Looking after your supply chain

Even in a tough market, there will always be demand for roads, rail, ports, hospitals, telecommunications and defence. Significant opportunities are still available despite the ongoing impact of the GFC.

To meet the challenge of the current market the private sector has increased efforts in building long term relationships with global players in the supply chain and also local players. In some cases, there has been a move away from traditional customer-supplier relationships towards

long term performance based relationships, which foster an environment where parties are able to invest in capability and are willing to be more flexible as project demands change.

Developing a strong performance based contract requires significant negotiation, particularly where the supplier has clout. This cannot be left to the last minute. However, the effort does pay off. We talk about performance based contracting in more detail on page 8.

Insurance: notation of interests 2

Protecting confidentiality 6

Performance based contracting 8

International arbitration 10

Discussed inside:

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Notation of Interests in Insurance Policies

Insurance is an important component of the risk profile of any major construction and engineering project. Construction and procurement contracts usually require the contractor or supplier to take out insurance policies to cover various risks that might eventuate during the course of the project. It is common for the principal’s interest to be ‘noted’ on these policies. Here are two examples of policy certificate wordings that deal with the notation of interests:

Noting [OwnerName Pty Ltd] for their interest in contract number 01010101.…

Noting [OwnerName Pty Ltd, of 1 Project Road, Melbourne, Victoria] – in contracts with [BuilderName Pty Ltd].

Noting a principal’s interest on an Australian insurance policy does not make the principal a party to the policy. But does noting an interest in this manner give the principal the right to be covered by the insurance policy and to make a claim under it, even though the principal has no contractual relationship with the insurer?

In looking at this question, we will focus on the rights available to third parties by reason of the Australian High Court’s decision in Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107 and Section 48 of the Insurance Contracts Act 1984 (Cth).

The privity of contract rule

In law, there is a long established rule called ‘privity of contract’, which means that only the parties to a contract are bound by the contract and are able to enforce its terms.

Because of the privity rule, it had been the case that it was not open to a third party – somebody who was not a party to an insurance policy – to be able to sue under the policy or to enforce the terms of the policy for its own benefit, even if the policy itself evidenced some intention that the third party should benefit from the cover. However, by its decision in Trident the High Court of Australia recognised the potential injustice that this rule can cause in the context of insurance, and established a specific exception.

In Trident, the High Court upheld the contractor’s right to indemnity under an insurance policy effected by a principal that was expressed to benefit the contractor even though it was not a party to the insurance policy. The High Court decided that while the privity of contract rule continues to be part of Australian law, there may be an exception to the rule where the following circumstances exist:

•thetermsofthepolicyshowclearlythatthe intention was to benefit the third party;

•thereisalikelihoodofreliancebythe third party on the promise being performed;

•itwouldbeunjustifthethirdpartyisrefused relief.

The High Court reasoned that, in cases where it is clear that an insurance policy extends cover to third parties, a strict application of the privity doctrine does not give effect to the expressed common intention of the parties, on the basis of which the third party has ordered its affairs.

While the decision in Trident does afford some relief to third parties seeking indemnification under Australian insurance policies, it is by no means clear that this relief would be available to principals or others whose interest is merely ‘noted’ under the policy. In order for the Trident exception to apply, it must be clear from the terms of the insurance policy that the third party is intended to be covered.

Rights under Section 48 of the Insurance Contracts Act 1984 (Cth)

The decision in Trident came at a time when the Insurance Contracts Act 1984 (Cth) (Act) had not long been in force (it commenced on 1 January 1986). If this legislation had applied retrospectively, it is unlikely that the decision in Trident would have been necessary, at least in the context of third party rights under insurance contracts. This is because Section 48 of the Act creates a statutory right of a third party to have the benefit of cover afforded under an insurance policy, and a right to make a claim under such a policy, provided that the third party meets the requirements of the provision. Section 48(1) states:

Where a person who is not a party to a contract of general insurance is specified or referred to in the contract, whether by name or otherwise, as a person to whom the insurance cover provided by the contract extends, that person has a right to recover the amount of the person’s loss from the insurer in accordance with the contract notwithstanding that the person is not a party to the contract… (Emphasis added)

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As in the Trident decision, it is important to note that Section 48 does not make the third party a party to the insurance contract; it only gives the third party a right to indemnification by the insurer for a loss which is covered by the terms of that insurance contract. This was confirmed by the High Court in the recent case of Zurich Australian Insurance Ltd v Metals & Minerals Insurance Pte Ltd and Others (2009) 261 ALR 468, in which the Court held (at [24]) that:

Section 48 confers a statutory right of recovery upon a non-party referred to or specified in a general contract of insurance as a person insured or to whom cover extends. It does so directly…Section 48 does not deem such a person to be a party to the insurance contract thus attracting the rights conferred on a party. It does not purport to confer contractual or equitable rights upon such a person.

