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; BIRD & BIRD
90 Fetter Lane
. London ECA 1}P
To: POCL ; ; echo
Atten\Ref: Joe Ashton, PO Legal Services
Jonathan Evans, POCL
Sarah Graham, DSS Q
George McCorkell, BA ox
Dave Miller, Horizon Ustendon
Marilynne Morgan, DSS oeeebielscom
Mena Rego, POCL
Jeff Triggs, Slaughter and May
From: Hamish Sandison Partners
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Client: BA/POCL omcoyite
Account No: BPOCL/0001 TM Conk
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Date: 13 November 1998 Pett
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‘Number of pages (including this page) : 24 fecuatey
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Note: This fut is Intended for the named addressee only, Tecontains Information which may be confidential and OES
which may also be privileged. Unless you ore the named addressee (or authorised to receive for the addressee) Po} inn
you muy not copy or use it, or disclose it to anyone else. If you have received It In error please notify us Hi Sondien
immediotely so that we can arrange for its retum. To do so, or if you have any queries, plesse telephone 0171 payer
415.6000. . . : R)Viand
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THE ICL PROPOSAL - LEGAL AND CONTRACTUAL IMPLICATIONS jawed
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I attach a revised version of the Memorandum which I issued to you yesterday. Mere
This is still in draft form, but I have taken the opportunity overnight to correct Crendoen
some typos and to amplify our analysis of Pathway’s acceptance proposals (see HI Ran
paragraphs 30-36) based on my discussion with Dave Miller and colleagues aweaker
yesterday afternoon in which they reported back on their earlier meeting with ensinad
John Bennett and Richard Christou. Although their written proposal was not FARE
entirely clear, it is now apparent that Pathway are proposing that the Authorities bebe
should have no termination rights at all in relation to failure of live trial. RH Beswoch
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‘As agreed by George McCorkell and Jonathan Evans last night, I have also issued this
Memorandum -to Sarah Mullen to assist her in preparing the Interdepartmental Working
Group's Progress Report to Ministers. Ihave made clear that the attached Memorandum. is
still subject to your comments, which I would welcome at your earliest convenience.
HAMISH SANDISON
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MEMORANDUM
Legally Privileged & Confidential
TO: George McCorkell, BA
cc: Joe Ashton, PO Legal Services
Jonathan Evans, POCL
Sarah Graham, DSS
Dave Miller, Horizon
Marilynne Morgan, DSS °
Paul Rich, POCL
7 Jeff Triggs, Slaughter and May
FROM: Hamish Sandison and Hazel Grant, Bird & Bird
DATE: : [ ] November 1998
RE: The ICL Proposal Dated 9 November - Legal and Contractual
Implications .
BACKGROUND
1. You haye asked for our comments on the legal and contractual implications of
the proposal by ICL ple (“ICL”) and ICL Pathway Limited (“Pathway”), as set out in
a letter dated 9 November from Kcith Todd to Stephen Byers and the four attachments
to that letter (the “ICL Proposal”), in order to assist POCL and BA in drawing up a
joint assessment of the ICL Proposal for presentation to Ministers as part of the
Interdepartmental Working Group's progress report. Our comments address three
principal issues;
(1) How far the ICL Proposal departs from the current contracts with
Pathway (“the Related Agreements”);
(2) How far the ICL Proposal departs from the proposal tabled by Graham
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2 Corbett on 11 October 1998 at the end of the first round of discussions
between ICL, BA and POCL (‘the Corbett Proposal”); and
(3) How far the ICL Proposal departs from best practice in government
contracts as we see it, including where relevant the guidance issued by
the Treasury Taskforce on Standardisation of PFI Contracts:
Taskforce Guidance on Project Agreements (draft dated 7 September
1998) (“the Taskforce Guidance”),
‘We do not express any view on the acceptability or otherwise of the ICL Proposal to
either of the public sector parties.
2. In the time available, we have not been able to provide a detailed analysis of
the ICL Proposal. We are currently working on such an analysis. This Memorandum
represents a high level summary of the key points.
3. After commenting briefly on Keith Todd’s covering letter, we address the four
documents attached to his letter, in the same order they were attached, as follows:
: (1) ‘The “Heads of Agreement” for a public/private partnership between.
Pathway and POCL;
(2) The “Pathway Funding Paper” describing the changes they say are
needed by Pathway to enable them to raise finance for the completion
of the project; :
(3) The “Acceptance” paper which contains proposals for changing the
existing acceptance procedures; and .
