the qualifying sub-contract is performed by MOD compliance with allowable cost element of the pricing formula and consequential certainty of prices is placed at significant risk. The regulations make it clear that the higher tier contractor is responsible for agreement with its subcontractor of the profit allowance. The regulations are silent as to whether it is the MOD or the higher tier contractor that is responsible for the agreement of allowable costs with the subcontractor; some in MOD have verbally stated that they will not perform this task (leaving it to be established by the purchaser). If the sub-contract price is subsequently found by MOD to have not have been calculated by the sub-contractor in accordance with the regulations then the priced will be corrected and settlement made and it is uncertain in the regulations approved by Parliament if this is to be directly between the sub-contractor and MOD or through the contracting line or the MOD is left to pick the party it wishes on a case by case basis.

Regulation state that each higher tier contractor is responsible for assessing if any sub-contract to be awarded is a qualifying sub-contract (thereby subject to the regulations). Failure by a higher tier contractor to notify its sub-contractor that a sub-contract will be a qualifying sub-contract exposes the prime contractor to significant penalties. In order to avoid the risk of serious penalties it is likely to be that higher tier contractors will default to sub-contractors being advised that the sub-contract will be a ‘qualifying sub-contract’ and thereby the regulations apply. The sub-contractor has the right to appeal to the SSRO the higher tier contractor’s assessment that the contract will be subject to regulations.

In order to agree the price of a single source contract which is to be priced by reference to cost estimates the contractor should agree with MOD’s Cost Assurance and Analysis Service (CAAS) not only rates and factors to be used within the pricing, but also the prime cost estimates to which these are applied. Whilst this is likely to be secured in the pricing of the initial contract it is uncertain if MOD has the desire, capacity or capability to support the pricing of changes to qualifying sub-contracts that not the consequence of changes MOD made to the prime contract SOW

CAAS accountants are responsible for the investigation and recommendation of both actual and forecast labour and overhead rates together with assessment of the contractor’s Capital Servicing Allowances based upon the latest agreed by government. The sub-contractor is not required to make this, or any other pricing information available to its customer; it is only required to make the information available to MOD as part of its records and reporting obligations.

CAAS accountants and cost engineers will jointly review labour rates and utilisation and discuss implications that an excess or shortfall in capacity has upon the rates. For those contractors that are subject to supplier reporting regulations (31 through 45) there are specified templates issued by the SSRO together with statutory guidance.

Arrangements for new non-qualifying contracts

Many existing DEFCONS are either withdrawn for use on new contracts to reflect the demise of the Review Board and absence of remedy limitation for defective pricing (DEFCONS 648; 648A, 650; 650A; 651; 651A, 652) or substantially modified (DEFCONs 127; 530; 643; 653) or new DEFCONs that aim to MOD similar rights to those contained within the DRA and regulations (811, 812; 813; 814815). These DEFCONs need to be negotiated and not assumed to be fit for purpose or provide an adequate framework.