Under Section 48 of the Act, an insurance policy must specify that a third party is “a person to whom the insurance cover provided by the contract extends”. So, is the act of simply ‘noting’ a principal’s interest on an insurance policy sufficient to demonstrate that the insurance cover is to extend to the principal? The authorities on the topic, such as the case of Perkins v Commonwealth Bank of Australia Ltd & Ors [2003] NSWSC 346, suggest that the answer to this question is likely to be ‘no’. In that case, the plaintiff, Perkins, was a bank teller who was injured at work. Perkins was employed by Adecco, a company which supplied casual workers to the defendant, the Commonwealth Bank (the Bank).

Simpson J found that the Bank was liable in negligence for Perkins’ injury. The Bank then commenced proceedings against Adecco, arguing that it breached a clause of an agreement between Adecco and the Bank that required Adecco to “effect and maintain workers’ compensation insurance and unlimited Common Law insurance cover for [Adecco’s employees] in the name of [Adecco] (with the Bank’s interest noted thereon)”.

The evidence showed that Adecco only took out a workers’ compensation policy and failed to take out an insurance policy covering common law claims. The Bank argued that the requirement in the clause that the Bank’s interest be noted on the policy was intended to be a requirement in terms of Section 48 of the Act – namely, that the Bank be noted on the policy “as a person to whom the insurance cover provided by the contract extends”. Ultimately, as the relevant policy did not exist, Section 48 did not need to be considered. However, Simpson J considered Adecco’s obligations under the contract and held (at [294]) that:

Construction of the clause is not straightforward. Strictly speaking, the clause requires only what it says: that Adecco effect (relevantly) insurance against common law liability, in its own name, “with the Bank’s interests noted thereon”. Senior counsel for the Bank was unable to provide any authority which clarified the effect of a notation on an insurance policy of the interest of a third party. It seems to me that, without more, such a notation would give the third party no rights under the policy. The third party would not

Noting a principal’s interest on an Australian insurance policy does not make the principal a party. But does it still give the principal the right to be covered?

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thereby be made a party to the policy and would not be entitled to cover under it.

If [the clause] were to be interpreted as requiring Adecco to do no more than note the Bank’s interest on the policy it would be pointless so far as the Bank was concerned…I am satisfied that what the parties intended by [the clause] was that Adecco was required to effect relevant insurance with the Bank noted on the policy as a person to whom the insurance cover provided by the contract extends. That would give the Bank the right to indemnity under the policy against its liability to the plaintiff. (Emphasis added)

According to Simpson J, a mere notation of an interest of an insurance policy would not afford rights to a third party under provisions like Section 48 of the Act. There is, it is suggested, some justification for Her Honour’s view. It is difficult to see how a mere notation would be sufficient to demonstrate that a third party was to be a person to whom the insurance cover

provided by the contract extended such as to bind the insurer to cover that party, whether under Section 48 of the Act or otherwise. If this is what is intended, then it should be made clear in the policy wording or the certificate (or both).

More important in the particular case before Simpson J was the contractual term which gave rise to the obligation of Adecco to effect the insurance in the first place. On its face, the contractual clause in question only required Adecco, when taking out the insurance policy, to “note the Bank’s interest thereon”. However, while Simpson J considered that merely noting an interest on the policy (had it been taken out) would not have been sufficient to demonstrate that cover was intended to extend to the Bank, she was prepared to find that the parties’ contractual intention had nonetheless been for the policy to have had this effect. This raises another important point, which is that a contractual term which creates the obligation on the contractor to note the principal’s interest or to otherwise ensure that the principal has cover under the insurance policy, itself needs to be clearly worded.

Practical considerations

Both Trident and Section 48 of the Act enable principals and other third parties to a contract of insurance to have the benefit of cover afforded by an Australian insurance policy where it is intended that they should do so. However, there are some basic requirements that must be met in order to ensure that this protection is available. Most importantly, it must be clear from the terms of the policy that the cover available is intended to extend to the principal or other third party concerned. While the aim of simply noting a principal’s interest on a policy might be to give the principal the benefit of the insurance cover, there is a risk that it won’t have this effect.