(4) The “Commercial and Contractual Proposals” paper which lists all the
issues which Pathway consider have to be resolved now in order for
the project to move quickly ahead to completion.
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+ We note that this is not necessarily their order of importance for the public sector
parties. oO .
4, By agreement with BA and POCL, we are submitting this Memorandum in
draft form for comment by both public sector parties prior to any wider circulation
within government. It represents our own views, and not necessarily those of either
BA or POCL. Circulation of this draft Memorandum to HM Treasury has also been
authorised by BA and POCL in order to assist the Interdepartmental Working Group
in preparing their progress report to Ministers.
KEITH TODD’S COVERING LETTER
5. We note Keith Todd’s proposed date of “no later than 31 December 1998” for
the legal and contractual work to be done before “completion.” We presume that
“completion” means signature of any agreed amendments to the Related Agreements
to implement the ICL Proposal. The significance of this is that, in effect, Ministers
would not be in a position to know whether agreement had been reached or not on the
ICL Proposal until that date, We express no vicw on whether this timetable can be
achieved or improved, although we certainly agree that the legal and contractual work
implied by the ICL Proposal in the context of the Related Agreements is likely to be
highly complex and extremely time consuming.
» 6. We draw attention to Keith Todd’s request to let him know with whom he
should work on behalf of the public sector. This suggests - and we think this is
sensible - that, if Ministers wish to take up Keith Todd's invitation to hold further
negotiations, then they will need to include in their initial response to the ICL
Proposal some indication of their preferred approach to the negotiating process and
their proposed membership of a negotiating team on the public sector side,
7. We have no further comments on Keith Todd’s covering letter at this stage.
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cans OF AGREEMENT
8. The Heads of Agreement have been signed on behalf of ICL, Pathway and
POCL, but are stated to be non-binding (with the exception ofa standard
confidentiality provision in Clause 6). In particular, we note that the Heads of
Agreement are stated to be “subject to II M Government consent (including any
requirements of the DTD..., any relevant legal and tegulatory constraints (including
competition and public procurement issues), consideration of their impact on existing
contractual relationships with the Post Office or POCL and any relevant limitations
on the Post Offices’s powers” (paragraph 5.1), and “a satisfactory resolution of all of
the issues arising as part of {the Corbett] discussions (including any issues arising
with the Department of Social Security)” (paragraph 5.2). If these conditions are not,
met by 31 December 1998, the Heads of Agreement will lapse, underscoring the
importance of the “completion” date of 31 December 1998 mentioned in Keith Todd’s
cover letter.
9% For these reasons, we have not reviewed the Heads of Agreement in depth.
_Overall, however, they do not appear to contain any financial proposals which, on
their own, would serve to bridge the financial gap between Pathway and POCL which
existed at the end of the first round of the Corbett discussions. It seems clear
therefore that, if this gap is to be bridged, it must be bridged by other elements of the
ICL Proposal which are in addition to the proposed public/private partnership .
envisaged by the Heads of Agreement.
PATHWAY FUNDING PAPER
{ntroduction
10. _ The Pathway Funding Paper sets out the changes to the Related Agreements
which Keith Todd says are needed to enable Pathway to raise finance for the
completion of the project. Pathway’s proposals draw heavily on the Taskforce
Guidance. However, as Pathway notes, and as the Treasury itself has acknowledged,
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Oe Taskforce Guidance is “more suited to accommodation rather than information
technology projects” (paragraph 1.1). Accordingly, it will be important in our view
for the public sector parties not to assume that suggestions contained in the Taskforce
Guidance are appropriate for the BA/POCL automation project. In particular, they
will wish to take account of comments on the Taskforce Guidance made by CCTA,
the Government's IT advisory agency. (As you know, Bird & Bird are legal advisers
to CCTA, and we will be happy to facilitate a read across from the CCTA view of
‘best practice in IT contracts to the Treasury Guidance where appropriate.).
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11. _ Inits introduction, the Pathway Funding Paper also refers to the proposed
restructuring of the ICL/BA/POCL relationships to establish a single interface
between Pathway and POCL,; as described in greater detail in the Contractual and
Commercial Proposals paper (see paragraph 37 below). Indoing so, ICL asserts that
this revised structure is “more likely to facilitate raising additional finance from
lenders” (paragraph 1.2). This is obviously not a subject addressed in the Taskforce
Guidance, and need not be accepted at face value, While in principle it ‘hmust be right
that funders will prefer a simpler contract structure, we suspect that they will favour
whichever structure is best suited to secure successful completion of the project to the
mutual satisfaction of all the parties involved, including ICL, BA and POCL.
