Eskom ignored five legal opinions, some from within its own ranks, warning the power utility that its contentious “at risk” consulting contract with McKinsey was probably illegal. So nervous about the contract was McKinsey that its own in-house lawyer concluded Eskom would have to be “brave” in order to sign, newly leaked McKinsey documents show. Eskom should have been in no doubt that its proposed multi-billion rand contract was on shaky ground. They signed it anyway. By Pauli van Wyk for SCORPIO with AMABHUNGANE.
“Ultimately we are appealing to [Eskom’s] bravery,” McKinsey in-house lawyer Benedict Phiri concluded on 3 December 2015. He was consulted over questions about the legality of the contingency or “risk-based” contract for the contentious “turnaround” programme McKinsey had devised for Eskom.
“Please use [this advice] very cautiously and sensitively,” Phiri said in the email, which was ultimately sent to Eskom project leader Prish Govender.
The email revealed McKinsey solicited two legal opinions to advise on the legality of its proposed contract with Eskom. One from law firm Webber Wentzel and another from Ledwaba Mazwai. The verdicts “diverge substantially”, Phiri cautioned and said the matter at hand was an untested “grey area” of the law.
The grey area Phiri referenced was Eskom’s determination to sign a consulting contract with McKinsey based on a contingency fee (rather than hourly rates) and without seeking competitive bids.
Eskom argued this was okay because of the clever way McKinsey structured the contract: supposedly it was “at risk”, meaning that McKinsey only shared a percentage of the benefits Eskom derived from McKinsey’s advice.
The plan had its origins in June 2015 when the Eskom board approved a mandate to negotiate with McKinsey based on an unsolicited proposal received from the consulting firm in March 2015.
Eskom decided that the ailing power utility needed a turnaround plan and that global consulting giant McKinsey was just the firm for the job.
There was no competitive bidding process. Instead, McKinsey was identified as a “sole source” and the contract would be on an “at risk” basis.
It provided that the consultants would be paid roughly 10% of any benefits to Eskom on their watch.
The plan was highly problematic.
To keep a thumb on the expenses of state-owned companies, national treasury issues practice notes in order to guide the appointment of consultants.
Government consulting contracts are so lucrative and so open to abuse that the practice notes set down strict guidelines: It warns state-owned companies not to use consultants willy nilly, caps the hourly rates and directs that contracts awarded must go out on open tender.
To deviate from these prescriptions, Treasury’s approval must be obtained.
Eskom’s conundrum was that it had to somehow legitimise a possibly irregular decision to offer McKinsey and Trillian a multibillion rand contract with the potential for runaway costs.
When Eskom picked up resistance from its own legal and compliance divisions, the company sought advice from the party that stood to gain the most from the contract: McKinsey.
Phiri, the McKinsey in-house lawyer, in turn sought the opinion of Webber Wentzel – which shot down the proposal – and Ledwaba Mazwai, which gave a conditional go ahead.
Phiri, presumably acting under instructions from McKinsey, produced a memo addressed to Eskom that talked up Ledwaba Mazwai’s more positive conclusions and ignored the Webber Wentzel opinion.
But, whether by accident or for reasons of transparency, McKinsey’s Johannesburg principal consultant Lorenz Jüngling forwarded Phiri’s distinctly more cautious covering note when sending the memorandum to Govender, so Eskom was well aware that Webber Wentzel held a different view.
Phiri’s nervousness should have been a red flag to Govender and everyone that had sight of Phiri’s email.
Indeed, Eskom had plenty of other warnings.
According to a leaked report compiled by external investigators, G9 Forensic, Eskom’s own legal department and their group compliance manager argued strongly against the McKinsey contract.
Advocate Neo Tsholanku of the Eskom legal department told G9 Forensic he was “called in towards the end of negotiations to provide legal opinion on the remuneration model and the sole sourcing question”.
He said he “had on numerous occasions warned Mabelane and Govender that the remuneration model was not consistent with law”.
Tsholanku didn’t approve of the contract, noting it was “in essence a McKinsey drafted document”.
Neither did Aziz Laher, group compliance manager and a Public Finance Management Act (PFMA) specialist.
Laher confirmed to G9 Forensic that he provided advice to Govender, as well as to chief financial officer Anoj Singh to Eskom and procurement boss Edwin Mabelane – in emails in some cases and during formal or informal conversations in others.