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Accordingly, it would be a good idea to make it obvious on the policy certificate that the parties intend to attract the operation of Section 48 of the Act and the principles under Trident. Some examples might be:

Noting [name of principal/third party] as a person to whom the cover provided by this insurance contract extends.

Or:

Noting [name of principal/third party] as a person to whom the cover provided by this insurance contract extends for the purposes of Section 48 of the Insurance Contracts Act 1984 (Cth).

In addition, it is important to check the terms of the policy to ensure that there is nothing that would exclude or negate any extension of coverage to the third party.

Of course, another way to avoid the risks outlined above is to have the principal expressly named as an insured in the policy.

Finally, decisions like Perkins demonstrate that contractual clauses requiring contractors or others to effect insurance intended to cover the principal must be carefully drafted. A term of a construction contract which requires a contractor to effect insurance with the principal’s interest to be merely ‘noted’ on the policy

might lead to argument. Clauses should clearly state that the insurance cover to be effected by the contractor must extend to the principal, or preferably, require the principal to be named expressly as an insured in the policy. n

“While the aim of simply noting a principal’s interest on a policy might be to give the principal the benefit of the insurance cover, there is a risk that it won’t have this effect.”

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Over sharing or careless sharing between consortium members creates confidentiality problems. A team member may be part of a rival consortium on another bid in the future. This creates the risk that information shared today with a team member may ultimately fall into the hands of a rival consortium on the next bid.

Team members should sign a confidentiality agreement at the earliest possible time. Don’t wait until the consortium agreement is formalised – this may never happen, particularly if the bid is not successful. Don’t exchange any confidential information until every team member has signed the confidentiality agreement. Once the confidential information has been provided, there may be no incentive for the other team members to sign.

The confidentiality agreement is helpful but it is not a complete guarantee that your information will be protected.

Be aware that your conduct may strengthen or undermine your claim to confidentiality. The Courts will look at factors such as:

•expresswarningsofconfidentiality;

•measurestakentoguardorprotect the information;

•thevalueoftheinformationtothe person disclosing the information;

•thesensitivityoftheinformation;

•whethertheinformationisgivenaway for free, or if payment is required;

•evidenceofpastpracticegivingrise to an understanding of confidence; and

•whetherthepersondisclosingtheinformation has an interest in the purpose for which the information is to be used.

Restrict access to your confidential information by disclosing only as much as necessary. This is particularly relevant for pricing data, where the devil is often in the detail. Limit the number of recipients.

Make it clear that the joint bid is confidential. This can be covered in the confidentiality agreement.

Establish a protocol for marking documents as confidential and stick to it.

Establish a protocol for use of and access to any shared database. Ensure there is a written agreement about what will happen to the data uploaded onto the database after the bid stage is completed.

Retain a separate back up copy of any document you upload onto a shared database.

Do not place confidential information in the public domain. As soon as information is in the public domain, it becomes ‘public property’ and loses the quality of confidentiality necessary to be protected as ‘confidential information’ (although the information may still be protected in specific circumstances, such as where intellectual property rights arise).

Don’t tolerate misconduct. If you find that bid information is being misused, you may be entitled to an injunction or an order for delivery up of the confidential information. Damages or an account of profits may also be available. n

Joint Bids – Protecting Confidentiality

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Joint bids necessarily involve sharing confidential information. Today’s team member may be in a rival team next time… with the risk your information will fall into the wrong hands.

Many businesses are looking for ways to reduce supply chain risk. There is a move away from the traditional customer-supplier approach towards performance based contracts that emphasise accountability by creating direct links between performance and remuneration. A KPI regime can underpin a strong long term relationship where the supplier has ‘skin in the game’. However, the KPI regime will have no teeth unless it is contractually binding and has the necessary flexibility to change as business priorities change.

KPI regimes have been in use for years. Over this time, industry commentators have identified a number of factors that can ‘make or break’ a KPI regime.

Flexibility

Inflexibility in the regime is a factor which is often identified as a source of problems - where the parties have locked in an arrangement without giving adequate consideration to the possibility that they will need to change the indicators and weightings as business priorities change.

Negotiating a KPI regime that is both binding and flexible can be a challenge.

