Commercial Notes No. 6

No. 6
27 November 2002

Standardised Funding Agreements

AGS has been working with a consortium of agencies since May
2001 to standardise funding agreements across the Commonwealth.
The agencies involved fall under the Financial Management
and Accountability Act 1997 (Cth), and the standardised agreements
are intended to be used for providing funding to communities,
that is, when agencies make a general call for applications
for funding. The agreements could be adapted for use in other
circumstances, such as where funding is under a statutory program.
This work has been done under the More Accessible Government
Initiative administered by the Department of Transport and
Regional Services.

Three standardised funding agreements have been developed:
long form, short form and minimalist form. The titles reflect
the complexity and length of the documents. Accompanying each
of the three agreements are guidelines which provide explanation
and assistance for program managers in constructing and administering
the agreements. There are also general guidelines which provide
assistance in determining which of the funding agreements to
use in a particular situation. The determination is based essentially
on risk, but not merely financial risk.

The standardised funding agreements reflect the decision which
each of the regular consortium members (being the main funding
agencies in dollar terms) had already reached independently
as to the nature of such agreements; that is, that they should
be contracts rather than gifts or grants (for a discussion
of the difference see Commercial Notes, Number 4, 28 November
2001 'Nature of the Legal Relationship under a Grant'). This
approach is accepted by the Australian National Audit Office:

4.9 Where a contract is chosen, it is important to avoid
uncertainty regarding the legal relationship. The contract
should not be called a 'grant contract' nor 'grant agreement',
should not include any reference to a 'grant' or 'grantee'
and should include all the normal provisions of a contract
such as termination and applicable law provisions. 1

Generally, agencies do not regard funding as being subject
to the Commonwealth Procurement Guidelines (CPGs) made under
Regulation 7 of the Financial Management and Accountability
Regulations 1997 as funding is not used to procure goods or
services for the Commonwealth.

It may be that agencies choose to use a procurement style
process to select funding recipients, but this is for reasons
of transparency and accountability in regard to expenditure
of public money, rather than for reasons of application of
the CPGs.

The form of the three standardised funding agreements is different,
even though they are all contracts. The long form is in a traditional
contract style and is executed in the normal way by the parties.
The short form and the minimalist form contracts are entered
into by exchange of letters. All three forms reflect policy
positions agreed to by agencies as a common starting point
on issues (for example, ownership of intellectual property
created by the funding recipient).

The three standardised funding agreements and guidelines are
available for use now by agencies. Though use of them is a
matter for individual agencies because of a Chief Executive's
individual responsibility under section 44 of the Financial
Management and Accountability Act, their use is seen as consistent
with efficient, effective and ethical use of Commonwealth resources
by the agencies which contributed to their development.

Individual agencies may modify an agreement to suit particular
circumstances but it is intended that agencies keep track of
such changes and submit them to a review to be conducted in
December 2003 by the More Accessible Government Working Group.

Notes

1 Administration of Grants - Better Practice Guide,
Australian National Audit Office, May 2002 (available at www.anao.gov.au)

Contact for further information:

Russell Wilson
Senior Executive Lawyer

Tel: (02) 6253 7148
Fax: (02) 6253 7316
E-Mail: russell.wilson@ags.gov.au

Terminating Contracts for Non Performance

Sirway Asia Pacific Pty Ltd v Commonwealth
Federal Court of Australia
[2002] FCA 1152, 18 September 2002

This case serves as a reminder to parties engaged in contracts
to be cautious when negotiating contract variations and considering
termination for non performance.

Facts

In 1996, the Commonwealth (the Department of Defence) issued
a Request for Tender for the supply of crockery for a period
of three years under a standing offer agreement (the Standing
Offer). The Standing Offer required that the crockery be supplied
to meet the specifications set out in the Standing Offer. The
specifications covered size, shape and colour, as well as levels
of chip resistance and water absorption. The applicant submitted
a tender and was the successful tenderer, with the Standing
Offer being signed on 11 August 1997.

The first purchase order under the Standing Offer was raised
in August 1997, with a further purchase order raised in October
1997. At the same time, there were discussions between Commonwealth
personnel and the applicant concerning finalisation of the
working samples. These discussions focused on the size, shape
and badging of the crockery. In January 1998, the Commonwealth
advised the applicant by letter that the working samples had
been approved. This letter specifically noted that this approval
did not relieve the applicant from the requirement to comply
with the specifications.

The first delivery of crockery was made in May 1998. Random
testing of the crockery showed that it did not meet the specifications,
particularly in relation to water absorption. Meetings were
held with the applicant in June 1998. The applicant asked for
assistance in finding an alternative method of disposing of
the defective crockery, with the result being the purchase
of the crockery at a discount.

In September 1998, the applicant advised the Commonwealth
that it was unable to meet the specifications. Following further
discussions between the parties, the Commonwealth terminated
the Standing Offer in December 1998.

