My Lords, this is a crucial element of the Bill because it protects the taxpayer against contractors earning excessive profits while also protecting industry from excessive losses.
The basis of the Bill is that contractors should get a fair return on single-source work, and even better returns if they can drive cost efficiencies which deliver long-term benefits to the MoD. However, they should not be entitled to super-profits just because, despite best intentions and efforts, both parties happened to get the pricing wrong. Likewise, in the same circumstances, suppliers should not be expected to suffer losses. This clause offers protection to both parties. The clause enables a final price adjustment on completion of a contract if the actual costs of the contract turn out to be markedly different from those agreed at the time of pricing. The mechanism will be applied to all qualifying defence contracts priced at the outset on the basis of a firm or fixed price.
At Second Reading in the House of Commons, statements were made to the effect that provisions such as this are undesirable because an agreed contract price should be an agreed contract price and that clauses like this remove pricing certainty and dampen supplier incentivisation. There is some truth in the observation, but I believe the clause strikes a good and proper balance between incentivising suppliers and protecting the public purse in the way that the noble Lord, Lord Currie, recommended it should. It should also be noted that on a number of occasions in the past when suppliers incurred very substantial losses, such as on the Nimrod programme, they have come back to us for more money. Since we need the capability they provide, it is not in our interest to let a supplier go bankrupt by holding it rigidly to its contract price.
I must also tell the Committee that this clause does not introduce a new idea into single-source contracting. Provisions for a final price adjustment have been in place since 1968 under the existing Yellow Book arrangements, and a mechanism very like Clause 21 has been in place since 2004. It is in many of our single-source contracts and has already been successfully used to recover excess profits from our suppliers on some contracts. However, because the existing mechanism is contractual and needs to be negotiated, sometimes suppliers refuse to agree to its terms. This happened
on a recent large maritime maintenance contract where commercial officers had to give it up in exchange for another provision we desired. That is why we want to legislate to provide this protection. If Clause 21 falls, a significant protection for both parties falls with it.
Clause 21 also states that any adjustments to the final price will be determined by the Secretary of State and the contractor. However, if an agreement cannot be reached on whether an adjustment is required or on the amount of that adjustment, the clause enables either of the parties to refer the matter to the SSRO for a binding determination. The clause will be used for particular types of contracts—firm and fixed-price contracts, which account for 60% of our single source contracts—and the SSCRs will set out the minimum value for applying these provisions.
Finally, the clause gives the Secretary of State a power, on a case-by-case basis, to exempt a QDC from any final price adjustment as long as the value of that QDC is within the range to be specified in the SSCRs, which is expected to be between £5 million and £50 million. When deciding whether to make such an exemption, the Secretary of State must have regard to any matters which will be specified in the regulations. The clause is an important element in protecting both parties in defence contracts: the Government against suppliers’ excessive profits and industry from substantial losses, which ultimately would not be in the MoD’s interest. It is therefore crucial that it remains in the Bill.
Amendment 23C is part of a group of amendments which relate to the regulations that are to be made by statutory instrument under Part 2 and the parliamentary procedure by which those regulations will be made. We have previously discussed this in relation to Clauses 19 and 20 and Amendments 23A, 23C and 23D. Amendment 23C would provide for regulations under Clause 21 to be subject to the affirmative procedure. These regulations are for the final price adjustment and are currently subject to the negative procedure. The final price adjustment is expected to apply to around half of qualifying defence contracts—those which are firm or fixed price—and will have effect only when the costs incurred under these contracts are significantly different from those estimated at the time of pricing. The mechanism provided for by the draft regulations under Clause 21 is a relaxation of an existing mechanism that has been in place since 2004 and follows one of the recommendations by the noble Lord, Lord Currie. The Delegated Powers and Regulatory Reform Committee did not recommend that regulations under Clause 21 need be subject to the affirmative procedure and we, too, do not consider that these regulations warrant it. I urge the noble Lord not to move Amendment 23C.
Clause 21(4)(a) applies only to a particular kind of contract. The final price adjustment applies to all firm and fixed-price contracts, but with “pain and gain share” contracts, where the MoD and industry agree sharing provisions such as 50:50, it would not be appropriate to have two sharing mechanisms running simultaneously. Clause 21(4)(a) allows us to exclude “pain and gain share” contracts from the final price adjustment. The noble Lord queried the effect of Clause 21(4)(b). It is only to provide for a de minimis
level. I am advised that the effect of Clause 21(5)(a) and 21(5)(b) is complex, and I will write on that.