Accordingly, we suggest that ICL’s proposed contract structure should be evaluated
on its merits, and not simply on its asserted attractiveness to ICL’s lenders.
Acceptance Regime
12. If termination occurs on acceptance, presumably because Pathway has failed
acceptance, Pathway propose that POCL should pay termination payments and
guaranteed volume payments (seé paragraph 2). It is not clear to us what the
guaranteed volume payments would be in a scenario where acceptance had not been
achieved, The reference to termination payments is also unclear, since paragraph 6.2
Gi) states that no compensation will be payable prior to the start of national roll-out in
the event of Pathway default. ,
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“13, Although not expressly stated in the Pathway Funding Paper, the relaxation of
” acceptance procedures, criteria and remedies proposed in the Acceptance paper are
clearly a key element of ICL’s proposals for enhancing the fundability of the project,
and the Pathway Funding Paper needs to be read in conjunction with the Acceptance
paper. If Pathway's proposals on acceptance are not agreed, it is unclear whether the
proposals contained in the Pathway Funding Paper will be considered sufficient on
their own to raise enough finance to complete the project.”
Termination by POCL
14, Pathway propose to limit POCL’s present termination rights. As now, POCL
would be entitled to terminate after a force majeure event fora specified period,
voluntarily on payment of compensation (ie, termination “for convenience”), on the
ocourrence of Pathway default, and on breach of the prohibition against corrupt gifts
(subject to modifications described below) (see paragraph 3.1), However, POCL
would not be entitled to terminate in the event of a change of control of Pathway, eg,
if it were taken over by another company (see paragraph 3.4). Moreover, termination
for Pathway’s default would require either proof of “persistent and material breach of
a material obligation” (coupled with a new regime for written wamings and a further
breach of that obligation before termination would be allowed) or an unspecified
accumulation of “performance deficiency deductions” (see paragraph 3.2(i) and (iii).
15. POCL’s termination rights would also be subject to the step-in rights of
Pathway’s lenders (see paragraphs 3.3 and 10). Undera so-called “Direct
Agreement” between the lenders and POCL, the lenders would be allowed to step in
and take over Pathway’s obligations or to appoint a substitute entity to replace
Pathway. Although such step-in rights are endorsed by the Taskforce, it may be
questioned whether they are appropriate in complex IT services contracts and whether
it is realistic to suppose that a lender could step in and take over the services.
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* Termination by Pathway
16. . Unlike the present Related Agreements, which do not give Pathway any rights
of termination (with the minor exception of a breach of IPR licence agreements),
Pathway propose that they should be entitled to terminate in a number of
circumstances, including non-payment of charges in excess of £250,000 and force
majeure lasting for a specified period of time. This change is in line with the
Taskforce Guidance, but is contrary to existing government contracting practice, and
the public sector parties must ask themselves whether they are prepared to place the
performance of statutory functions at risk of termination in this way.
Compensation on Termination.
17. . Unlike the present Related Agreements, Pathway propose that they should be
compensated in the event of termination, including termination for their own default.
The level of compensation would vary according to the event which led to termination
(see paragraph 6.1). In the event of voluntary termination (ie, termination “for
convenience”) and termination for POCL default or force majeure (neither of which
entitle Pathway to terminate at present), Pathway would be entitled to repayment of
all outstanding debt under any third party loans (“Lender Liability”). In addition, in-
the case of voluntary termination and POCL default, Pathway would be entitled to
repayment of all ICL equity, loan stock and third party equity raised in the future to
invest in the project (“Equity”), termination costs Gncluding the costs of terminating
funding and hedging agreements and sub-contractors’ agreements), and a retum on
the Equity for the remainder of the project (see paragraph 6.2). Compensation to
Pathway in the case of POCL’s default is in accordance with the Taskforce Guidance,
“but only on the basis that POCL would be entitled to recover the project assets, as.
Pathway have proposed here (see paragraph 50 below).
