Fallibility of the Fall Clause

‘Fall Clause’ is one of the many terms and conditions that pertains to government functioning, primarily relating to defence contracts whose value exceeds the prescribed monetary limit. In the absence of a standard definition, the Fall Clause could generally be described as a legally enforceable assurance to the buyer that it would not end up paying more than the price at which the same vendor may have sold or be selling a similar product to another government-sector buyer under a separate contract. While the purpose of the Fall Clause is indubitable, some issues concerning its applicability and implications, both for the buyer and the seller, merit a review.

Applicability

The first issue concerns application of the Fall Clause to all kinds of contracts, which, in the present context, can be divided into two categories: stand-alone contracts for a specific quantity of items/goods/products and Rate Contracts (RCs) that are basically price agreements for commonly procured items. The RCs are valid for a specific period within which the authorised persons/entities can purchase the rate-contracted items directly by simply placing a supply order on the RC-holder at the price, terms and conditions contained in the RC.

The basic instructions on public procurement are contained in the General Financial Rules, 2017 (and its earlier versions), which evidently include no reference to the Fall Clause.  A reference to the Fall clause, can, however, be found in the Manual for Procurement of Goods, 2017, issued by the Ministry of Finance (MoF). As per para 8.1.14 of this 2017 Manual (corresponding to para 14.14 of the Manual on Policies and Procedures for Purchase of Goods, 2006), “Fall Clause is a price safety mechanism in rate contracts”. Three of the four procurement manuals used in the Ministry of Defence (MoD) echo the same sentiment.

The Defence Procurement Manual, 2009 (DPM 2009) states in para 8.7.2 that “Fall clause is a price safety mechanism in rate contracts”.  The Ordnance Factory Board’s (OFB’s) Procurement Manual, 2018 also says that the Long-term Umbrella Agreement/Contracts shall contain a Fall Clause [para 2.6 (c) (vi)] and that it is a safety mechanism in RCs (para 6.12). Similarly, para 15.14.11 of Chapter 15 in the Defence Research and Development Organisation’s (DRDO’s) Purchase Manual, 2016 says that all RCs and Price Agreements will be governed by the Fall Clause.

One may add that DPM 2009 also says (in para 7.18.1) that “In cases where contracts have to be concluded with the firms, whose rate contract with DGS&D/other central procurement agencies has expired and renewal of RC has not taken place, a ‘fall clause’ should be incorporated in the Supply Order/Contract to the effect that during the currency of the Supply Order/Contract, in case rates are found to be lower on conclusion of rate contract, the lower rates as in the rate contract shall be applicable.” A similar provision exists in para 7.49 in the OFB Manual. However, it is obvious that in the context of these provisions, the word ‘contract’ implies a stand-alone contract for item/items which is/are likely to be covered by an RC, while the stand-alone contract is under execution.

It is clear from the above-mentioned provisions of DPM 2009, DRDO’s Purchase Manual, 2016 and OFB’s Purchase Manual, 2018, not to mention the MoF’s Manual of 2017, that the Fall Clause is primarily applicable to RCs or stand-alone contracts concluded for items which are likely to be covered by an RC while the stand-alone contract is under execution. The Defence Procurement Procedure, 2016 (DPP 2016) and its earlier versions, however, stand on a different footing in this respect, as generally, there are no RCs for capital acquisitions. Yet, para 85 of Chapter II thereof makes the Fall Clause applicable to all procurements under ‘Buy’ and ‘Buy and Make’ categories.

While the MoD is within its rights to apply the Fall Clause to stand-alone capital acquisition contracts also, notwithstanding the provisions in other manuals which indicate its applicability to RCs, the text of the standard Fall Clause prescribed in DPP 2016, as indeed in other MoD manuals, is problematic from the point of the buyer as well as the seller, which brings us to the second issue concerning the Fall Clause.

Text of the Standard Fall Clause

The text of the standard Fall Clause prescribed in DPP 2016, which is similar (but not exactly the same) to the corresponding clause prescribed in DPM 2009, reads as follows:

11. Fall Clause

11.1 The Bidder undertakes that he has not supplied/is not supplying the similar products, systems or subsystems at a price lower than that offered in the present bid in respect of any other Ministry/Department of the Government of India and if it is found at any stage that the similar system or sub-system was supplied by the Bidder to any other Ministry/Department of the Government of India at a lower price, then that very price, with due allowance for elapsed time, will be applicable to the present case and the difference in the cost would be refunded by the Bidder to the Buyer, even if the contract has already been concluded. 

1.2 The Bidder shall strive to accord the most favoured customer treatment to the Buyer in respect of all matters pertaining to the present case.

