Pathway
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Ref: — Contract
PATHWAY. DRAFT CONTRACT RESPONS Version 1.0
Date: 29-Dec-95
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PATHWAY DRAFT CONTRACT RESPONSE
1
yee Ld
This paper provides the response to the Draft
Contract’ Version 1.5 dated 21 December 1995
BA/POCL Core Negotiating Team
Bird and Bird
Pathway Shareholders
Pathway Banks
First draft: Internal to Pathway only
Tony Opperiheim
Tony Oppenheim
Tony Oppenheim
2 January 1996
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PATHWAY DRAFT CONTRACT RESPONS Version 1.0
Date: 29-Dec-95
0.1 CONTENT
0.1.1 DOCUMENT HISTORY
VersionI Date Reason
0.1.2 ASSOCIATED DOCUMENTS
Version I Date Title Source
0.1.3 ABBREVIATIONS
BA Benefits Agency
BES Benefit Encashment Service
BPS Benefit Payment Service
CAPS Customer Accounting and Payment s System
CMS Card Management Service
PAS Payment Authorisation Service
PMS Payment Management Service
POCL Post Office Counters Limited
SSR Statement of Service Requirements
TMS ° Transaction Management Service
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PATHWAY DRAFT CONTRACT RESPONS I Version !.0
Date: 12/29/95
1. INTRODUCTION
There are three separate contracts:.an “Umbrella” agreement, a POCL
agreement and a DSS agreement.
The first draft was issued by BA/POCL on 21 December for high level comment
back by mid-day on 3 January.
No Schedules are included, but in all other respects, the documents are
substantially complete. Timescales remain unclear.
This is a first pass brief for Pathway personnel as to the key issues. Ie will be
re-written as input to BA/POCL.
Comments are invited!
2. HIGH LEVEL COMMENTS ON PRINCIPLES
In general, there is a lack of symmetry as between Contractor and Authorities’
rights and obligations. This lack of balance represents a poor basis for an
enduring business relationship - all stick and no carrot.
The possibility exists for the Authorities to be better off in the event of a
default (which may not be material, but nonetheless provides a pretence for
non-acceptance or cancellation) than if the contract is carried out perfectly.
This goes.against fundamental principles of English law.
Events of default are not defined by reference to clear SLA’s or delivery
milestones, nor is there any provision for step in.and substitution.
There is a very high level of risk transfer. Comprehensive fraud risk,
consequential loss, government legislation change and obsolescence are notable
for not being within the Contractot’s sole control.
As written, several of the conditions are both unbankable and uninsurable.
There is a strong reliance on and requirement for parent company guarantees.
Given the lack of requirements-definition at this point, there is a strong
likelihood that the products and services produced initially (at Contractor’s cost
and risk largely ahead of award) will fail to meet.all the Authorities’ aspirations.
The.standard.remedy period is just 30 days. This translates into a high level.of
discretion on-the part of the Authorities as to whether or not they choose to
accept certain services:or to’continue with them even-after they have been
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PATHWAY DRAFT CONTRACT RESPONS Version 1.0
Date: 29-Dec-95
accepted. This represents-a high risk scenario for shareholders in any but the
most favourable of circumstances.
Judgements are provisional based on implied initént-at this stage because none of
the key Schedules which define the:spécific terms is includéd.
3. SPECIFICS IN NO PARTICULAR ORDER OF IMPORTANCE
3.1 Liability and termination
Contractor liability on fraud appears unlimitéd, whether or not under
Contractor control. It extends to impersonation of card holders arid DSS and
POCL staff:or agent fraud. The onus is entirely on the-Contractor to prove
fault on the part of the Authorities in order to mitigate financial impact or to
secure correction [page 66 of.Main Agreement]. Yet the “overall service
objectives” [page 2] appear to imply that such.risk transfer should be at no/
minimal cost to the Authorities: [Also, the extent of risk transfer is completely
at odds with earlier statements to the effect that a minimally compliant PFI
structure was being sought, with minimum risk transfer and minimum cost.]
Limits of liability on Contractor. for matters other than fraud (unlimited) are
uncommercially/ uninsurably high and are in extremis difficult to quantify. At
150% of “Charges payable over the duration”, these could exceed £1 billion
(pages 69 to 75}.
Consequential loss [page 74] applies to Contractor but not to Authorities.
Authorities may terminate the contract at six months notice for convenience (ie.
without cause), albeit a Termination charge is then payable [pages 78 and 79].