Integration

The first step is to ensure the KPI regime is properly integrated into the contract and is consistent with the risk allocation. Obvious problems will arise if there is a conflict between the KPI regime and the obligations described in the terms

and conditions. Sometimes the KPI regime seems to be an afterthought with the contract being signed before the regime is fully documented. If the contract indicates that a KPI regime is to be negotiated after execution, this may give the impression to the supplier that the purchaser is not serious and that the regime is nothing more than a reporting mechanism. If the regime is intended to be contractually binding and to have financial consequences then it needs to be documented before the contract is signed and it needs to be annexed to the contract.

Scope

One of the attractions of a KPI regime is the opportunity it provides to bolster and clarify the general obligations described in the terms and conditions. The person drafting the regime needs to have a clear understanding of those general obligations and to work within that framework.

Often the service obligation described in the contract is expressed in high level terms. The clause may rely on the Scope to identify and define the services to be delivered. For example, the contract may include a clause that says:

The Contractor shall supply the Security System and carry out the Maintenance Services described in the Scope of Maintenance Services in accordance with the terms and conditions of this Agreement.

The Scope then provides details of the services. For example, it might include a provision that says:

The Contractor is to:

•Establishandmanageapreventativemaintenance program for the Security System, including documenting an asset management plan, recording maintenance performed or deferred, and monitoring of warranties, defect liability periods and service contracts;

•Manageadhocmaintenanceandrepairrequirements, including recording of and responding to ad hoc maintenance and repair requests.

This demonstrates that even at the Scope level, the requirements may be expressed in general terms. The Purchaser may be unable or unwilling to prescribe in the Scope how the services should be performed, preferring to use the KPI regime to set performance benchmarks.

For example, the key objective for maintenance of the Security System may be that the Security System should operate without interruption, except for planned maintenance. If so, the Purchaser might decide on a single performance indicator for preventative maintenance, such as “no Major Unplanned Disruptions to service”.

At this point, the negotiations get into the nitty gritty. For example, the parties would need to agree on the definition of ‘Major Unplanned Disruption’ (MUD) and the source data to be used to determine whether any particular interruption to the services was a MUD. The parties would also

Performance Based Contracting – Update

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need to agree on the measurement period (for example, monthly) and the penalty points that apply if the requirement is not satisfied.

From the Purchaser’s point of view, this approach provides an opportunity to pinpoint the consequences for specific kinds of non-performance. There is an art to this aspect of the exercise. Deficiencies and failures may be scored and weighted, leading to an immediate fee adjustment and attracting the immediate attention of the Contractor’s management.

The upside is that the requirements and outcomes can be locked in. The downside is that the arrangements may lack the desired level of flexibility.

Purchasers are often hoping for a flexible arrangement that imposes obligations that can be changed unilaterally. Although there are limits to the amount of flexibility that can be achieved, there are a number of ways to manage this issue.

Unilateral Change

Some KPI regimes include provisions that seem to give the Purchaser an unfettered discretion to vary key aspects of the regime, including adding or deleting KPIs and changing the financial consequences of KPIs. However, this kind of provision may run into enforceability problems if challenged. Generally, a variation (meaning a change in the terms of the contract) requires “consideration” (that is, payment of money) to be enforceable. A unilateral variation of the regime may ultimately be found to be unenforceable in the absence of consideration, if challenged.

Agreement to Agree

Another common approach is to include an ‘agreement to agree’ provision. For example, the contract may include a clause that states:

The Key Performance Indicators will be reviewed annually. The parties will use their best endeavours to agree on adjustments to ensure the Key Performance Indicators continue to provide an accurate measure of performance.

The ‘agreement to agree’ approach can work well when the relationship between the parties is strong. However, this kind of arrangement may let the Purchaser down when it is most required – when there is a sustained period of poor performance and no sign of improvement. If relationship difficulties have arisen, it may not be possible to negotiate changes. An ‘agreement to agree’ clause gives the Contractor the ability to block onerous changes. The Purchaser is not in a position to drive through unilateral adjustments to the KPIs without agreement.

Discretion to Determine Points

In some contracts the Purchaser is given discretionary rights that allow for a variable outcome, without the need to change the KPI regime. For example, the Purchaser may have the discretion to determine the number of penalty points that apply to breach of a particular KPI, within a pre-agreed range.

Generally, it would be expected that the exercise of the discretion would be expressed to be subject to certain criteria which afford some protection to the Contractor. For example, the contract might include an express term that when exercising the discretion the Purchaser must take into account the severity of the breach giving rise to the failure, the efforts made to prevent the failure, steps taken to correct the failure and the frequency of any previous failures to satisfy this particular requirement.