18. In the event of termination for Pathway’s default, Pathway would be entitled
to repayment of Lender Liability and the costs of terminating funding and hedging
agreements, less rectification costs capped at an undefined level reducing over the
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a of the project (ee paragraph 6.2(ii)). Depending upon the level of ‘capping,
this formula is apparently intended to allow a net repayment to Pathway’s lenders
even after termination for Pathway’s own default. Although compensation in the
event of supplier default is contemplated in the Taskforce Guidance, the method of
calculation proposed here by Pathway (outstanding debt less rectification costs) isnot
recommended by the Taskforce. :
Change Control
19. Pathway propose a new regime for change control (see paragraph 7.1).
Curiously, they propose that changes should no longer be permitted “without their
consent,” which is no different from the present position under the Related
Agreements, Apparently, regardless of who proposed the change, Pathway expect
POCL to meet the cost of ‘implementing the change if Pathway could not finance the
change themselves after having used reasonable endeavours to obtain funding. Under
these circumstances, POCL would be expected both to fund any capital expenditure
by making a lump sum payment to Pathway, and also to fund any increase in
Pathway's operating costs by an increase in the charges, If Pathway were able to
meet the cost of the change, the guaranteed volume payments would still have to
increase in order to repay Pathway’s indebtedness in full. This is broadly in line with
Taskforce Guidance, although the Taskforce make clear that the customer should
have the right to market test the supplier’s changes and should not be required to
proceed with a change if the charges for it are unacceptable.
Change in Law
20. Pathway propose a new regime for changes in law. Where the change isa
“discriminatory change”, POCL would be required to indemnify Pathway’s costs (see
paragraph 8.1). A “discriminatory change” is defined as any change in law :
discriminating against the project, against Pathway or against PFI suppliers generally,
and includes any legislation affecting the operation of post offices or the payment of
benefits, This approach is broadly in line with the Taskforce Guidance, but is more
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> onerous than the present Related Agreements, which call for a negotiated adjustment
in prices, but not an indemnity against costs for change in law. By contrast, the : 1.
indemnity proposed by Pathway would require payment by POCL of a lump sum :
equal to the cost incurred (see paragraph 9.3).
Force Majeure and other Relief from Liability -
21. Pathway propose a new regime to relieve them from liability for delays
resulting from events beyond their control which are not currently within the,
definition of force majeure in the present Related Agreements (see paragraph 9.1).
The extent of this further relief is not defined. If the delay is caused by POCL,
Pathway propose that they should be allowed not only additional time to perform but
also should be paid the full value of forecast transaction volumes over the period of
the delay. This proposal is not supported by the Taskforce Guidance, which suggests
that any compensation should be based on the supplier’s actual losses and his duty to
mitigate those losses; it also goes much further than the “reasonable additional costs”
allowable under the present Related Agreements in such circumstances.
Lenders’ Security
22. Pathway propose that thcir lenders should have first security over project
assets and Pathway’s rights. In the event of Pathway’s insolvency or loan default, this
proposal would defeat POCL’s rights under the present Related Agreements to buy
back the project infrastructure, and would pose a threat to the continuity of service
which this buy-back option is intended to assure.
Corrupt Gifts
23. I Where an employee or sub-contractor makes a corrupt gift without their
connivance, Pathway propose that they should be allowed 30 days to remove that
person from the project or terminate that sub-contract before POCL could terminate
for breach of the corrupt gifts clause. This is broadly in line with Taskforce
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“Guidance. Under the present Related Agreements, however, the right of termination
is immediate.
Dispute Resolution
24. Pathway proposes a commercial dispute resolution procedure which would be
separate from and additional to the expert determination procedure proposed for
technical disputes under their Acceptance paper (see paragraph 13.1). The proposed
commercial dispute resolution procedure is broadly in fine with the Taskforce
Guidance, but it is not clear how far it would prevent POCL from resorting to the
courts to resolve commercial disputes, which is allowed under the present Related
Agreements.
25. Under the new commercial dispute resolution procedure, POCL would not be
able to withhold or set off any payment in dispute above a cumulative cap which
would ensure that cash flow to Pathway was not “materially diminished” (see
paragraph 13.2). This is coupled with a more general proposal that POCL should not
be entitled, as at present, to set off any sum due from Pathway against a sum due to
Pathway above the permitted cap. Taken together, these proposals would
significantly limit POCL’s ability to withhold or set off payments against amounts
owed to Pathway. This would be especially serious in the case of a termination for
Pathway’s default, where lenders would have first call over project assets but POCL
would be unable to set off its claims against money owed to Pathway.
Interest on late payments
26. In line with Taskforce Guidance, Pathway propose that POCL should pay
interest on any late payment. However, they propose that the rate of interest should
be the equivalent of the default rate specified in their lenders’ funding agreements.
This rate is not specifically endorsed by the Taskforce Guidance, and is likely to be
much higher than the rate of interest normally payable in IT services contracts.
