REUTERS | Jason Lee

Making use of audit rights

With the increased use of “cost reimbursable” or “cost plus” contracts such as the IChemE Green Book and NEC3 option E, now is a good time to consider the employer’s right of audit in more detail.

The mere mention of “audit” often triggers a certain amount of eye-rolling even from accountants, so it’s hardly surprising that the construction industry pays little attention to contractual audit rights. As a result, audit provisions are, more often than not, consigned to the back of contracts along with the remainder of the “boilerplate” clauses, rarely to be considered again until it’s too late. However, if they are properly drafted and utilised, audit provisions can serve clients as both sword and shield.

The need for audit rights

One benefit of “cost plus” contracts is that the contractor, safe in the knowledge that its profit margins are protected, does not need to build-down to meet an erroneously low contract price. On the other hand this can cause problems for an employer, who may be faced with ever mounting and unpredictable costs, not to mention an administratively burdensome mountain of receipts and invoices.

The majority of employers using this form of contract will be experienced enough to administer it effectively. Despite this, the sheer volume of cost items incurred in complex developments means that cost issues do occasionally arise, whether through mistake or otherwise.

The employer’s right to audit, if clearly highlighted to the contractor at the outset, can ensure that costs are properly managed and identify any accidental mistakes. It affords the employer the comfort of knowing that he is getting exactly what he has paid for.

Audit: more than just making sure the numbers add up

Although the term “audit” conjures up images of a laborious trawl through financial records, a painstaking review of every receipt and perhaps a large calculator, audit provisions can extend the scope of investigation well beyond the contractor’s financial records and are not limited to “cost plus/cost reimbursable” contracts.

In the recent case of Transport for Greater Manchester v Thales Transport & Security Ltd the court interpreted the audit provision as allowing TGM to see:

  • Documents detailing things done and not done by the contractor.
  • Accounts and costs information.
  • Company and group board minutes.
  • Internal reports.
  • Documents that were commercially sensitive, containing personal or confidential information.

The court concluded that the word “audit” had an equivalent meaning to “vetting” or “checking” and rejected the contractor’s claims that any review should be limited to the verification of financial records.

Contractors may question whether it is reasonable for an employer to have such wide audit rights. In the Thales case the judge commented that the project was part of a much larger infrastructure project, expected to cost about £1 billion. Also, TGM was a public body with statutory powers to procure, among other things, the extension of the Metrolink tram system in Greater Manchester. In that context, TGM had a legitimate interest in having a detailed understanding of exactly what was going on in relation to the project, given its importance to the overall extension scheme and TGM’s own statutory responsibility. In effect, the judge concluded that the clause was reasonable in the context of this project.

While a court will allow wider audit rights in some situations, employers should not expect unfettered access. A court will not permit an employer to go on a “fishing expedition” any more so than it would under pre-action disclosure. The courts are reluctant to allow requests that are not aligned with the purpose of the audit clause itself.

From the perspective of parties negotiating an audit clause, one further key consideration is whether the contractor is obliged to maintain specific categories of documents. Clearly, audit rights are fairly limited if there is nothing to audit. Contractors should, under the terms of the contract, be obliged to maintain records in line with the audit provision for at least the duration of the project.

Audit not just an end in itself

There have been a number of occasions when our clients have sought to enforce their contractual rights to audit certain documents. In the majority of cases, they have been met with strong resistance and the scope of the audit has been questioned. This may be because their contractual counter-party has something to hide. However, it is more likely to be because the counter-party has not appreciated the true extent of the audit provisions and is, understandably, reluctant to disclose documents that it regards as confidential or commercially sensitive.

Given the possible very broad nature of the information/documentation caught by an appropriately worded audit provision, combined with the fact that access to this may be granted at a much earlier stage than disclosure in legal proceedings, an audit provision may not always be an end in itself but could work as a powerful bargaining tool.

Perhaps then, an audit isn’t so dull after all.

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