The Reform of the UK Single Source Contracting Regime - A brief guide to the key changes implemented by The Single Source Contract (Amendment) Regulations 2024

The much-anticipated Single Source Contract (Amendment) Regulations 2024 (the Amendment Regulations) came into force on 1 April 2024.  The Amendment Regulations introduce a number of important changes to the Single Source Contract Regulations 2014 (SSCRs) which, together with the Defence Reform Act 2014, provide the regulatory framework within which the UK Ministry of Defence is required to undertake single source procurements. These changes constitute the most significant reform to the single source regime since it was originally introduced a decade ago. 

This article provides a brief overview of the background to the Amendment Regulations, before going on to summarise the key changes that have been introduced.  

Background

The Defence Reform Act 2014 and the SSCRs were originally introduced in order to place the process by which the Ministry of Defence (the MoD) procures equipment and services on a non-competitive basis on a clear statutory footing and to address a number of perceived issues with the previous non-statutory regime. The core purpose of the statutory regime, which remains unchanged following the Amendment Regulations, was to ensure value for money in public expenditure is achieved in sole source procurement while at the same time ensuring that fair prices are paid to industry.

Section 39 of Part 2 of the Defence Reform Act 2014, which was the enabling primary legislation for the single source regime, requires the Secretary of State for Defence to undertake a periodic review of the statutory regime. The current reforms are the result of the most recent such review which culminated in a Command Paper, which was released by the MoD in April 2022 and included some 30 proposals for changing the regime. The MoD launched a consultation on the first tranche of the proposed amendments in November 2023 (see the consultation paper here) and, following the conclusion of that process, published its response to the consultation in January 2024.

The MoD’s stated aims in introducing the current reforms are to support delivery of the Defence and Security Industrial Strategy (DSIS) through:

(i) improving choice and flexibility in the contracting approach by ensuring the SSCRs can be used in a wider range of sectors and contract types; 
(ii) allowing the regime to be used to speed up and simplify the acquisition process; and 
(iii) adapting the SSCRs to ensure they support innovation and exploitation of technology.

The necessary amendments to primary legislation to enable the introduction of the detailed changes contained in the Amendment Regulations were enacted through Schedule 10 of the Procurement Act 2023, which amended the Defence Reform Act 2014. The Amendment Regulations themselves contain the first tranche of the planned reforms. A second tranche of amendments are planned to deliver some of the more detailed reporting and technical changes proposed in the Command Paper and the MoD had indicated that it was aiming for the second tranche to come into effect in October 2024. However, the election and a possible change of government may now have an impact on this proposed timing.

To coincide with the coming into force of the Amendment Regulations the Single Source Regulation Office (SSRO) has published new guidance on the alternative pricing methods that may now be used to price single source contracts (Alternative Pricing Guidance) and updated versions of its Statutory Guidance on Allowable Costs (Allowable Costs Guidance) and the setting of the Baseline Profit and its adjustment to reflect the amended regime (Baseline Profit Guidance). Each of these sets of guidance will apply from 1 April 2024 and must be taken into account by contractors when pricing single source contracts under the amended regime from that date.

Key areas of reform

The Amendment Regulations have introduced the following key changes to the SSCRs:

• a widening of the definition of what constitutes a Qualifying Defence Contract (QDC) and certain clarifications as to when amendments being made to an existing contract can be considered to have created a ‘new contract’ for the purposes of the SSCRs;
  
• the introduction of certain alternative pricing mechanisms which permit the price of a QDC to be calculated other than by means of the (CPR x AC) + AC formula;
  
• the broadening of the ability for a QDC to be split into different components (componentisation) and the introduction of new component-level reporting requirements; and 
  
• the amending of the six-step process that must be followed in order to calculate the Contract Profit Rate in circumstances where the default profit formula is being used.

We consider each of these key changes in turn below.

1. Definition of a Qualifying Defence Contract 

Meaning of a contract “for defence purposes”

The single source regime is defined as applying to what are described as “Qualifying Defence Contracts”. Under the Defence Reform Act 2014 a QDC was defined as being a contract under which the MoD procures goods, works or services “for defence purposes”. The SSCRs in turn defined “defence purposes” as being “the purposes of defence (whether or not of the United Kingdom) or related purposes”.  In practice, a number of cross-government single source contracts which were used partly by the MoD and partly by other government departments or agencies were falling outside the regime.

In order to address this gap and enable contracts of this nature to be clearly brought within the scope of the single source regime, the Defence Reform Act 2014 has been amended so that a QDC is now defined as being a contract for the procurement of “goods, services, and works wholly or substantially for defence purposes”. The Amendment Regulations have then introduced an amendment to the SSCRs to define what this means in greater detail. A contract is therefore now “substantially for defence purposes” where: 

• the value of the goods, works and services for defence purposes under the relevant contract is more than £5,000,000 and more than 30% of the total value of the contract; or
  
• the value of the goods, works and services for defence purposes under the relevant contract is more than £25,000,000.