G9 Forensic reported that he told them the project “could not or should not proceed without Treasury approval in respect of a deviation on the remuneration model for the contract”.
By contrast, McKinsey’s December 3 memo to Eskom professed that nothing stood in Eskom’s way to sign the contract and stated, “our view is…also supported by external legal counsel” – a misleading claim, given the conflicting legal advice McKinsey itself received.
In addition, the memo did include a stringent caveat right at the bottom: “Please note though that i) our opinion above is not a legal opinion or a substitute for similar or other professional advice; (ii) we expect that you will remain fully responsible for any decisions or actions you may take in respect of the above as well as any related compliance with applicable laws, rules and regulations.”
Eskom did take its own external legal sounding – and then effectively ignored it.
On December 7 senior counsel Paul Kennedy formally advised Eskom that the draft McKinsey contract was in violation of Treasury instructions that precluded the payment of consultants on any basis other than at hourly rates.
He concluded that if Eskom was wedded to the “at risk” model, it would be advisable to apply to Treasury to grant approval for a deviation.
Did Eskom get Treasury approval? McKinsey thought so.
McKinsey told Scorpio: “We were advised by Eskom on 5 February 2016 that it received National Treasury approval and we have reviewed Eskom’s Steering Committee minutes from 9 February 2016 that confirm that fact.”
But the G9 Forensic report reveals just how thin Eskom’s Treasury fig-leaf was.
Firstly, Eskom and McKinsey signed the contract long before any supposed “approval” from Treasury – and, secondly, details of Eskom’s interaction with Treasury reveal how contrived the claim of approval was.
On 17 December Mabelane, for Eskom, and Alexander Weiss, for McKinsey, signed a “notification of acceptance for the provision of consulting services” and on 7 January 2016 they signed the detailed contract, known as the Master Services Agreement.
It was not until February that Eskom sidled up to National Treasury.
The G9 report shows that on 4 February 2016 Eskom senior manager Dave Gorrie wrote to the chief procurement officer at Treasury asking him to confirm that a 2003 “practice note” regulation governing the appointment of consultants was still valid.
Writing back, Treasury advised Gorrie that “the retainer/contingency fee principles are not clearly outlined in the practice note, if you intend to apply them, you need to do some further work to ensure that you do not compromise…the constitution and other legislation.”
Eskom declined to tell Scorpio what “further work” had been done, if any, or to answer other questions, saying it would be “premature” to do so. It said the questions “…relate to matters that are subject to investigations currently underway to resolve matters revolving around McKinsey/Trillian”.
In any case it seems unlikely that “further work” was done. The very next day, on 5 February, Eskom informed McKinsey that Treasury had given approval.
Gorrie, when interviewed by G9 Forensic, insisted that Treasury’s cautious email could be accepted as approval. G9 Forensic recommended he face disciplinary charges.
Minutes of the Eskom steering committee dated 9 February 2016 note how Govender assured Eskom and McKinsey that Treasury gave the thumbs up for the project. The minutes note: “National Treasury approved confirmation of the contract methodology for the risk based approach with the chief procurement officers (sic) office”.
It was under this agreement that Eskom eventually paid out R1,6-billion in fees to McKinsey and its de facto empowerment partner, Trillian.
Now, over a year and a half later, Eskom has done an about face.
Based on a legal opinion by senior counsel David Unterhalter, the power utility now wants its R1,6-billion back, and is threatening to initiate court proceedings in order to compel the consultants to pay up.
“The Eskom board would expose itself to significant risk of these provisions of the PFMA if it failed to seek recovery of the enormous sums of money paid over to McKinsey and Trillian … There are potentially serious consequences for Eskom’s accounting authority, including criminal liability, if it does not do so,” Unterhalter warned.
Unterhalter advised “McKinsey and Trillian may claim that Eskom was unjustly enriched by the rendering of services to it should [the contracts] be set aside, these companies would have to prove such enrichment. Even if they could do so, their compensation would never be on the inflated basis upon which they were rewarded…”.
McKinsey this month told South Africans the company will pay back the money if a court rules the contract invalid.
In the absence of a court order, McKinsey “will act independently to return the money to the Republic of South Africa”, the firm said in a statement sent to its alumnus.
The firm maintained it acted in “good faith” and “stands by our work” at Eskom. DM