Update | Construction: information under an audit clause

Following a recent case in the technology and construction courts, the extent of information that employers are able to request of contractors through audit clauses has become a major topic in debates relating to construction contracts. It has therefore become increasingly important for companies to understand what information they are obliged to present to their employers under an audit clause.

Audit clauses in construction contracts have nothing much to do with accountancy. They are clauses that oblige the contractor to provide all sorts of information to the employer and often to allow the employer to send auditors into the contractor’s ?offices to look through its records. Similar clauses are often put into consultants’ appointment contracts.

There is nothing to stop the employer’s chosen auditor being a construction litigation lawyer who is handling, or preparing, litigation against the contractor. Indeed, my own firm has carried out audit exercises, in one case using an audit clause in a consultant’s appointment with devastating effects on the consultant’s defence.

A case decided in the technology and construction court on 21 December last year provides an excellent example (and many useful comments on the relevant law by Lord Justice Akenhead).

In Transport for Greater Manchester v Thales [2012] EWHC 3717 (TCC) Transport for Greater Manchester (TGM) awarded a contract to Thales for the supply of a tram operating system. The original contract price was £22m. Four years later only a third of the original contract price had been paid, Thales was possibly liable for £36m of liquidated damages for delay but was claiming in litigation a 43-month extension of time and a payment of £42.3m, based on a combined claim submission with 19 files of annexures. Things had clearly not gone swimmingly.

As is normally the case in these situations, Thales as contractor had by far the majority of the hard evidence as it was employing the sub-contractors and staff, and had all of the detailed programming information. TGM clearly feared a spate of single issue adjudications, which it might lose for lack of the hard information with which to rebut Thales’ claims. TGM was also no ?doubt hampered in its ability to present detailed claims of its own, by lack of the same information.

The contract contained, as such contracts normally do, obligations for the contractor to maintain proper records and a widely drafted audit clause. TGM is a public body and there were references to the powers of public sector auditors and the Freedom of Information Act, but the audit clause was not tied to these. Nor was the audit clause tied to the maintenance of records clause – it allowed TGM to audit all information “relating to” the performance of the contract and it also allowed the audit of “information, records or documents …which relate to” the records that Thales was obliged to maintain. The drafting was wide but not unusually so – draftsmen normally try to make such clauses as all-encompassing as they can.

Digging deep

TGM requested massive quantities of information and, when its request was not fully complied with, went to court asking for an order for specific performance. TGM wanted Thales to disclose 53 categories of document. The court accepted almost all of the requests. The judgment contained some useful statements about audit clauses and their enforceability, including then following points.

First, the judgment made it clear that it doesn’t matter that the audit clause requires disclosure of information and documents that goes beyond what the normal court rules would require as part of the litigation disclosure process – an audit clause is contractual, so it can go as wide as the parties have drafted it. This brings home the necessity of ensuring that contracts are carefully studied prior to agreement being made. All parties need to be aware of what they are contractually obliged to disclose.

A key to understanding the implications of the judgment is appreciating what information can be understood as relating to the performance of a contract. Documents are considered to relate to the performance of a contract even if they are not required by the contract to be maintained as records and even if they are not generated as a natural part of doing the work. Therefore, internal reports produced months after the event by Thales’ Tiger Team, appointed to investigate the project and report to Thales’ senior management on the project team’s performance, were subject to audit. It is therefore vital that companies fully analyse what may be demanded of them in the future based on the audit clauses of the contracts they sign.

Documents tending to show failures or non-performance can also be said to relate to the performance of the contract and so are subject to audit, as per the agreement in the audit clause. Again, this stresses the importance to contractors of ensuring that they are satisfied with the details of the audit clause prior to signing a contract. Even if they think they are happy with the current terms, they must realise that their circumstances may alter and that this information would also have to be revealed.

Information about payments to sub-contractors and suppliers were subject to audit even though it was a fixed price contract, because such information can be understood as relating to the performance of the contract – the issue is what the audit clause says, it is simply a contractual test. Information about costs could shed light ?on performance and/or non-performance ?of Thales’ obligations and so it was a reasonable thing to request and within the scope of the clause.

Documents can be audited even if they are commercially sensitive – the contract contained a confidentiality clause binding on TGM so Thales should have no problems in disclosing any information to TGM.

The fact that TGM’s requests had been triggered not by any abstract thirst for information but by Thales submitting substantial claims was immaterial – the contractor normally has the vast bulk of the hard information so, “it is not unfair that Thales has to supply or make available documents which may help, undermine or hinder its claims” as this enables both parties to know where they stand and ensures that “Thales cannot then readily (even if unconsciously) mislead TGM or an adjudicator with evidence, information and documentation which does not tell the ?whole story”.

The judgment did say that the requests for information must be “reasonable” and that their purpose must be “to enable TGM to vet or check information supplied to TGM under the contract or to enable it to verify whether or not Thales had complied with its obligations” – but surely that covers almost everything an employer might ever want to know? Akenhead J noted that the project had gone wrong, that logically either TGM or Thales or both of them must be responsible, and that “either way, TGM has a very real interest in determining whether and to what extent it or Thales is responsible for what has happened”. What employer could that not be said of?

Be prepared

The only material categories of document where disclosure was not ordered were where the request was so vaguely expressed that the court could not really order specific performance (although it was made clear that the court would look at these again if the employer came back with more precise requests). The requested disclosure of “documents explaining the reason(s) for the departure from the project” of four named senior staff members was held by the judge to be unreasonable as there could be many explanations that had nothing to do with the particular project. TGM could not say precisely what their reasons for departure would be likely to show, and the reasons were bound to be highly confidential to the individuals concerned.

Following the Thales case, solicitors drafting construction contracts will have a good look at the case and make sure that the wording of their audit clauses is as wide as it can be. The case has provided some good guidance in relation to this. Wide purposes will be set out to justify the clause, followed by widely expressed requirements for disclosure, with a confidentiality clause included in the contract to cover off any commercial confidentiality arguments.

There is no realistic prospect of contractors being able to get these widely drafted audit clauses deleted. Nor is there much prospect of contractors seeking to have their wording cut down. A request for any ludicrously wide drafting to be limited so that it covers only information relating to the project in question should be acceptable, but why would employers allow any further reductions? What is the contractor trying to hide? Is the contractor saying he or she will not be open and honest? Particularly in a tender situation in the current market, it is nigh on impossible to argue against widely drafted audit clauses. Contractors therefore have to live with them more or less as they are.

Contractors should assume that the documented lie will be exposed – an internal note about the true state of affairs on a project when set against a contemporaneous letter to an employer assuring them everything is fine is not just embarrassing, it is a clear lie and risks prejudicing every other piece of evidence the contractor tries to produce.

Indeed, the best thing contractors can do is assume that more or less everything will be auditable, except legally privileged documents. Solicitors should therefore be involved in discussions as soon as it appears that something might “go legal” – certainly they should be involved before people start producing reports which might show that the contractor had done something seriously wrong.

To some extent contractors will proceed on this basis anyway in light of the possible discovery process should a matter go to litigation, but audit clauses are contractual so they can go wider than litigation discovery. Moreover, they can kick in without warning, with no need for any formal legal process beforehand. Contractors have to ensure that all of their staff operate with this knowledge.

The final insult is that producing all of this information costs the contractor a fortune. Many employers would concede that contractors should be entitled to payment if requests for audit information result in costs above a given level, or require more than so many days’ work, but that isn’t in the first draft of an audit clause, and few contractors think to ask for it when tendering.