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* Performance Deductions/Service Credits
27. Pathway propose unspecified changes in the present provisions for
“performance deductions”, by which they presumably refer to service credits for non-
conforming services (see paragraph 16). They want “an objective regime” for
calculating performance deductions, and a cumulative cap on the deductions _
available. :
Transfer/Change of Status by POCL.
28. . If POCL were to transfer-its agreement or change its status, Pathway propose
that there should be a “credit enhancement” of the charges, possibly through POCL .
purchasing credit enhancement insurance.’ At present, POCL’s freedom to transfer its
agreement or undergo a change in status is unfettered.
Fraud Risk
29, Finally, Pathway propose significant changes in the present provisions on
fraud risk. At present, subject to a list of excepted risks, Pathway is liable for all
fraud losses in relation to the services. Pathway propose to reverse this transfer of
tisk by providing that Pathway will only be liable for fraud where POCL can prove
both its loss and that the loss was within a specific risk expressly transferred to it by
Pathway (see paragraph 18). This proposal will substantially reduce the level of
Pathway’s liability for fraud losses.
ACCEPTANCE ©
30. Pathway propose wide changes to the acceptance procedures. Broadly, they
envisage final acceptance (and loss of termination rights) occurring before live trial.
31. Pathway propose two phases of testing: “systems acceptance” involving 7
technical testing and model office testing; and “field service acceptance” involving
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&.. tial (see paragraph 2.1). If acceptance is achieved after technical and model
office testing (phase 1), the public sector parties would lose their rights of termination
for subsequent failed acceptance in live trial (phase 2). If acceptance was not
achieved at phase 1, they would then be required to give Pathway a cure period until
the end of live trial. If acceptance was not achieved after the end ‘of live trial, there
would be a right of termination for failure of technical and model office testing (phase
1), subject to the conditions described below. However, although the ICL Proposal is
not entirely clear on this point, we understand that there would be no right of
termination for failure of live trial (phase 2),
32. Once live trial had commenced, the Authorities would only have a right of
termination for failure of technical/model office testing (phase 1) in the event that
Pathway failed to meet the acceptance criteria after a 6 month extension period, and
only if that failure is due to the exclusive default of Pathway. As a result of these
changes, the public sector parties would find it almost impossible to terminate due to
failure to achieve acceptance under technical/model office testing, because it would
be almost impossible to prove that failurc to achieve such acceptance was due to the
exclusive default of Pathway. Moreover, the public sector parties would have no
tight of termination for failure to achieve acceptance under live trial.
33. Ineffect, the public sector parties will be required to accept the services before
they have been trialled “in the field.” A further complication is that it is not clear
whether the acceptance procedures would simply relate to NR2 for sinele benefits, in
which case the services would not be tested for multi-benefits before the termination
rights were lost.
34. Pathway propose that the criteria for termination should also be amended, The
effect of their proposal is that up to nine acceptance incidents could occur in each of
the 23 test streams and the termination rights would still not arise. The relevant
acceptance incidents would be category A or B, both of which have a significant
effect on business.
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735. Pathway propose that they should self-certify readiness of releases after
* acceptance,
36, Pathway propose that any disputes relating to acceptance be automatically
resolved by an expert. This is an amendment to the present procedure, which requires
the agreement of the parties to use an expert determination procedure.
COMMERCIAL AND CONTRACTUAL PROPOSALS
Introduction
37. The paper on “Contractual and Commercial Proposals” comprises two main
elements (see paragraph 1.1): :
first, there are the amendments proposed by Pathway to reflect the original
Corbett Proposal tabled on 11 October 1998 at the end of the first round of
discussions between Pathway, BA and POCL;
second, there are amendments proposed by Pathway to reflect the latest ICL
Proposal.
In addition, there are three further proposals for 4 contingency and sharing
‘mechanism, for the resolution of outstanding contractual and commercial issues (the
so-called “running sores” issues), and for the restructuring of the Related Agreements.
Our comments below on these proposed amendments are focussed mainly on the
_ question of how far they depart from the original Corbett proposal.
Amendments to reflect Corbett Proposal
38. Subject to some clarification and checking of the figures, the amendments
proposed under this heading appear to us to capture accurately the main elements of
the original Corbett Proposal on contract term extension (see paragraph 2.1(i) and
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(ii), forecast transaction volumes (see paragraph 2.1 (iv)) migration to ACT in the last .
three years of the BA contract (see paragraph 2.1(v)), POCL funding of technology
refreshment (see paragraph 2.1 (vi)) and service point pricing for the last five years of
the POCL contract (see paragraph 2.1(vii)). We cannot assess the proposal for
banking services (see paragraph 2.1(ii)) without taking further instructions from
POCL. .
