Encounters of the third kind

Public service reform is high on the political agenda. All major political parties say they intend to award more contracts to charities, not-for-profits and social enterprises ('third sector organisations') to deliver public services across a range of sectors from health and social care to education, leisure services and criminal justice.

The market for outsourced public services in the UK was estimated to be worth £79bn in 2008. Of this, some £7.8bn was provided by charities and not-for-profit organisations. However, in 2007, the National Council Voluntary Organisation (NCVO) found that third sector activity still only accounted for some two per cent of total public spending. Since 2006, the government has actively pursued a policy of attracting more third sector providers into the market and developing their capacity. This has been achieved by creating a new Office of the Third Sector in the Cabinet Office; targeted funding support like the Futurebuilders and Communitybuilders funds and capacity-building programmes, such as specialist training programmes for public sector procurement officers.

Involving third sector organisations more closely in designing and delivering public services has many advantages. Third sector organisations are said to be better at working with difficult-to-reach user groups '“ such as drug users, refugee communities or offenders '“ who may be suspicious of and less inclined to use services provided by state agencies. They may also be able to innovate and implement change quickly.

A more diverse provider market also builds extra capacity, choice, and, crucially, competition, which is said to drive up standards and improve efficiency. The Department of Health encourages new providers through policies such as 'any willing provider', which has seen the growth of clinician-led groups taking on services. A Cooperation and Competition Panel was launched in January 2009 to referee this new competitive landscape and develop a new body of law in this area (see www.ccpanel.org.uk). However, health secretary Andy Burnham controversially signalled an apparent u-turn recently by saying that NHS organisations should be the 'preferred provider' of health services. Hardly a level playing field, argue prospective new entrants.

The challenge for the third sector

For third sector organisations facing a continued squeeze on grant funding and income from donations, the prospect of tapping into new revenue streams from public sector contracts is attractive. However, such contracts require careful preparation and thought.

There is concern that entering into contracts with state agencies may compromise organisations and limit their freedom of action. This may be particularly difficult for campaigning and advocacy organisations whose remit is frequently to critique government policy and track record.

In the Charity Commission's recently published 'Charities and Public Service Delivery' guidance, trustees are urged to exercise independent judgement and properly manage conflicts of interest. In some cases, public authorities may seek to include conditions in funding agreements which put trustees in breach of trust or restrict their ability to act solely in the charity's interests. These could include rights to nominate clients or beneficiaries, to appoint trustees or to send representatives to trustee meetings.

The charity must not accept any terms or conditions that are contrary to its governing document; for example, the mechanisms for trustee appointment. Trustees must not surrender or restrict their discretion unless they are satisfied this is in the charity's interests.

Do we have the necessary powers?

A key issue for charities and not-for-profits is whether they have the necessary constitutional powers to bid for and undertake the contract. This is particularly relevant for regulated entities, such as registered charities and community interest companies, whose activities are monitored to ensure they comply with their published objectives and deliver the new requirement of 'public benefit'. Local authorities will check that providers have the necessary powers to undertake contracts.

Trustees and board members are under a fiduciary duty to ensure the organisation's resources are used prudently and that assets and reputation are not unduly put at risk. Entering into a contract for service delivery involves risk. Trustees should consider the business plan carefully and be satisfied the organisation has the necessary expertise, resources and working capital to undertake the business activity and manage the risks. Ensuring appropriate capacity might involve looking at the skills set of executive staff and board members to properly oversee the plans.

Charities may choose to insulate the risks of trading activity from their main assets by establishing a separate trading subsidiary. There can also be tax consequences of trading. Unless the activity is furthering the charity's objectives (so called 'primary purpose trading'), then income generated may be subject to corporation tax. An example of a primary purpose trade would be a care charity, established to 'relieve sickness and care for the elderly', charging residents to stay in its care homes. If the activity is not a primary purpose, by setting up a separate company and remitting the profits through gift aid to the parent charity, the organisation may be able to shed the tax liability.

Winning the contracts

Securing a contract can be expensive and time consuming. Typical procurement times from publication of a contract notice to contract signature can be 12-18 months; or longer in complex service environments. Tackling this challenge requires dedicated in-house resource, management time and usually external legal and financial support. Trustees must be satisfied this represents a good investment. Organisations that routinely sign contracts without proper review or negotiation should undertake proper due diligence on what they are getting into. Trustees may protect themselves against allegations of negligence or breach of trust by taking proper advice and carefully minuting decision making.