New vs amended QDCs

Previously, under the Defence Reform Act 2014, a new contract that met the requirements for a QDC would automatically be subject to the single source regime. However, a non-QDC that was already in place (either because it was entered into prior to the regime originally coming into effect or because it did not meet the QDC criteria when it was originally entered into) could become a QDC on amendment (assuming at that point it met the relevant criteria) - but only where the parties expressly agreed that it should do so.  The MoD has long held that this requirement for there to be agreement between the parties before a contract could be converted to a QDC meant that in practice too many contracts that were being amended on a single source basis were falling outside the regime. Prior to the introduction of the Amendment Regulations the MoD and SSRO had sometimes sought to address this issue by arguing that an amendment to an existing contract was tantamount to the creation of a new contract and therefore should be caught automatically by the regime. However, for this to be the case at common law, the amendments in question would need to be significant enough to amount to a recission of the existing contract and the substitution of a new contract and, in practice, that test is often difficult to assess. Such an approach did not therefore create any additional certainty around this question.

In response to this situation, new Regulation 7A seeks to clarify the circumstances in which an amendment should be treated as a new contract for the purposes of the regime.  In short, it provides that an amendment which adds goods, services, or works to an existing contract is considered a new contract in two alternative situations.

1. The first situation is where:

• the same or substantially the same commercial outcome could be achieved either by amending the existing contract or by procuring the additional goods, works or services under a separate contract without making disproportionately numerous or complex amendments to the existing contract; 
  
  
• procuring the goods, works or services under a separate contract would not give rise to any unavoidable and material additional commercial risks or duplication of costs or resource; and 
  
  
• the additional goods, works or services are not subject to a “price restriction”, which is defined as being where: (a) the relevant contract was subject to a competitive process when it was originally awarded and specifies the way in which the price of the additional goods, works or services is to be determined and (b) the way in which the price is to be so determined was agreed either, in respect of single source contracts, prior to the date the SSCRs originally came into force (i.e. 18 December 2014) or, in respect of non-single source contracts, on the date the contract was entered into and is in each case incompatible with the single source regime.
  

2. The second situation is where an existing contract is amended in such a way as to amount in effect to the termination of that contract and the creation of a new contract. 

While the first situation does introduce a degree of greater certainty around the circumstances in which a new contract can be said to be created for the purposes of the SSCR regime, there will still be an element of judgment required as to whether the tests have been met, particularly in relation to the requirement for the separate contract not to create any material additional commercial risks.

The second situation preserves the common law position described above and where the relevant test is met the whole contract will fall to be assessed under the regime (rather than just the part which relates to the additional scope as is the case with the first situation). However, it still begs the question of how the materiality of the amendments will be assessed in practice. 

It should also be noted that Regulation 7A(4) enables the parties, if they both agree, still to treat a  contract that would otherwise qualify as a new contract under Regulation 7A as an amendment to an existing contract.  This effectively gives the MoD the power to disapply the above conditions. It is currently unclear when the MoD will use this right in practice, although the MoD internal guidance (available on the Defence Gateway site) suggests that the purpose of this right is to provide the parties with an option to convert whole contract to a QDC on agreement (i.e. not just the part of the contract dealing with new scope). It remains to be seen whether the MOD will seek to use this right any more widely.

2. Alternative pricing mechanisms

This is perhaps the most significant change to the regime introduced by the Amendment Regulations. The SSCRs previously mandated that the price payable under QDCs, regardless of which of the originally permitted pricing methods  was selected for the contract, had to be determined by applying the same pricing formula:

(CPR x AC) + AC

where:

CPR is the contract profit rate determined by a statutorily prescribed method, and 

AC are the supplier’s allowable costs (being those costs which are defined as being appropriate, attributable to the contract and reasonable in the circumstances, having regard to the SSRO’s statutory guidance on allowable costs ). 

(the Default Pricing Formula). 

A key concern of industry - and one that featured prominently in the Secretary of State’s review of the regime – has been that in many situations the application of the Default Pricing Formula to calculate a contract price was not proving practical or possible and that there were likely to be other, more appropriate means by which a fair price could be established. In response to these concerns, the Amendment Regulations have introduced seven specific scenarios where the parties will not need to use the Default Pricing Formula in order to calculate the contract price (or component price) and outline how, in each of the scenarios, the parties may demonstrate that the contract price represents value for money and a fair price for the contractor. The MoD hopes that these alternative pricing methods will reduce barriers to contracts falling under the regime by providing for the flexibility to accommodate a range of contracting circumstances.  Each of these alternative pricing methods is summarised briefly in the Annex to this article.