Amendments to reflect the ICL Proposal
39, : Under this heading (see paragraph 3.1), Pathway propose twelve amendments
as follows:
@) Pathway Funding Paper
40. ~ Pathway propose amendments to enable them to seek limited recourse of
funding after acceptance. These are detailed in their “Pathway Funding
Paper”,
ii) Guarantees
41. Pathway propose a number of changes to the present guarantee payments I
structure which they say are needed “to facilitate funding.” They also state that the ©
proposed guarantees will not apply to the level of future additional business, although
_ it bears noting that they are proposing a guaranteed minimum payment in relation to
the new banking service. The proposed changes are as follows:
(a) They propose guaranteed payments at 80% of new transaction volumes
forecast for the core business of BA and POCL. This compares with
75% proposed by BA under the Corbett Proposal. -
(b) They propose a 90% payment guarantee on forecast banking
transaction volumes. This was not part of the Corbett Proposal.
©) They propose a £40m minimum charge for PAS (Payment
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Ps Authorisation Services) and CMS (Card Management Services) in the
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last year of the BA contract, This is presumably in addition to the 80%
guaranteed payment for these services. This was not included in the
Corbett Proposal.
(d) They propose that présent discount bands should be revised to apply
only above guaranteed transaction volumes, and that the bands should
be raised to align with the revised guaranteed transaction volumes.
This was not included in the Corbett Proposal and of course represents
a significant price increasc. .
(e) _ They propose to revise the algorithm for guaranteed payments during
national roll-out so that guaranteed payments are calculated by
multiplying the proposed guarantee percentage by the revised forecast
transaction volumes. This was not included in the Corbett Proposal. It
would mean that payment was guaranteed regardless of the rate of roll-
out. By contrast, under the present Related Agreements, guaranteed
payments are tied to physical implementation and benefit migration.
In addition, they propose that late delivery of national roll-out for
which Pathway were responsible would be subject to unspecified
liquidated damages. Curiously, this is a departure from the present
Related Agreements, which do not provide liquidated damages for
delay in roll-out, only for delay in the Start Date and/or End Date of
Operational Trial.
Gii) Acceptance and Termination
42. Pathway state that the application of revised guaranteed transaction volumes
and compensation for failed acceptance will require associated alterations to the
provisions on acceptance and termination. These are discussed in their papers on
Acceptance (see paragraph 30 above) and in their Pathway Funding Paper (see
paragraph 10 above). :
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“ (iv) Acceptance
43... Here Pathway summarise their proposals for acceptance of New Release 2
which are detailed in their Acceptance paper (see paragraph 30 above).
(v) —_ Indexation
44. - Pathway propose that prices should be indexed by RPI minus 2% from April
1999. For BA, this represents a departure from the Corbett Proposal, which was
based upon the current indexation provisions, namely, a year on year price reduction
of 3% starting in 2001/2, with no price increase for RPI up to 6%, and a 50% sharing
of any RPI increase above 6%, For POCL, Pathway’s proposal also departs from the
Corbett Proposal, which suggested only canceling the 3% per annum reduction from
2006 onwards.
(vi) Payment
45. Pathway propose adjusting the present payment terms from monthly in arrears
to quarterly in advance. This is contrary to standard government contracting policy,
and there is no obvious basis for it in the Taskforce Guidance. It clearly represents a
hidden price increase.
(vii) Term of POCL Agreement
46. Pathway propose that the term of the POCL Agreement should roll-over
annually from 2007 (at POCL’s option) subject to eighteen months’ notice of
termination, the earliest termination date being September 2008.
(viii) Past liquidated damages
47. — Pathway propose to remove the provisions for liquidated damages for delay in
the present Related Agreements. As noted above, these relate only to delays in the
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e.. Date or End Date of Operational Trial, which have already passed. The only
issue, therefore, in our minds is whether the liquidated damages already accrued will
be considered recoverable under Pathway’s proposal or not. In the spirit of the
Corbett Proposal, it was envisaged that all past claims such as these would be waived
as part of the overall settlement, Thus, assuming that an overall settlement is agreed,
this proposal appears to present little difficulty.
(ix) Dispute Resolution Procedure
48. Pathway propose a new commercial dispute resolution procedure based upon
that proposed in the Taskforce Guidance. This is discussed in greater detail elsewhere
(see paragraph 24 above).
