On 26 August 2015, the Cabinet Office and Crown Commercial Service published guidance on the procurement rules relating to “Public/Public Contracts” under the Public Contracts Regulations 2015 (SI 2015/102) (PCR 2015).
The guidance summarises the key points of the drafting of regulation 12 PCR 2015 (public contracts between entities in the public sector) and provides a copy of the regulation. Regulation 12 is a provision that did not appear in earlier procurement directives. It exempts two types of public to public contracts from the need to seek competition under the regime.
The first exempts certain “vertical” arrangements using an in-house company. This exemption reflects the case law that developed from Case C-107/98, Teckal and therefore is commonly known as the Teckal exemption. The second type exempts certain “horizontal” or “co-operation” arrangements between public bodies and this exemption (in regulation 12(7)) reflects the decision in the Hamburg waste case (Case C-480/06).
With the guidance are four Frequently Asked Questions:
- What constitutes “control” for the purposes of an in-house company?
- How do I calculate the necessary 80% of activities with the controlling authority?
- Can we rely on the exemption where some of the funding is provided through private capital?
- Does the “co-operation” have to take a particular legal form.
(For more information on regulation 12 and the case law on public to public arrangements, in which these concepts are discussed, see Practice note, Public to public collaboration and the procurement rules.)
Understandably, the Cabinet Office/CCS guidance cannot cover all questions asked. Therefore in this blog, I have sought to answer another FAQ that is regularly asked by lawyers seeking to apply regulation 12 to real life situations, to which the answer is perhaps less straightforward and more open to a range of alternative views. This is my contribution to the debate.
Can a contracting authority use a Teckal company to trade on the open market and directly award it contracts?
Is it permissible to use the in-house company exemption under regulation 12 PCR 2015 to set up a company that will actively trade on the open market (up to 19% of turnover), and perform the authority’s work “as of right” (that is, without tendering for it)?
The question has been at the heart of many public projects due to:
- The financial constraints on the public sector, leading to the leverage of public bodies’ assets and expertise in delivering public services to generating income from private clients, often to enable the continued delivery of those public services.
- The expansion of the procurement regime to cover contracts for many public services, such as health, education and social services, that were previously largely excluded.
- (In local government) the restrictions on trading other than through a company.
The starting point for any answer is that regulation 12(1) sets out three cumulative conditions that have to be met:
- The contracting authority must exercise control over the company which is similar to that which it exercises over its own departments.
- More than 80% of the activities of the controlled company must be for the “parent” authority.
- There is no direct private capital participation in the in-house company.
This third condition is based on some of the post-Teckal case law. As an example, in the Stadt-Halle case (C-26/03), the exemption was held not to apply to a situation where the German city of Halle decided to award a contract to a company in which it held 75.1% of the share capital but the remaining 29.9% was held by a private limited company. The ECJ held that this type of arrangement was not permitted unless the jointly-owned company won the work in competition.
However, these limitations, set out within regulation 12 itself, are not the only provisions that apply to this question. There are also wider considerations of “vires” (the power used to set up the company and the motives of the authority) and also potentially state aid (see the BIS state aid manual of 10 July 2015).
Recital 31 of the public sector directive (Directive 2014/24/EU) indicates that the pre-directive case law on the in-house exemption is still relevant. It states:
“It is…necessary to clarify in which cases contracts concluded within the public sector are not subject to the application of public procurement rules. Such clarification should be guided by the principles set out in the relevant case-law of the Court of Justice of the European Union”.
This suggests that the drafting of regulation 12(1) is not the end of the matter and it is necessary to look behind that drafting to the principles developed in earlier case law. In this connection UK law based on European law must always be interpreted “purposively” and this too tends to require lawyers to look beyond the mere wording of an exemption.
To answer the question asked we need to look at that wider context. Here the motive for the authority setting up the in-house company appears to be “commercial” in nature. One reason why the ECJ in Stadt-Halle was concerned about the private capital investment was that while the relationship between a public authority and its own departments is expected to be governed by public interest considerations, the involvement of any private capital investment will lead to private interest considerations.
In Case C-29/04, Commission v Austria, the facts related to the Austrian town of Mödling setting up a wholly owned company and awarding it a waste contract (using the Teckal exemption) in September. The town then sold shares to a private company in October. Even though there was technically no private participation when the contract was originally awarded the matter was looked at as a whole and the terms of the exemption were held not to be met.
Also, in Case C-458/03, Parking Brixen, the ECJ looked beyond the mere ownership of shares in a wholly owned subsidiary when determining proper “control” and concluded that the company was market-orientated and therefore independent from the parent authority. In Case C-340/04, Carbotermo, again there were concerns about the balance of control versus independence.
Regulation 12(3)(a) suggests that the “control test” will always be met in any situation where the parent authority “exercises a decisive influence over both strategic objectives and significant decisions of the controlled legal person”.
If this is looked at in the context of the pre-Directive case law outlined above, it would suggest that it is not just the fact that the control can be and is exercised; but also that the public body will need to exercise that proper supervision in a particular manner. If the case law is taken to narrow the direct words of the regulation, the supervision will have to ensure that the company is not too independent nor too market-orientated. It would therefore seem prudent when advising on this issue to be clear about the precise role to be fulfilled by the in-house company and the dominant motive for setting it up, at least until any post-Directive case law indicates whether or not this public interest focus remains necessary.
In this connection it should be noted that regulation 2(1) of PCR 2015 retains the earlier definition of contracting authorities to include “bodies governed by public law”. This means that a wholly owned company is only a contracting authority if it is “established for the specific purpose of meeting needs in the general interest, not having an industrial or commercial character”.
If the in-house company is set up to have a “commercial character” then it would seem that the company itself would not be a “contracting authority”. If this is the case, then it would seem perverse to consider that company to be part of the wider “in-house” arrangements of the authority. Therefore, for example, where a local authority sets up a commercial company because of the requirement in s4(2) Localism Act 2011 (“Where, in exercise of the general power, a local authority does things for a commercial purpose, the authority must do them through a company”), it would appear to be setting up a company that was not a “contracting authority”. (See Practice note, Localism Act 2011: the general power of competence.)
In the circumstances of the original question asked, a safer course of action that has been used is to set up two companies. One would have a public sector focus and could be used to deliver the authority’s services using the exemption within regulation 12 of the PCR 2015. Its focus would be on efficiencies and savings for the authority.
The other could be a market-orientated commercial company that would perform third party work but would not meet the in-house exemption. This trading company is likely to be share-based, with the authority as the initial principal shareholder, though perhaps also offering shares to employees, with external directors and commercial expertise. Its purpose would be to deliver profits back to the shareholders, and may eventually be spun out from the public sector as a going concern.
Costs would be reduced if suitable staffing arrangements could be put in place to support both entities with (if necessary) the same member of staff working part time for each entity and being charged appropriately. Ideally, these resourcing arrangements will flex as the public sector focused company generates efficiencies and the trading company increases its customer base.
Different powers would be used to set up each entity and different considerations would be applied to their delivery of services.