(Note: The words highlighted in the text above do not figure in the text prescribed in DPM 2009)

It may be mentioned at this stage that the Fall Clause figures in the Pre-Contract Integrity Pact (PCIP) which is required to be submitted by the bidders while submitting their bids, along with an Integrity Pact Bank Guarantee (IPBG) for the prescribed amount. The following difficulties arise from the way the standard clause is worded, which the vendors are not at liberty to deviate from:

1. Since the PCIP is applicable to stand-alone contracts also and it has to be submitted along with the bid in all cases exceeding the prescribed monetary threshold, the Fall Clause ipso facto becomes applicable to such contracts concluded under the provisions of DPM 2009 and other manuals, although these manuals indicate that the Fall Clause is meant for RCs.
2. The first sentence of the standard clause contains an undertaking that the bidder ‘has not supplied’ or ‘is not supplying’ a similar item at a lower price under a different contract. This implies that the bidder is not expected to increase the price of any item in the bid under submission vis-à-vis the price at which a similar item may have been/is being supplied under a previously concluded contract, irrespective of when it was concluded, which is unrealistic.
3. What is a ‘product’, ‘system’ or ‘sub-system’ is not defined in the manuals, leaving it open to subjective interpretation by both the parties and, consequently, a potential dispute, especially on the question of whether the offered product, system or sub-system is ‘similar’ to the previously supplied product, especially because the yardstick for determining similarity has also not been laid down in the manuals.
4. Going by a plain reading of the text, if the fact of a previously supplied similar item being cheaper comes to the notice of the MoD, it will bring down the price of such an item mentioned in the current contract ‘with due allowance for elapsed time’, work out the difference, and seek refund from the seller. It is, however, not explained in the manuals how ‘due allowance’ will be given for the elapsed time and who will be the arbiter of the fairness of any such exercise.
5. It is not clear what will be the consequences where the fact of the previous supply of a similar item at a lesser price is not disclosed but comes to notice before the bid, in the context of which the undertaking is given by the bidder, is finalised and the contract signed.
6. The manuals contain no instructions on what the vendors need to do while submitting the bid, if they have supplied a similar ‘system’ or ‘sub-system’ in the past at a lesser price and they want to disclose this information along with the justification for increase in price while submitting the PCIP.

The issues mentioned above can give rise to serious disputes even before a contract is signed as well as after the conclusion of the contract. Except where the MoD determines the extent to which the price of an item covered by an ongoing contract should be reduced on account of the previous supply of a similar item at a lesser price and the seller accepts the decision without any demur, the Fall Clause provides no clue as to how the dispute would be settled, which brings us to the third issue regarding consequences of the breach of the clause.

Consequences of Breach of the Fall Clause

The PCIP is primarily meant to prevent corrupt practices in defence contracts. It is, therefore, an oddity that the Fall Clause, which is related to the issue of pricing, is a part of the PCIP. Furthermore, while DPM 2009 requires a (differently worded) Fall Clause to be included in the main contract (Para 9, Part IV, Appendix C, DPM 2009), DPP 2016 does not seem to provide for inclusion of, or a reference to, the Fall Clause in the main contract.

Be that as it may, the question is whether breach of the undertaking contained in the Fall Clause would amount to a breach of the PCIP exposing the bidder to all the consequences mentioned in Clause 10 of the standard format of PCIP, ranging from calling off of the contract negotiations to blacklisting (which are applicable if the bidder is found to be involved in some corrupt practice), or whether the consequences would be limited to the action mentioned in Clause 11 (Fall Clause) only, which is reproduced above. There is also a lack of clarity as regards the remedies available to the bidder if the MoD holds it responsible for the breach of the undertaking where the purported breach comes to MoD’s notice before or after the new contract is signed.

Need for Review

The complexities mentioned above need to be addressed. A pragmatic approach may be to (a) limit the scope of the Fall Clause to the previous contracts that are still in the course of being executed when the new bid is submitted, (b) define the terms ‘products’, ‘systems’, and ‘sub-systems’ (c) lay down the yardstick for determining ‘similarity’ of items, and (d) require the bidders to disclose the previously-charged price of the similar products, systems and subs-systems (as per the new definitions) in the commercial bid, with an explanation of why a higher price is being quoted in the bid under submission. This information could be used at the time of commercial negotiations before finalisation of the new contract. In any case, a more appropriately worded Fall Clause should form a part of the main contract and not the PCIP, which will automatically make any dispute concerning pricing of similar products that arises after conclusion of the contract on account of suppression of facts by the bidders subject to the arbitration clause.

Views expressed are of the authors and do not necessarily reflect the views of the IDSA or of the Government of India.