(x) Change Requests -
49, '° Pathway propose that their right to raise change requests should be embodied
within the revised Related Agreements, This proposal is puzzling, as the existing
change control procedure already allows any party to request a change.
(xi) Transfer of service infrastructure -
50. Pathway propose that the service infrastructure should be transferred to POCL
on the expiry of the POCL Agreement in accordance with a revised formula reflecting
“additional value created by the exploitation of future additional business
opportunities.” This formula is not specified. This is a departure from the present
POCL Agreement, which gives POCL an option to buy these assets but does not
require them to do so.
(xii) Incorporation of other proposals
51. Inaddition, Pathway suggest that their proposals on a contingency and sharing
mechanism, the resolution of “running sores” and restructuring of the Related
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© ccnens should be incorporated as amendments to the present Related
Agreements. These proposals are discussed in greater detail below.
52, Finally, under this heading, Pathway note that the ICL Proposal is conditional
upon agreement by all parties to a final version of all Acceptance Specifications, of
which 23 have so far been produced by Pathway for approval by the public sector
parties (see paragraph 3.3), It should be noted that there are still significant
commercial and technical issues outstanding in relation to these specifications.
Contingency and Sharing Mechanism
53. In order to avoid what they cali a “blame culture", Pathway propose a new
“Contingency and Sharing Mechanism” (see paragraph 4.1). In essence, they propose
_ that a contingency fund of £80 million should be established by an increase in
transaction charges paid by the public sector parties rather than by an advance
payment by them. In the event that certain contingencies identified by Pathway do not
arise, the pre-paid amount would be shared equally between BA, POCL and Pathway.
In other words, Pathway would kcep one third of the pre-paid amount and would
refund the remaining two thirds to BA and POCL in equal shares by way ofa credit
note against future invoices. :
54, I We havea number of comments on this proposal. First, it is radically different
from the Corbett Proposal, which envisaged the establishment of a jointly managed
contingency fund by means of an advance payment from the parties; where the
contingency did not arise, the surplus was to be released in equal shares to Pathway
and the public sector parties on a 50/50 basis. Thus, under the Corbett Proposal, there
‘was no automatic price increase, Pathway were required to substantiate a claim from
the contingency fund, and all the parties were incentivised to avoid or at least
minimise the contingency event. By contrast, under the ICL Proposal, Pathway
Teceive an automatic price increase, the public sector parties bear the burden of
claiming back their share of the contingency fund, and Pathway is incentivised to
deliver late in order to keep the price increase. Second, we note that Pathway’s
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—_ contingency and sharing mechanism is intended to operate without any ©
regard to fault. Thus, even if Pathway were exclusively responsible fora project
delay, they would be entitled to keep the contingency funding in full. Allin all,
therefore, this proposal appears to us to be another hidden price increase.
Resolution of Running Sores
55. Inline with the Corbett Proposal, Pathway propose to resolve the “running
sores” (the outstanding contractual and commercial issues which have stood in the
way of completing the project) as part of the overall settlement. Their list of the
principal running sores coincides with our own. Their detailed statement of the
” running sores and their proposals for resolving them are set out in an attachment to
the Commercial and Contractual Proposals paper (Attachment C). We are still
studying their proposals, and will wish to discuss them with the public sector parties
before providing a definitive assessment of them.
Restructuring the Related Agreements
56. ' Asnoted already, Pathway propose a fundamental restructuring of the present
tri-partite contractual relationship between Pathway, BA, and POCL, to create a
“single client interface” between Pathway and POCL under a single contract between
them, backed up by a “fully managed service relationship” between POCL and BA
under a single contract between them (see paragraph 6.2). These new contractual
arrangements would replace the current arrangements from the start of national roll-
out (Le. following successful acceptance) in July 1999,
57. The legal and commercial implications of this restructuring proposal require
very careful consideration. In the time available, we can offer only our initial
observations, Further study and discussion will undoubtedly raise additional issues.
58. - First, there is the question of how to achieve this restructuring. Pathway
suggest that it can be achieved simply by “assigning” to POCL the DSS contracts for
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Pus and PAS. This is a serious over-simplification.
59. The PAS and CMS services are currently embodied in the contract between
Pathway and the DSS (“the DSS Agreement”), and it is true that this Agreement could
be transferred by the DSS to POCL. (Technically, this would be a “novation”, by
which POCL would step into the shoes of the DSS under a new agreement with
Pathway on the same terms as the DSS Agreement. An “assignment” would mean:
that the benefit of the DSS Agreement was transferred to POCL while its burdens
remain with the DSS - presumably not the intention here.)