Allegations

The applicant commenced legal action in the Federal Court
against the Commonwealth. The applicant's claims against the
Commonwealth were based on a number of grounds, including:

  • breach of the Standing Offer, on the basis that in meetings
    between Commonwealth personnel and the Contractor, the Commonwealth
    personnel agreed to the variation of the specification set
    out in the Standing Offer; and
  • breach of an implied obligation to 'act in good faith,
    fairly and not capriciously in exercising a power conferred
    by the contract', relying on Hughes Aircraft Systems v Air
    Services Australia (1997) 76 FCR 151.

Findings

In relation to the first issue, Justice Sundberg found that
no variation of the specification had been agreed between the
parties and as such there had been no breach of the Standing
Offer. In relation to the second issue, Justice Sundberg found
that the Commonwealth had not acted unfairly or capriciously
in exercising its right to terminate the Standing Offer.

Trade Practices Act

The applicant also made claims under the Trade Practices Act
1974 (the TPA), on the basis that the Commonwealth had engaged
in:

  • misleading and deceptive conduct (s.52); and
  • unconscionable conduct (Part IVA).

Justice Sundberg noted that section 52 and Part IVA will only
apply to the Commonwealth if 'it was carrying on a business
and in the course of carrying on that business engaged in the
conduct that is the subject of the claim'. He referred to JS
McMillan Pty Ltd v Commonwealth (1997) 77 FCR 337 and the judgment
of Justice Finkelstein in Corrections Corporation of Australia
Pty Ltd v Commonwealth (2000) 104 FCR 448, in which Justice
Finkelstein states that the expression 'carrying on a business'
is intended to refer to activities of the Commonwealth that
are 'undertaken in a commercial enterprise or as a going concern'.

The applicant's argument was that in calling for tenders and
entering into a contract for the supply of crockery, Defence
was carrying on the business of trading in chinaware. Justice
Sundberg noted that this 'alleged' business is supportive of
Defence's core function and that in determining whether the
acquisition of chinaware amounted to the carrying on of a business,
it was 'relevant to bear in mind that the Department's primary
activity does not amount to the carrying on of a business'.
He concluded (at para 62):

Because the Department's trade in or acquisition of chinaware
so obviously relates to the execution of a government function
which is in the interests of the community, it does not have
the characteristic of carrying on a business. … Because
I am considering an activity that is of a subsidiary priority
when compared to the Department's main function, my conclusion
regarding the true purpose for which the activity is performed
is informed by the principal government duty that is discharged
by the Department.

As such, the TPA did not apply. In any event, Justice Sundberg
found that even if the TPA did apply, the claims would not
have been successful.

The applicant was ordered to pay the Commonwealth's costs.

Summary

The case illustrates the importance of careful contract management
particularly in dealing with a contractor who is unable to
meet its obligations. Had Commonwealth personnel been less
cautious in their discussions or in drafting correspondence,
it is possible that Justice Sundberg may have found that the
specifications had been varied. In this context, it is relevant
to note that the Commonwealth first sought legal advice on
its options and the appropriate steps to be taken relatively
early in the process - after the initial meetings with the
applicant following the delivery of the defective crockery.
This ensured that subsequent action, including accepting some
of the crockery at a discount, did not prejudice the Commonwealth's
right to take action under the Standing Offer.

It also shows the importance of keeping accurate and contemporaneous
records of any meetings and of confirming the outcome of meetings
in writing. Many of the facts of this case, particularly in
relation to the conduct of the parties and the outcome of discussions,
were in dispute and, in most instances, the Court accepted
the Commonwealth's submissions on these issues.

The case also provides a useful summary of the application
of the TPA to the Commonwealth, particularly in relation to
the tendering and contracting out of 'non core' functions.

Text of the decision is available at: http://www.austlii.edu.au/au/cases/cth/federal_ct/2002/1152.html

Contact for further information:

Kenneth Eagle
Senior Executive Lawyer

Tel: (03) 9242 1290
Fax: (03) 9242 1481
E-mail: kenneth.eagle@ags.gov.au

Termination for Convenience Clauses

Many Commonwealth contracts and funding agreements contain
a termination for convenience clause which provides that the
Commonwealth may, at any time, by providing notice to the contractor
or funding recipient terminate the contract or agreement in
whole or in part. If the Commonwealth exercises its rights
under this clause it will only be liable for direct costs (excluding
any loss of prospective profits) incurred by the contractor
or funding recipient which are directly attributable to the
termination or partial termination.

The principal reason for the inclusion of such clauses is
to enable the Commonwealth to terminate its commitment in the
event of a change of government policy or other related government
exigencies. There is no general Commonwealth policy documentation
which dictates or otherwise generally recommends the use of
termination for convenience clauses.

The decision for inclusion of such clauses in contracts is
a matter for individual departments and agencies (acting in
accordance with their Chief Executive Instructions).