Automatic Adjustment

Another option is to pre-agree on a mechanism to reset the KPIs upwards to drive long term improvements. For example, the parties might agree that each year certain KPIs will be reset by an agreed percentage, irrespective of performance actually achieved.

Alternatively, the parties might decide that each KPI will be recalculated by reference to actual performance for the past year. This can backfire if the Contractor is, in effect, penalised for strong performance in one or two months of the year and has no incentive to do better than average. To avoid this outcome, the parties could agree to average the highest results for an agreed number of months and/or to impose an overall cap on the annual increase for the relevant KPI. An adjustment provision of this kind would need to be documented with care to ensure that it is clear and enforceable. n

If the KPI regime is intended to be contractually binding then it needs to be documented before the contract is signed.

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The High Court’s decision in Westport Insurance Corporation v Gordian Runoff Limited [2011] HCA 37 was highly anticipated given its implications for the finality of arbitral awards. The High Court allowed Westport’s appeal and set aside the arbitral award that had been made in favour of Gordian Runoff due to the arbitrator’s failure to give adequate reasons. The High Court determined that the level of detail required in the reasons will depend on the circumstances of the case. This means that the level of detail that would be adequate for a simple case would not necessarily be adequate for a highly technical, complex case.

Notably however, the High Court’s decision related to a section of the old Commercial Arbitration Act 1984 (NSW) that has since been repealed to enable the incorporation of the UNCITRAL Model Law on International Commercial Arbitration (Model Law) into State and Territory commercial arbitration legislation. The introduction of the Model Law is intended to support the practice of international arbitration in Australia, and enhance Australia’s profile as an international arbitration jurisdiction by, among other things, giving parties more power to tailor the arbitral process to their needs and reducing the scope for judicial intervention. It will also apply to domestic arbitration.

Section 31(3) of the new legislation – based on Article 31(2) of the Model Law – provides that “the award must state the reasons upon which it is based, unless the parties have agreed that no reasons are to be given …”. While the High Court in Gordian Runoff declined to comment on whether its determination under the old legislation will continue to apply to the Model Law, it is certainly questionable whether it will do so given the intent behind the Model Law as explained above.

International Arbitration Update: Big Decisions, Big Changes

Despite the outcome in Gordian Runoff, arbitration still offers some genuine advantages over litigation, particularly flexibility and ease of enforceability for cross-border disputes. In terms of international arbitration, the incorporation of the Model Law represents a positive step in the right direction. However, there is a risk that there might be an international perception – based on the trend from cases such as Gordian Runoff and the recent Victorian Court of Appeal decision in IMC Aviation Solutions Pty Ltd v Altain Khuder LLC [2011] VSCA 248 – that Australia is not an arbitration-friendly jurisdiction given the possibility of judicial intervention and the High Court’s

statement that arbitration is not a wholly private matter. On the other hand, the 2010 Mealey’s International Arbitration Report, which surveyed corporate counsel’s views toward international arbitration, noted one source of disappointment as being “bad decision making” or “poor reasoning” in awards. It might be said that the Gordian Runoff decision goes some way to addressing these concerns, particularly in the context of large and complex disputes. n

Disclaimer

The content of our publications is intended only to provide a summary and general overview on matters of interest, current at the time of publication. The content is not intended to be comprehensive, nor does it constitute legal advice. You should seek legal or other professional advice before acting or relying on any of the content.

The endnotes to the articles in this publication have been omitted. Full versions of the articles can be downloaded from our website at: www.molinocahill.com.au/publications

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Tony Molino

Director

MolinoCahill Lawyers

T +61 3 9606 3210

tmolino@molinocahill.com.au

Meghan Cahill

Director

MolinoCahill Lawyers

T +61 3 9606 3299

mcahill@molinocahill.com.au

Penny Swain

Director

MolinoCahill Lawyers

T +61 3 9606 3209

pswain@molinocahill.com.au

Alastair Oxbrough

Director

MolinoCahill Lawyers

T +61 3 9606 3215

aoxbrough@molinocahill.com.au

Brigid Lloyd

Director

MolinoCahill Lawyers

T +61 3 9606 3202

blloyd@molinocahill.com.au

Level 22, 181 William Street, Melbourne, VIC 3000, Australia

Telephone +61 3 9606 3200 Facsimile +61 3 9606 3222

www.molinocahill.com.au