The Dotted Line

At the best of times, the government can be the ideal client.

Save for the likes of Greece and Iceland, governments rarely go broke, they almost always pay, and usually on time. Governments are highly susceptible to public scrutiny, and will typically do everything in their power to uphold their side of the contract. In the world of roads and civil works, governments are the most likely candidates for more money and more work, as they cater to the needs of a growing population.

The fall-out of Victoria’s East West link project, however, has shown that even this ‘ideal’ client has some flaws. In the November state 2015 election that saw the defeat of the state Coalition Government, the incoming Labor Government made the cancellation of the East West Link project a central platform. The letter issued in December cancelling the project would have come as little surprise to the East West Connect Partnership, who saw the fate of their project tied up in the election.

The East West Link is not the first major infrastructure project to be cancelled due to a change of government, nor will it be the last. When dealing with public funds in the political space, the policies of the government can make or break a project. Leading up to the $339 million settlement in April, public debate around what compensation would or should be paid brought forward some important subjects for discussion. For the construction industry the question arose: how protected can a company be in the face of a change of government?

Kyle Siebel, a partner with leading law firm DLA Pipers, explains that according to the letter of the law, governments are well protected when it comes to their ability to cancel contracts. However, the legal system has precedents for a number of factors which need to be taken into consideration when looking at what losses can be claimed when governments cancel contracts.

Executive Necessity

At its essence, Mr. Siebel explains that there are no inherent legal protections in place for companies that suffer losses from a result in a change of government or a change in government policy. On the contrary, it is possible for governments to opt out of contracts for almost any reason they see fit. The principle is called the doctrine of executive necessity.

“The government must be able to best govern for the people given the current circumstances,” he explains.

To put an extreme example forward, say Australia entered into a contract to buy submarines from Japan. If we suddenly went to war with Japan, then it would not be in our best interests to maintain that contract. This doctrine says that the government can cancel those contracts without compensation.

“The policy covers the government’s ability to change policy, depending on its platforms. That doctrine of executive necessity sits over everything. So in its purest form, a government can absolutely cancel a contract without having to pay compensation.”

An important point here to consider, Mr. Siebel explains, is that under the hierarchy of law, legislation sits above the private right of contract. Even leaving aside executive necessity, the government absolutely has a right to sign in legislation that can make a contract null and void without having to pay losses.

Mr. Siebel gives another extreme example to illustrate the point: “Let’s go back a few years to 1865 in the United States. The South is flush with contracts regarding the buying and selling of slaves. When the emancipation policy is introduced, it automatically cancels the legitimacy of those contracts. A government, as a result of change of policy, can enact legislation to cancel contracts that it sees as no longer relevant or appropriate for the population.”

Another important legal precedent to consider, Mr. Siebel explains, is that a current government cannot introduce policy or legislation to bind a future government.

“For example, the government can make contracts with coal or oil companies, but in the future, a new understanding of climate change might come into effect, and the government must be able to cancel those contracts,” he says. “When you consider all these things together, you can see that a government must be able to change policies according to what it sees fit.”

Moral Exemplars

With so much protection in place for the government, what is a private contractor to do? The natural move, Mr. Siebel explains, would be for companies to ask for provisions in case the contract in cancelled. However, even if these are included in the contract, Mr. Siebel says it’s unlikely that provisions would be strictly enforceable. A company is entitled to ask for a termination payment, however if a government challenges this, with the current understanding of the law, the pay-out of an unreasonable termination payment would be a tough case to make.

Fortunately for contractors, Mr. Siebel says that there is a convention that new governments tend to honour previously signed contracts. Even more than adhering to contracts, he says the courts believe that governments should act as “moral exemplars”, which means acting in good faith when it comes to upholding contracts.

“The government is held to higher standards than private enterprise. Even if something is technically legal, there is still an understanding that the government should pay some compensation,” he says.

Except, that is, in exceptional circumstances – such as when a government has come in on a platform to cancel a contract. “There is an understanding that governments should not act capriciously, and should honour contracts unless it’s seen as necessary for the public good not to,” says Mr. Siebel. “Herein lies the debate regarding the East West Link. Is it a public good to cancel the contract? This is where we start to split hairs.”

Termination for convenience

Because of the government’s tenable position, Mr. Siebel says he has yet to see a government contract that doesn’t contain what’s called a “Termination for Convenience Clause”. The clause follows the principle that because the government is acting according to the will of the people, which might change, it essentially reserves the right to terminate the contract on notice for no reason.

“When a party contracts with the government, they know that clause is going to be there,” says Mr. Siebel. “This is the main difference between government contracts and private contracts. The government always reserves the right to terminate the contract not for any breach or fault, but following a change in policy.”

This clause typically also spells out what compensation will be paid if the government exercises that right. Although Mr. Siebel hasn’t personally seen the East West Link contracts, he has yet to come across any government contract that wouldn’t have this clause.

“Companies know that if they want to do business with government, they have to accept it,” he says. And although certain extreme examples, like the East West Link, show some potential downfalls to signing deals with the government, by and large Mr. Siebel says that common practice still make the government a pretty good client: “Because governments are expected to act in good faith, and 99.9 per cent of the time they will do the right thing.”