Contracts in Uncertain Times

Credit: YMCA

Credit: ESSA

John Summers considers the future for ‘guaranteed’ contract sums for outsourced aquatic and recreation centres

So what is the future of guaranteed contract sums for aquatic and recreation facility management contracts, now that closures and disruptions as a consequence of COVID-19 have resulted in so many being varied to such an extent that they may as well have been non-guaranteed/fee for service?

Over the past six months of the COVID-19 pandemic, it seems that “guaranteed contract sums” may not have provided councils with the budgetary certainty that it was assumed they would. As has been often noted, we are certainly living through unprecedented, extraordinary and extremely uncertain times, but one wonders whether we will now see a move from more guaranteed contracts to non-guaranteed. If so, what will they look like?

The attraction of guaranteed contracts would seem to be twofold. Firstly, there is the full transfer of financial risk to the contract management company. Secondly, there is the view that under a guaranteed contract, the contractor will drive the ‘business’ harder than they would otherwise under a fee for service model, and as such council will be the beneficiary of increased net performances.

With almost 400 aquatic, recreation or sporting facilities managed by third parties on behalf of councils across Australia, there is no doubt many councils are retendering or renegotiating option periods, giving consideration to this issue. So, will it be guaranteed, non-guaranteed or maybe a bit of both?

As Belgravia Leisure Chief Executive, Nick Cox recently suggested, contract management companies, following the COVID-19 pandemic, would more than likely be pushing back on onerous contract requirements, particularly relating to financial expectations. This is hardly surprising, and it will therefore be interesting to see where some common ground maybe found in this regard.

So what might this ‘common ground’ look like?

Fully non-guaranteed for the duration of the contract Having personally reviewed and responded to more than 50 tenders during my time at the YMCA, I could count on one hand the number of tenders for which the council were willing to assume full financial risk for the duration of the contract. In such cases, the level of financial scrutiny by council was extensive. While it is arguable whether this scrutiny actually enhances net performances, there is certainly an increased need to fulfil the due diligence obligations.

Ideally there will be some embedded incentives for exceeding participation targets, particularly for memberships and swim school enrolments, and consideration could be given to total income.

I have witnessed the management of expenditure control in isolation to income generation, whereby incentives or penalties have been applied for operating within, or exceeding an expenditure budget. However, I do believe this approach is often flawed in its design and application noting the correlation between increased income and expenditure in many parts of the operation.

So, while this approach may still achieve optimum financial outcomes, it does expose councils to financial risks, as would be the case within an inhouse model, where council becomes the guarantor.

Credit: YMCA

Credit: ESSA

First year non-guaranteed, and guaranteed thereafter Often applied for a greenfield site, the logic is quite sound, that once a full year of operations have been completed and a clear understanding of likely performances has been ascertained, both parties are both more comfortable with anticipating future years performances.

The establishing of future performances, whether they be during the initial contract term, or for an option period, does in my view, put the council at a significant disadvantage during the negotiation of the guaranteed sums. While at the time of the tender, the power of tenderer selection and contract sum determination, clearly sits with council, there is a significant shift in this power dynamic once there is a contract sum negotiation mid contract term (or at the time of the awarding of an option period). Both parties are on a more equal footing, and often it is the council that are loathe to go back out to market, and I would suggest, the contract management companies are fully aware of this.

While a pre-set methodology is one option that I have seen used, they invariably fail to account for the inevitable variables, or utilises a complex model, that still will fail to account for unforeseeable circumstances.

While declaring some degree of conflict of interest, I am surprised that councils don’t engage an independent external consultant to make a determination of an appropriate contract sum for the future years of the contract and/or the option period. Most importantly, I would be proposing that this process is mandated within the contract from the start, and includes that both parties are bound by the determination of that sum by the independent assessment. It is then accepted by both parties, or it goes to market.

This would certainly address what I hear so often, and that is council noting that while they have agreed to a revised contract sum, they are not overly pleased with the outcome. I have in fact been party to such an exercise on two occasions, where an independent consultant was engaged, and in both instances the parties felt that the outcomes were fair and reasonable and based on sound logic.

Guaranteed and Non-Guaranteed Councils may also wish to consider a hybrid approach in which a net amount for each year is non-guaranteed but only to a point. I have been working with a council recently in which this

Credit: Zoggs

model is being utilised, and tender respondents are required to quantify the contract sum that they believe they can achieve, however the council will not require the contractor to guarantee this amount, but rather, they are to nominate a second amount that they will then guarantee.

In essence, it provides the contractor a buffer zone from guaranteeing the areas of performance that they are less confident in achieving. The amounts between these two sums are fully the responsibility of council to underwrite. Performances that then are inferior to the guaranteed sum are then fully borne by the contractor (or at a rate shared between both parties).

While adding some element of complexity, might this be the model for the times, where the risk is more evenly shared?

Guaranteed (but not all categories) This approach is not dissimilar to the previous option, but rather than have a set sum (between the guaranteed and non-guaranteed sums) that accounts for those areas that the contractor is uncomfortable and unwilling to guarantee, in this instance, the council will have set aside the more volatile income or expense lines as either straight out non-guaranteed amounts, or have stipulated provisional sums. The outcome is the same for both, the difference in both these approaches only differs in respect to the timing of the money payable/receivable by the contractor.

These provisional sums are increasingly being applied for maintenance, as well as for utilities. It will however be interesting to see if councils broaden the application of provisional sums for income categories such as recreational swim, learn to swim, as well as health and fitness with consideration to the challenges of COVID-19 now and into the future.

It is certainly going to be interesting over the next 24 months as to the approach councils with outsourced facilities select as we continue to navigate these most uncertain times. John Summers runs Leisure Management Excellence consultancy. Prior to establishing his consultancy in 2018 he was a senior manager with YMCA Victoria including having been Chief Executive of YMCA Aquatic and Event Services Ltd between 2011 and 2016. He can be contacted on 0409 205 212, E: john@lmexcellence.com.au