Providers need to be alive to the risk of contractors becoming insolvent and how to limit the resulting inevitable disruption.
The Lifeline Project was a well-regarded charity, providing drug and alcohol rehabilitation services to thousands of people across the UK. In March 2017, the Insolvency Service found that the CEO, Ian Wardle, had entered the charity into three contracts, all of which were subject to unachievable outcomes.
Mr Wardle’s failure to carry out adequate due diligence and understand the targets within the contracts led the charity into insolvency and resulted in a personal, 7-year disqualification order.
All contracts come with some risk attached to them, but some pose a more substantial threat than others. It is important you understand the terms you are signing up to and the repercussions for your organisation if a contract fails. The collapse of the charity and personal consequences for Mr Wardle¹ highlights the importance of seeking specialist advice when entering such risk-based contracts.
What are Payment by Results (PbR) contracts?
A PbR contract is an agreement where payment is made only if agreed outcomes are achieved and independently verified. Some of the most common examples are Social Impact Bonds (SIBs) and tariff-based PbR contracts, which are used predominantly within the health and social care sector.
Why enter into a PbR contract?
PbR contracts can be attractive to commissioners because they guarantee value for money, transfer risk to the supplier, and incentivise quality by ensuring that only the best services are paid for. For suppliers, PbR contracts offer the flexibility to determine the manner in which the outcomes are achieved, but this comes with the risk of financial loss if the contracted outcomes are not realistic.
What to look out for
Some contracts will involve some upfront costs to cover the initial set-up, and suppliers should consider whether they can afford to bear these without some contribution from the commissioner. If these payments cannot be agreed, are not paid, or if there is a financial shortfall, the supplier must self-fund everything until the outcomes are achieved. If timelines for completion are extended or implementation costs exceed estimates, financial borrowing is sometimes the only resort for suppliers to bridge the gap. If, regardless of the measures taken, the contract is then breached, or outcomes are not achieved, the supplier is left both without the promised payment and potentially in debt to lenders.
Another downside to PbR contracts, which is often overlooked, is the administrative burden of proving that the services have been implemented efficiently and that they have made a substantial impact within the specified area. This may mean introducing more sophisticated and costly data management systems and regular data monitoring to ensure that providers can demonstrate that they are making steady progress towards the agreed goal.
The most significant risk, however, is the outcomes themselves. If thorough and necessary due diligence is not undertaken, organisations remain in danger of setting and agreeing to unrealistic targets. Some CEOs or board members may not have the required knowledge or experience to understand the challenges faced by frontline staff and the resources required to get the job done. This could mean key issues are not addressed before the contract is signed, inevitably leading to lost income or a breach of contract.
These risks, individually or combined, can leave organisations in a state of irreparable financial loss. For the Lifeline Project, a failure to achieve the PbR outcomes across three local authority contracts resulted in a financial loss of £1.4 million and it quickly became insolvent.
With some forward planning and appropriate asset management, PbR contracts and similar initiatives offer great opportunities for the right organisations. It is important that both company directors and charity trustees enter into contracts with their eyes open, and undertake an analysis of the risk versus reward, before putting their organisations and themselves at undue risk.
For more information on this briefing, or if you are in need of a second opinion on your contracts, please contact Emma Watt. For information about reviewing your charity’s governance, please see the charities section of our website.
Article drafted with assistance from Cortney Adams.
1. A disqualification ban means that an individual cannot become, or act, as a director of a company, take part, directly or indirectly, in the promotion, formation or management of a company or limited liability partnership or be a receiver of a company’s property.
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