In that event, Contractor must [pages 81. to 85] assign/ novate all assets, service
agreements, licence, pass across full source and documentation, assist
Authorities in transition for a fee, permit third parties. to develop extensions to
software, enable transfer of key personnel to the Authorities, and hold data on
past.service for six years (free) [page 53].
The basis of Termination/ Transfer charge is unclear [no Schedule 9].
A change-in “government regulations” is deemed an example of Force Majeure
(without any limitation) [page 35] notwithstanding that one of the Authorities is
to be the Secretary of State for Social Security. Unless bounded, this could
include the active promotion of ACT’s, changing from weekly to monthly
benefit encashments, privatising the post office or POCL (possibly ‘resulting in a
large reduction in the number of post offices), permitting supermarkets to cash
benefits, etc..
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Force-Majeure protects the Authorities from third party action [Are the
Subpostmasters third parties, could a-contractor developing CAPS be deemed to
be a third party?], but the Contractor is required to carry on the service if any
other party could be held to be in a position to do so, its failure to do so within
90 days being grounds for termination. ‘The right to termination is one way.
3.2 Operational trial and roll ouit of steady state services
The definitions of requirement or timetable are not clear in the absence of
Schedules C2, C3 or A7.
Acceptance of the Trial.system does not in itself represent acceptance of Steady
State Services. there-appears to be some duplication and overlap as between the
two, or at the least, a need to define clearly how they differ.
The onus is on the Contractor to have assessed requirements correctly in
sufficient time to develop the Trial system for “successful” Trial.
The Trial may be successful in whole, in part or not at all. The Authorities may
extend the time to permit a successful Trial, but they may choose not to and to
reject that part of the system. [pages 16, 17] The same applies to Steady Stae
Services.
The notion of a pro-rated Charge in event of partial take up of either Trial
system or Steady State Services needs to be related to the charging mechanism
by. component of service. [Charterhouse:scorecard approach] -
There is an implication that there could be a charge related to acceptance of the
Trial system which is-different from the service based charging mechanism. This
does not correspond to the Charterhouse document and needs to be clarified.
The term “Roll Out Completion Date” has yet to be -defined, Contract term is
to be S years from that date.
Ivis still unclear how’in practice card versus infrastructure roll out.is to be
tackled, specifically: with respect to foreign encashments, or how Roll Outis
supposed to be carried. out viz-a-viz Operational Trial. Clause 404.2 of the
POGL agreement states that “POCL may on prior written notice defer
implementation of the POCL Steady State Services until-successful completion
ofthe Operational Trial ....” Clause 902.4 of the Main.Agreement states that
“in the event of any-termination of the Authorities’ Agreement ..... prior to the
Operational Trial Procedures being recorded as successful .... the Authorities
shall be entitled to return the Service Infratructure .... and the'Contractor shall
give full refund of all monies paid in connection with such returned items and
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the Development Services [implying a possible separate payment?], and shall
reinstate the Premises to their prior state at no cost to the Authorities.” These
would tend to imply an expectation that roll out may be going on in parallel to
Operational Trial at Contractor’s risk.
3.3. Intellectual Property Rights
Clause 501.1 states that “Ownership of.all IPR in the design of the Service
Architecture (as set out in the Service Architecture Design Document) shall vest
in the Authorities upon acceptance by the Authorities of the Operational Trial
System.....” “Service Architecture” is defined as the overall structure of the
Steady state Services, thé Service Infrastructure and thé Service Environment.
This is a very high level (and potentially all-embracing) definition. The
implications need to.be understood, both with respect to existing use (as by An
Post) of a similar blueprint and components thereof, and for re-use of
components elsewhere (eg. in other Post Offices overseas).
Clause.506.1 of the POCL.Agreement states that, where IPR remains with the
Contractor, “in consideration of the payment of the rélevant Charges, the
Contractor grants ..... POCL.a perpetual, royalty-free irrevocable and non-
exclusive licence to use, reproduce, modify, adapt and enhance the relevant
Specially Written Softwaré and to use the Documentation. If owned by another
party, Contractor shall procure such a licence from the owner.
Clause 506.3 of the-same.agreement states that “the Contractor shall supply
POCL with a copy of the source code of the relevant Specially Written
Software”.
“Specially Written Software” is defined as any software written by or on behalf
of the Contractor pursuant to Clause 204 (Clause 204 describing “Supply of
Basic Products”, these being “all of the Products comprising the POCL Service
Infrastructure”) or as Optional or Additional Product”. The implied assertion is
that this is all bespoke for POCL and none derived from an existing source with
IPR already spoken for.