60. I However, the DSS Agreement does not represent the sum total of Pathway’s
obligations and liabilities to the DSS. To mention only one example, Pathway’s
liability to the DSS in respect of fraud risk is contained in Clause 808 and Schedule
B8 of the Authorities’ Agreement, the tri-partite agreement between Pathway, BA and
POCL. Thus; to achicve a complete transfer of BA’s rights (and obligations) in
relation to Pathway, it would be necessary not only to novate the DSS Agreement to
POCL, but also to strip out all of the relevant provisions of the Authorities’
Agreement and transfer them by means ofa novation agreement to POCL. Given the
size, complexity and myriad interfaces of the three Related Agreements, this is a
drafting assignment of very considerable magnitude.
61. I The second implication of Pathway’s restructuring proposal is a question of
timing, which will also impact upon the mechanics of negotiating the transfer from
the DSS to POCL. As proposed by Pathway, the transfer will not take place until
after acceptance has been achieved. We think this must be tight, because there would =
be little point transferring services which had not yet been accepted by the ultimate :
customer. What this means, however, is that at Jeast until July 1999, there will still be
a tri-partite contractual relationship between Pathway, BA and POCL; after July
1999, or whenever acceptance occurs, this will be replaced by a chain of bi-lateral
contractual relationships between Pathway and POCL, and between POCL and BA.
62,. This in tum raises a question which the ICL Proposal does not address: which
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— does Pathway require pre-acceptance; and which changes does it require
post-acceptance? Or to put it another way, which changes will need to negotiated and
agreed tri-laterally with all three parties; and which changes can be negotiated and
agreed bi-laterally betwecn Pathway and POCL? One obvious example in the former
category is the new acceptance regime proposed by Pathway, which will need to be
agreed by the DSS as well as POCL. But what about the other contractual and
commercial proposals discussed above, such as the contingency and sharing
mechanism, the running sores, and so on. Many of these will require resolution pre-
acceptance by all three parties; others, such as the funding proposals, are presumably
not intended to be implemented until after acceptance. We will need to seek
clarification from Pathway as to which of their proposals fall into which of these
categories, - . -
63. The implications of this for the mechanics of any negotiation with Pathway
will also need to be carefully thought through. Our initial thinking is that the first
task will be to identify and distinguish pre-acceptance issues from post-acceptance
issues, ie, the tri-partite issues from the bi-partite issues. Then there will need tobe
atwo wack negotiation: one involving Pathway, BA and POCL; the other involving
Pathway and POCL. Finally, all three parties will need to return to a single stream of
negotiation pulling together all the separate strands in an overall tri-partite settlement.
Again, the scale of this negotiating task is not to be under-estimated,
64, = The third implication of Pathway’s restructuring proposals which occurs to us
is that the restructuring of the Pathway/BA/POCL relationship cannot be completed
without a re-negotiation of the BA/POCL relationship. In this context, we believe it
is common ground between the public sector parties that such a re-negotiation must :
be governed by two basic principles. :
65. First, if BA withdraws from its direct contractual relationship with Pathway, it
will wish to ensure that all of its rights and remedies against Pathway are assumed by
POCL, subject of course to any amendments agreed by BA as a result of the Corbett
Proposal or the ICL Proposal. For example, if BA can no longer claim its fraud losses
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6. Pathway under the Authorities Agreement, it will wish to cldim them from
f POCL, who will in tum need to be able to re-claim them from Pathway. We refer to
this as the “back to back” principle.
66. Secondly, if POCL wish to make concessions to Pathway which are not
acceptable to BA, such as a price increase or a reduction in Pathway’s fraud liability,
POCL will obviously be free to do so in its own commercial judgement, but BA will
wish to ensure that its position is no worse off as a result. In other words, BA will
wish to be held harmless from such concessions. We refer to this as the “hold
harmless” principle. :
67. This in tum suggests two further implications. First, BA will need to be quite
closely involved even in the bi-lateral negotiations between Pathway and POCL, so
that POCL is aware when it is giving a concession to Pathway that BA expects to be
protected from it under the hold harmless principle. Second, POCL and BA will need
to hold parallel negotiations between themselves to keep pace with the
Pathway/POCL negotiations in order to ensure that any POCL concession to Pathway
which is acceptable to BA is embodied in the BA/POCL agreement under the back to
back principle.
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