Is it time to revisit your FM Contracts?


Author: Tim Wright


Tim Wright, Partner, Fladgate LLP (twright@fladgate.com)


 

With the UK remaining set to leave the European Union on 29 March 2019, possibly crashing out without a deal, buyers of facilities management (FM) services (who haven’t already) should urgently act to review key contract terms in relation to business critical services and, where appropriate, put in place contingency plans and contract amendments with their providers. Key areas of potential impact for review include:

Regulatory compliance – whilst the draft Withdrawal Agreement contemplates a transitional period during which European law will continue to apply in the UK, it is not so clear what will happen if there is no deal. FM outsourcing contracts are often low margin, hence the cost of change – including what the contract says about which party pays for implementing and complying with regulatory change related to the services – can be a point of contention between the parties. Whilst government policy is to try and provide continuity in the event of no deal, it is inevitable that there will be some regulatory change after March, as well as the potential for further divergence between UK and EU regulations in the future.

Staffingstaffing plans should be reviewed, unfilled roles identified and work-arounds agreed. Labour costs are the largest component of FM costs and, if Brexit results in a reduction to the labour force (for example if a points-based immigration system is introduced), wages may rise. Apart from wage increases, there will be related implementation and ongoing operational costs. If immigration laws get much tougher in UK – or across Europe – meaning that is becomes more difficult and expensive to recruit and hire staff, there will also be upward pressure on overhead and administrative costs related to personnel. Industries such as facilities management which are reliant on low cost migrant labour will bear the brunt of these cost pressures.

Other input costsapart from staff, other input costs (consumables, equipment, spare parts etc.) may increase after Brexit especially if the UK crashes out without a deal and sterling falls further; a no-deal scenario may also result in changes to when VAT becomes due on some categories of goods imported from the EU, which could impact cash flow. There may also be issues with scarcity of supply or delays where goods move across borders. It makes sense for customers to work with their providers to anticipate these types of issues, although the underlying contract provisions should, of course, inform any such discussions and renegotiations.

Who pays as costs rise? Depending on the contractual price model, increased wages and input costs may fall on the service provider or be reimbursed by the customer. Whilst the pricing of many FM contracts is on an ‘open book’ cost plus management fee model, whereby the service provider is to a large extent protected from most cost increases, there are plenty of other FM contracts which are let on a fixed price or guaranteed maximum basis, often over a considerable period. Open book contracts often include constructs such as a savings glide path, a commitment from the service provider to deliver savings on FM spend over the life of the contract, with savings much more difficult to achieve against a background of rising costs. Gain-share/pain-share models might also be affected, practically speaking.

Force Majeureit has been suggested by some that Brexit might amount to a force majeure event. In other words, a party unable to fulfil a contractual obligation (or faced with higher than expected costs) could argue that Brexit provides them with an escape route on the grounds of frustration. This is what the European Medicines Agency argued in a recent case before the High Court, in their bid to escape a 25 year lease with Canary Wharf Group following the announcement of their relocation to Amsterdam. However, the Judge ruled that the lease could not be avoided in the absence of an express right to break the lease. Some contracts will have a so-called Brexit clause, but this often amounts to little more than a trigger to reopen the pricing or a potentially unenforceable “agreement to agree”.

Innovation  whatever happens with Brexit, now is a good time for customers and providers to work together to ensure that they have robust contingency plans so that service delivery and quality is not affected, and risk is appropriately mitigated. In particular, the parties should take a fresh look at current solutions, as well as innovation and the implementation of operational enhancements (whether through a contractual innovation framework or via the governance structure). Disruptive technologies like robotics and automation could potentially be adopted to drive up performance and lessen reliance on a potentially shrinking, disrupted and increasingly costly workforce.

Future-proofed contracts

With many FM contracts let for terms of five years or longer, some will have been written many years ago and have been extended on one or more occasions. This means that contract terms will often lack mechanisms to deal with unexpected events such as Brexit, as well as other significant changes to scope brought on by mergers, acquisitions, disposals, shut downs and the like.

Where FM contracts are (re)negotiated to include Brexit clauses, customers should be wary of open ended clauses, especially where there is excessive (or unproven) risk pricing; equally customers should be looking to achieve robust scope removal clauses which give them the flexibility to adjust the scope (service lines, in-scope sites etc.) over the term of the agreement without being treated as a full termination or being held to ransom by their providers in connection with a range of issues (including cost) such as exit assistance, knowledge transfer, re-tender support, post-term licences, breakage costs, and transitional service support to the divested business.

Living Wills and Contingency Plans

Another area of concern relates to the financial viability of many of the larger FM providers. The insolvency of Carillion in January 2018 and the knock on impact on its supply chain has been much reported. Other big players such as Babcock, Keir and Interserve have all been in the press recently with reports of financial problems. Many are suppliers to the UK government which has been working to adjust its procurement procedures based on some of the lessons it learnt from having to step into the mess left by Carillion’s insolvency[1]. One idea is to have each major government supplier produce a “living will”; that is a plan “for how public services provided by a supplier can be secured and continued in the event of a potential company’s failure, to allow government time to transfer the services safely to a new supplier, or take them in-house”.

The notion of a “living will” appears to go beyond what we often see in B2B FM contracts around exit and contingency planning, so it may be worth keeping a close eye on what the government does here. In any event, undertaking ongoing due diligence on key suppliers, including any deterioration of their financial position, as well as other events which might cause them catastrophic damage, such as the loss elsewhere of a key contract, is important. Parent guarantees can provide some comfort, but not where the whole pack of cards comes crashing down.

IR35 and Contingent Workforces

An important change in UK employment law is coming into effect in April 2020 and could have a huge impact on any industry which relies on a significant numbers of self-employed contractors.  The change will crack down on tax benefits for the self-employed by reforming the “off-payroll” rules such that for self-employed contractors (who provide services via a personal services company) the responsibility for deducting tax and national insurance contributions will shift to the organisation responsible for paying the individual’s personal service company.  Failing to act on this change is likely to lead to companies falling foul of the new rules and being compelled to pay unpaid national insurance and tax as well as fines. Customers of FM services are usually wary about any co-employment risk which may potentially arise from the proximity of a service provider’s workforce at its offices, sites and other premises, and it would make sense to review contractual provisions in current FM contracts to ensure that the protections there are sufficiently robust.

Concluding Remarks

Whatever flavour Brexit ultimately takes, there will inevitably be friction. With the planned exit day fast approaching, an urgent review of relevant contractual provisions is recommended as part of wider Brexit contingency planning. Apart from Brexit, there are plenty of other reasons for a contractual review of existing FM contracts as well as the contractual forms being used in ongoing and planned FM procurement exercises.


[1] https://www.gov.uk/government/news/new-social-value-contracts-to-revolutionise-government-procurement


 

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