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Business law in real life

Commercial
contracts
for rail services

Procuring public transport in a commercially sound manner is the key to successful regional rail services. Public procurers put a lot of effort into fulfilling all the formal regulations; sometimes, at the detriment of the deal. But if the procurer manages to find a framework that is also commercially sound, business can reach a whole new level.

Unlike private sector business deals, public procurers have to find good solutions within the scope of procurement regulations. But while these regulations may entail restrictions in many aspects, they also allow public procurers a great deal of freedom. The procurer prepares the contract documents himself and can thus determine the conditions.

Think carefully about compensations!

A commercial procurement contract includes both a good formula for compensation and a reasonable allocation of risk. Compensations to a railway company should preferably be in line with the company’s cost trend. This applies to type of compensation – variable or fixed, based on time, distance, or number of units – as well as payment schedule.

If payments are in line with the company’s costs, in terms of both time and amount, the company doesn’t need to add additional financial and interest costs to their tender.

Allocating risks to a railway company is often okay, at least those that they can foresee and control. A skilled tenderer can evaluate and price a reasonable risk allocation. Adding big, uncontrollable risks with no maximum ceiling, however, makes the tenderer cautious. This results in excessive risk premiums being added into the tender and the procurer ends up paying more for the rail services than necessary.

Timetable is central

The procurer usually just wants to pay for what he sees and gets. For rail services, this is easily defined as the established timetable clearly specifies traffic volume. This makes the timetable a great measure of the scope of the contract. It is therefore often used as a base for determining compensation to the railway company.

Managing extra hours

Operating traffic involves work both before and after departure, and while the timetable may indicate when a train is in traffic, it doesn’t indicate the working hours of the staff. A train must be prepared for departure. Upon arrival at the final station, it has to be turned around and then wait for the next departure.

At the end of the day, the train is washed and cleaned and left in good condition for the next day. In other words, the railway company bears costs even when the trains are not in traffic. If the company only gets paid for hours and kilometres according to the timetable, chances are that the necessary increases to cover costs outside the timetable will be included in the tender.

Contracts, however, run over many years, and timetables and conditions are subject to change. Thus, there may be reasons to accommodate the company and allow variable compensation related to certain work outside the timetable.

Liability for traffic disruptions

Another important issue is the compensation to be paid when traffic is disrupted. Cancelled or delayed trains make the procurer feel as though he’s not getting the services paid for. The railway company, on the other hand, is taking a financial hit since company staff is on schedule and works even during the disruption. A disruption that may not even be the company’s fault.

A reasonable requirement is that the terms of compensation are transparent and clear. That way, both procurer and railway company know how compensation is determined.

The railway company knows how to price minor disruptions adequately, whether he receives compensation for extra time and work generated by the disruption, or if he adds a disruption fee to the ordinary variable compensation. It is the unexpected major disruptions that are difficult to handle for both procurer and railway company.

Final word

The timetable changes from year to year. And neither the railway company nor the procurer has the final word on this. The Swedish Transport Administration determines the final timetable, taking into account all requests for rail services. Sometimes, both procurer and railway company have to give way in favour of another request.

Since a new timetable may affect the railway company’s costs, the procurer has to make a choice. Should the railway company be allowed influence over next year’s timetable? Shared influence may lead to negotiation and adjustments. Or should the procurer retain sole authority and, at best, let the railway company have thoughts and comments?

Regardless of approach, conflicts of interest will arise when hammering out the details. Both parties want to optimise traffic, but on the basis of different goals. The railway company evaluates a new timetable based on cost while the procurer assesses traffic based on the traveller’s point of view. And, as mentioned before, the Transport Administration has the final word.

Worst case

Worst case scenarios can be a real headache for the tenderer depending on risk allocation. Train accidents can create huge costs for damaged vehicles and broken railroad tracks. If people are injured, you’re looking at personal suffering and economic costs that are difficult to foresee.

If the risk of vehicle damage and personal injury is allocated to the railway company, they are usually managed through insurance. This calls for finely tuned conditions for requirements on both railway company liability and insurance coverage.

Demand sufficient securities!

It’s becoming increasingly common for procurers to demand bank guarantees from the railway companies. These should generally be prepared and submitted by the contract-awarded railway company at the signing of the contract. Usually, on-demand guarantees are required. An on-demand guarantee means that the bank pays out as soon as the client demands so in writing. No preceding legal process before the court is required.

In public transport, the trains are usually owned by the procurer. The railway company is allowed to use them for the purpose of the contract. As train vehicles represent large investment values for the procurer, the railway company takes on a significant liability for their technical and economic value. A bank guarantee can provide security for this liability.

This includes covering a claim for damages from the procurer if the railway company breaches the contract and then goes bankrupt. The procurer does not, however, automatically get to keep the money paid out. Each pay-out must be supported by a claim on the railway company.

Excessive demands can be negative

A procurer who abuses the guarantee is liable to pay back the railway company for any amounts that cannot be justified under the contract. Additionally, the demand for bank guarantees increases the tender price. After all, a guarantee is a cost for the railway company. Fees are usually set as an interest on the guaranteed amount. With today’s interest rates, this means 1–4% depending on the credit rating of the railway company. Bank guarantees are a great security for payment ability. As a procurer, however, you shouldn’t routinely demand them from the tenderers. Any guarantees must be evaluated taken the big picture into account where contract terms regarding the railway company’s liabilities and insurance also play a role. Put simply, guarantees are not free.

Negotiations are essential but precarious

A good negotiation can make a good deal even better, for both parties. Some procurement procedures allow the procurer to negotiate with the tenderers. Due to legal regulations, this type of negotiation is a bit special. In many cases, the procurement is based on all competing railway companies pricing the contract on the basis of the current terms in the contract documents.

Any negotiation must therefore focus on the content of the tender, which must meet the requirements in the contract documents both before and after negotiation. Negotiation must not change the original terms in the contract documents. These include terms regarding liability, risk allocation, payment formulas, etc. But provided that the procurer leaves clear instructions, a negotiation may refer to specified portions of the contract documents, such as maximum ceilings for liability or other risk allocations.

Railway companies will want to negotiate away cost drivers in the contract. This can also benefit the procurer by reducing the tender price. If the procurer allows this type of negotiation, the outcome of such negotiation should be part of the tender evaluation. A change in risk for a railway company should also affect the evaluation of the tender. An experienced procurer knows up front what the railway companies will want to negotiate and can decide what leeway to give them.

Equal treatment is key!

Procurement regulations restrict how negotiations can be conducted. The requirement for equal treatment of all tenderers and confidentiality means that all tenders must be treated equally. All tenderers, at least those with a reasonable chance of being awarded the contract, must be given the same opportunity to improve their tenders through negotiation. Otherwise, discussions may arise on whether the procurer favoured a certain tenderer through extended negotiations where the negotiation outcome became a decisive factor in awarding the contract.