Possible Risks

The exercise of the right to terminate under a termination
for convenience clause by the Commonwealth is not free from
risk. It has been argued (eg, in Torncello v United States 1)
that a strict interpretation of a termination for convenience
clause would render a contract void and therefore unenforceable.
This is because the consideration provided by the Commonwealth
would be illusory and would render performance by the Commonwealth
effectively optional. This argument has been relied on in the
United States. However, inclusion of the requirement for the
Commonwealth to pay compensation to the contractor or funding
recipient in the clause mitigates this risk. Rather than rendering
performance 'optional', the clause permits the Commonwealth
to decide how it will perform the contract (that is, either
by seeing the contract through to the end or by paying the
contractor compensation). Accordingly, it is unlikely that
a court would find a contract or funding agreement void and
unenforceable by virtue of the inclusion of a termination for
convenience clause.

Interestingly, Torncello appears to no longer reflect the
United States position on termination for convenience - United
States law now appears to be that the inclusion of such a clause
does not invalidate the contract, and the exercising of rights
under such a clause will be improper only where the government
has acted in bad faith, or there has been an abuse of discretion:
Krygoski Construction Company v United States. 2

Noting this recent trend in the United States, it is possible
that a court would find that the Commonwealth may only exercise
a right to terminate for convenience in 'good faith'. It is
likely that an Australian court would imply an obligation of
good faith into a termination for convenience clause even if
one was not explicitly included. Given this requirement of
'good faith', it would not be appropriate for the Commonwealth
to seek to exercise its rights under a termination for convenience
clause, for example, to acquire a better bargain from another
entity, or to avoid potential liability for default under the
contract or funding agreement or where the Commonwealth has
from the outset no intention of fulfilling its promises.

Doctrine of Executive Necessity

If the termination for convenience clause is not included
in the contract or funding agreement, the Commonwealth may
still be in a position to terminate by virtue of the doctrine
of executive necessity. Broadly stated, the doctrine operates
to ensure that a government is able to fulfil the fundamental
purposes for which it was created, even though this may interfere
with contractual rights of others. As such, the absence of
a termination for convenience clause will not necessarily prevent
the Commonwealth from terminating the contract or funding agreement
at some point in the future. However, the exact nature and
scope of the doctrine of executive necessity at common law
is unclear and has rarely been considered in detail by the
courts. Relying on the doctrine of executive necessity alone
may potentially limit the grounds upon which the Commonwealth
could terminate a contract or funding agreement - for example,
it may be limited by a court to a change in government policy.

Although not historically part of the doctrine, it is also
now likely that a court would require the Commonwealth to pay
compensation to a contractor or funding recipient in the absence
of a specific termination for convenience clause. It is not
clear how such compensation would be calculated or what it
would cover. It is possible that it could extend beyond 'direct'
costs and include consequential and indirect costs.

Conclusion

A termination for convenience clause requires that the Commonwealth
act in good faith to avoid the need to terminate the contract
or funding agreement. It does not expressly require the Commonwealth
to only exercise the right where there has been a fundamental
change in government policy. It may be that the requirement
to terminate the funding agreement or contract arises not as
a result of a change in government policy per se but a change
in the method of achieving or delivering that particular government
policy.

It is questionable whether the doctrine of executive necessity
would allow the Commonwealth to terminate in these circumstances.
The Commonwealth could argue that these circumstances come
within the scope of the termination for convenience clause,
and that the clause regulates the consequences for the Commonwealth
exercising such a right (the payment of compensation to the
contractor or funding recipient).

One of the things agencies need to consider is to ensure that
the contract includes provisions to limit as far as possible
the direct costs incurred if there is a termination for convenience
- for example by requiring similar termination for convenience
clauses to be included in contracts with subcontractors.

Notes

1 See Torncello v United States 681 F 2d 756 1982
2 94 F3d 1537 (1996)

Contacts for further information:

John Scala
Chief General Counsel

Tel: (03) 9242 1320
Fax: (03) 9242 1481
E-mail: john.scala@ags.gov.au

For further information on commercial law matters and services
please contact:

National
John Scala

(02) 6253 7223

Canberra
Harry Dunstall
Anne Caine
Anne Kelly

(02) 6253 7066
(02) 6253 7145
(02) 6253 7004

New South Wales
Simon Konecny

(02) 9581 7585

Victoria
Paul Lang
Josephine Ziino

(03) 9242 1322
(03) 9242 1312

Queensland
Robert Claybourn

(07) 3360 5767

Western Australia
Lee-Sai Choo

(08) 9268 1137

South Australia
David Williams

(08) 8205 4283

Northern Territory
Ashley Heath

(08) 8943 1444

Tasmania
Peter Bowen

(03) 6220 5474

ISSN 1443-9549 (Print)
ISSN 2204-6550 (Online)

For assistance with supply of copies, change of address details
etc please Tel: (02) 6253 7052, Fax: (02) 6253 7313, E-mail: ags@ags.gov.au

The material in these notes is provided for general information only and
should not be relied upon for the purpose of a particular matter. Please contact
AGS before any action or decision is taken on the basis of any of the material
in these notes.

Back to Commercial Notes Index