Preparing to bid should start long before the opportunity comes to market. Contract opportunities from public bodies are usually advertised in the Official Journal of the European Union (OJEU), on the web portal www.supply2.gov.uk and may also appear in specialist trade press. The first step usually is to prepare and submit a pre-qualification questionnaire. The PQQ asks standard questions about accounts, capacity, track record and staff experience. Contracts for some services over a certain value require the public sector agency to follow the detailed rules laid down by the Public Contracts Regulations 2006. Only the prescribed criteria can be used to evaluate bids, set minimum time limits to respond to opportunities and provide certain rights for bidders to obtain feedback and redress if they have not been treated fairly.

Faced with criticism that contracts for Part B services (including education and health and social care, for example) were not covered by these regulations, the European Court of Justice used some judicial activism to develop general principles of law that certain minimum safeguards still apply to contracts which would otherwise be exempt services. These include a requirement to use minimum advertising, to act transparently in awarding contracts and to treat bidders fairly. A case involving a local authority tender, Letting International Limited v London Borough of Newham [2008] EWHC 1583, established that the principle of transparency requires public bodies to publish the evaluation criteria and relative weightings they intend to use, before receipt of tenders.

An issue for smaller organisations is insufficient balance sheet strength or trading history. They may get around this by collaborating with other partners who bring complementary skills and resources. Some commentators have called for more collaboration between private sector providers (who bring better access to capital and extensive resources) and specialist third sector providers who bring detailed knowledge of their clients, in so-called 'social-private partnerships'.

The invitation to tender

Bidders responding to an invitation to tender must provide method statements, detailed pricing proposals, and a range of supporting information (e.g. insurance details, staffing proposals). The tender document usually includes a draft contract and may invite comments on proposed contract terms. This can be a difficult area for bidders who must balance reviewing and suggesting amendments with the fear of losing marks for being non-compliant.

Bidders should examine draft contracts to check that the risk profile works for them. The risk allocation may be unbalanced with one-sided indemnities favouring the public agency. Bidders have three choices: accept the terms and price for the risk; see if they can obtain insurance for the risk; or qualify their bid and refuse to accept the risk. Putting this into a submission that will score well in evaluation is an art form where specialist advice can be invaluable.

To address the issue of fairness of dealings between third sector and public agencies, the key stakeholders developed 'The Compact' '“ a charter of fundamental principles that should apply to contracts in this sector. For example, under paragraph 4.8 of the 'Compact Code for Procurement and Funding', government undertakes 'to discuss risks upfront and place responsibility with the public sector body or voluntary and community organisation best able to manage them'.

Key commercial issues

Depending on the procurement process used, there may be scope for negotiation on some of the key commercial issues. Typically, the most difficult areas are:

• Performance and payment regime '“ public sector agencies increasingly look to tie payments to delivering successful outcomes. Third sector organisations should ensure performance measures are reasonable and attainable. A contract where income may not even cover costs is a recipe for insolvency. The timings of payment are crucial to cash flow.
• Employment and pensions issues '“ where a service is being outsourced for the first time or being re-procured, the Transfer of Undertakings (TUPE) regulations are likely to apply. Public sector agencies may struggle to provide bidders with quality information about employees ahead of the transfer. This can be a source of major additional costs and risks. Bidders should press for indemnities for issues outside their control '“ particularly events occurring before the transfer. Transferring employee pensions requires particular care, especially where public sector benefits have to be replicated.
• Risk, indemnities and insurance '“ parties need to be clear about the allocation of contract risks. Service providers should resist accepting liability for issues outside their control. Specialist insurance advice may be required to ensure that key risks are properly insured.
• Termination and exit from the contract '“ in certain circumstances, both parties may be looking for an exit. It may be necessary to include intermediate steps to allow disputes to be resolved informally or formally, perhaps using ADR, before proceeding to termination. Parties should consider what would happen in this Armageddon scenario '“ particularly where vulnerable service users are involved. The public agency may have a statutory duty to step in and provide the service. It will need the cooperation of the outgoing service provider, access to key documents and personnel, intellectual property rights and employee lists.

This is likely to be a growth area for charities, not-for-profits and their professional advisers. Increasingly demanding citizens want better and more personalised services and greater choice. The third sector can play a key role in delivering this vision. Those that are properly equipped for the challenge should do well, but both they and their advisers should proceed with eyes wide open and take appropriate professional advice.