3. Componentisation

Another key aspect of the reforms is to allow a QDC to be split into different components, a process referred to by the MoD as ‘componentisation’. While parties to a QDC have always been able to apply different permitted pricing methods to different identified parts of the QDC, they did not technically have the flexibility to apply different contract profit rates to those different parts from the outset of the contract . The amended regime now provides much greater flexibility for the parties to create different components within a QDC and to treat these distinctly from one another for the purposes of calculating the contract price. 

Under Section 15 of the Defence Reform Act 2014 (as amended), a part of a QDC (a ‘component’) is to be treated distinctly from other parts of that QDC if the SSCRs contain provision to that effect, or if the parties agree that it should. 

Accordingly, new Regulation 9A, as introduced by the Amendment Regulations, identifies three scenarios in which a component should be treated as being formed:

• where a part of the QDC uses a different contract pricing method  to any other part in the QDC; 
  
• where a part of the QDC has a different contract profit rate to the contract profit rate used in any other part of the QDC; or
  
• where the price of a part of the QDC has been determined in accordance with an alternative pricing method or re-determined in accordance with the Schedule to the SSCRs (re-determination of contract price) and the relevant provision of the Schedule requires that part to be treated as a component (i.e. the effect is that part is treated distinctly in determining the price payable).

The parties are also free to agree that a separate component should be created but, under Regulation 9A(2), they may only do so where they can demonstrate a commercial purpose for such agreement, other than to affect the amount of any final price adjustment. 

The key impact of these changes is on a contractor’s record keeping and reporting obligations. It will now be necessary for the contractor to keep records and report in detail on how each component under a contract has been priced. For existing contracts that were awarded prior to 1 April 2024, however, the new component level reporting requirements will not come into effect until 1 April 2025, allowing contractors a transitional period to prepare for the new obligations.

It should also be noted that in the event that the parties cannot agree on whether the criteria for the creation of a separate component (and the associated additional reporting requirements) have been met, the matter can now be referred to the SSRO for it to give an opinion or determination on the question.

4. Changes to process for calculating contract profit rate – removal of Profit On Cost Once (POCO) and SSRO funding adjustments and amendment of the Cost Risk Adjustment 

POCO adjustment / SSRO funding adjustment 

Prior to the coming into force of the Amendment Regulations, the contract profit rate for a QDC had to be determined by following the six step process set out in Regulation 11.  Now, where the Default Pricing Formula (as opposed to one of the alternative pricing methods) is being used, the Amendment Regulations have simplified this process by removing two of the previously required steps: the adjustment previously included at step 3 to ensure that profit arises only once on the relevant allowable costs (the POCO adjustment) and the adjustment previously included at step 4 to add into the formula the SSRO funding adjustment.  

The SSRO funding adjustment has been removed on the basis that the MoD no longer considers it appropriate to seek to recover a contribution to the SSRO’s costs from industry. However, while the POCO adjustment step has been removed, the need to ensure that a Contractor should not include within its price profit earned at multiple levels within its group as a result of placing intra-group sub-contracts remains an important principle of the single source regime.  It will therefore now be dealt with by way of an adjustment to the Contractor’s allowable costs rather than a reduction to the contract profit rate. The amount of the reduction must be equal to what the Regulations refer to as the ‘attributable profit’ on any group sub-contract .   Detailed definitions of ‘attributable profit’ and ‘group sub-contract’ for these purposes are set out in Regulation 13A.

Cost Risk Adjustment 

The Amendment Regulations have also amended the way the cost risk adjustment (step 2) to the baseline profit rate is defined. Previously, step 2 involved adjusting the baseline profit rate by an agreed amount which was within a range of plus or minus 25% of the baseline profit rate, to reflect the risk of the primary contractor’s actual allowable costs under the contract differing from its estimated allowable costs.

Now the baseline profit rate is to be adjusted by an agreed amount which is within a range of plus or minus 25% of the baseline profit rate, to reflect the financial risks to the primary contractor of entering into the contract or component, taking into account the particular type of activities to be carried out by the primary contractor under that contract or component. This new formulation is intended to allow for a broader assessment to be made of the risk the Contractor is taking under a QDC. 

The Baseline Profit Rate Guidance states that "financial risk to the primary contractor” should be interpreted as meaning “the uncertainty associated with the profitability of that contractor relating to the contract or components entered into”. It then points out, however, that while one factor in this regard will be the uncertainty associated with “the extent to which actual costs may differ from estimated costs”, this is not the only factor that is relevant. Accordingly, a list of other risk factors the parties should consider when determining the cost risk adjustment is contained in Appendix C of the Baseline Profit Rate Guidance. 

View the Annex here.