The requirement on other than Specially Written Software is that there be a
perpetual etc. licence to Use (but not to modify etc., except if escrow is
invoked).
3.4. Basic Service, additions and rights-to use the infrastructure and databases
The Basic-Service is-defined as BES, APT, EPOS, Infrastructure Services and
Contingency Services. In addition, there is the possibility of “Optional
Services”, not yet defined, and “Additional Services”. Likewise DSS.
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Clause 503 of the Main Agreement states that “POCL shall have the right to use
the POCL Services and the Infrastructure to capture, develop and use databases
containing information:in relation to its customers.” Not: “The Contractor
shall provide the information services to POCL as specified in Schedule XYZ for
consideration specified under Clause ABC .....”
Clause 106 of the POCL agreement states that “the Contractor shall ensure
migration of appropriate automated systems without any reduction in existing
service or security levels to POCL’s clients and customers”, but that “POCL will
retain contro] itself-of its critical business processes”, and that “Charges for any
Additional POCL Services shall be .... labour and materials” based. Clause
204.3 states that the Contractor shall Jease the Leased Products (not defined) to
POCL per Schedule B7 (not included).
3.5 Subcontractors, change of control, and assignment
The list of approved subcontractors can only be modified with the Authorities’
express approval [page 30].
The Authorities permit themselves to-assign without reference to the
Contractor. There is no provision for credit guarantees by the Authorities .in
such event.
The Authorities may términate if there is a change of control in the Contractor
or its Parent Company [N.B. What is the intended definition of Parent,
Company in the case of Pathway? Charterhouse and CNT have indicated a
requirement for joint and several guarantees by the shareholders, which could
imply that a change in ownership of any of the shareholders or their Parents
could trigger this condition, eg. an A&L take over.]
As stated earlier; the Authorities may terminate at six months’ notice without
cause.
3.6 Service definition
The implications of Clause 201 appear to be that the Contract will initially be
awarded against summary requirements in Schedules B! and B” (not yet
available), which will subsequently be replaced by more detailed Schedules
within 3 months.
It is unclear what. happens if there is a failure to agree those schedules during
those.3 months. Alternatively, it is an opportunity to put right and clarify.
3.7 Transfer
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Transfer terms are that except in case of termination for convenience, the
Authorities reserve the option to buy the infrastructure.
The fact that this could perversely incent the Contractor to milk assets from
about four years into the contract is at odds with the objectives set out in the
Charterhouse document. It is possible that “change control” procedures might
address this issue by agreeing upgrades to infrastructure during the’initial term
which would qualify for an unconditional end of term transfer payment.
The exposure in the event of failure to perform is potentially mitigated by the
Authorities right to be selective about which services they reject, but there-is no
assurance that such right will be exercised. Hence no step in procedure which
the-banks could rely on. Maximum cash/obsolescence exposure exists at a point
about two years into the contract when the infrastructure has been completely
rolled out and little revenue yet received.
3.8 Parent Company Guarantee versus limited recourse financing
A.Parent Company Guarantee is mandatory [page 88].
The required form is unclear (Schedule A11), but will doubtless specify
fulfilment of all obligations, penalties, remedies and damages under the three
contracts, plus post termination audit facilities for six years.
There is likely to be little scope for sharing the financing burden with the banks
using limited recourse PFI structures now becoming established in other sectors.
In particular, reliance on subcontractor guarantees has been ruled out.
The'reasons appear to be a Combination of:
- NIRS 2 did not require it (IT precedent)
- political sensitivity (fear of riots and the Public Accounts Committee)
- “Choice” (if IBM or Andersens are prepared to guarantee it...)
- nervousness about Escher specifically (dependence on a key subcontractor)
- integrator risk (sum of the subcontractor parts does not equal the whole)
Andrew Stott was clear in his briefing at CNT on 21 December that a Parent
Company Guarantee would be required and that Pathway’s proposed financing
structure was not acceptable.
3.9 Absent
There is no mention of Contractor being preferred supplier to POCL for new
services,
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There is no notion of “partnership” with POCL in developing the business
together at shared risk for shared reward, even by reference to some such intent
by another name for another document. There aré only control levers, penalties
and exclusions.
4, BUSINESS CASE
The business case is being reviewed with a view to understanding thé possible
impacts.
Set against the'statement by Andrew’Stott that’“The.BA/POCL business case
remains weak”, it is unlikely to look good.
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