David Gollancz, Keating Chambers:
Ineffectiveness is a horrible remedy. Indeed calling it a “remedy” seems ironic: it does not make anything better. Ineffectiveness is by definition only available where the contract has been entered into, and the limitation period is six months. It follows that in many cases ineffectiveness will bite when contractual relationships are well developed and its impact could be significant not just for the contracting parties, but also others who have had no involvement in the procurement.
When will a declaration be made?
By the time a declaration of ineffectiveness has been made some or all of the following may have occurred:
- Sub-contracts concluded and assets acquired and resources allocated by the sub-contractors.
- Staff transferred pursuant to TUPE.
- Pension funds transferred (or more likely, the valuation process commenced by actuaries).
- Assets changed hands and work started.
But perhaps the most likely occasion for a declaration is the extension of the term of an existing contract, rather than when it is being let for the first time. Extensions of contracts which were originally advertised and competed may well amount to illegal direct awards if they do not conform to the highly restrictive provisions of regulation 14(1)(d)(ii) and regulation 14(5).
Whether the declaration relates to a new contractual relationship or the unlawful extension of an existing one, the “remedy” is capable of having a disastrous impact on people and companies which have had no part in the procurement process, as well as on the contractor which may well not have been aware of any illegality in the contract award.
The court’s powers to address the consequences
Perhaps in recognition of the potential impact of a declaration, regulation 47(M)(3) of the Public Contracts Regulations 2006 empowers the court to make “any order it thinks fit” to address the “implications” of declaring the contract ineffective and of any consequential matters arising from the ineffectiveness. Paragraph (4) gives examples of the sorts of things which might be so addressed:
“issues of restitution and compensation as between those parties to the contract who are parties to the proceedings.“
Given the width of the power conferred by paragraph (3), an example seems otiose. It is to be hoped that paragraph (4) will not be construed so as to restrict the ambit of the court’s power to making orders affecting those who are party to both the contract and the proceedings. To do so would mean that only the parties to the illegally-awarded contract could benefit from such orders, leaving others who stood to suffer serious damage (sub-contractors, for example, and employees) either without a remedy or needing to bring separate proceedings (for example, proceedings for negligence against the contracting authority) in order to get compensation. The Regulations are silent on the question of whether such persons have any rights but it is submitted that they ought to be allowed to join in proceedings as interested parties.
However paragraph (3) only confers a power on the court, not an obligation, and there is nothing in the Regulations (other than the paragraph (4) example) to guide the court as to how the power should be exercised.
Respecting the parties’ wishes: the pre-nup
Paragraph (5) provides an opportunity for contracting authorities and contractors to make their own provision to deal with the consequences of ineffectiveness. Such provision – often referred to as a “pre-nuptial agreement” or “pre-nup”, since it foreshadows the breakdown of the relationship – must have contractual force and its purpose must be to:
“regulate [the] mutual rights and obligations [of the parties to the ineffective contract] in the event of a declaration.“
The court is prohibited from using its paragraph (3) power inconsistently with the provisions of a pre-nup (paragraph 6), except to the extent that those provisions are themselves incompatible with the remedy – in other words, the pre-nup may not seek to render ineffectiveness itself ineffective. In short, a pre-nup, which sets up the rights and obligations of the parties in the event of ineffectiveness, but does not seek to evade the remedy, must be respected by the court. The extent to which any ongoing short-term service provision, for example, to cover the time it takes to carry out a procurement exercise, would be held by a court to be evasion rather than clearing up the mess is unclear. However, the words “to the extent” in paragraph (6) appear to enable the court to sever any provisions which do amount to an evasion, while leaving the rest of the pre-nup intact and effective.
Paragraph (5) specifies that the purpose of a pre-nup must be to regulate the parties’ rights and obligations as against each other; it does not mention third parties such as sub-contractors and employees. However, it is submitted that if the parties choose to create rights and obligations for the benefit of third parties, enforceable pursuant to the Contracts (Rights of Third Parties) Act 1999, the inclusion of such terms should not prevent the contract from attracting the protection of paragraph (6). Alternatively, where the pre-nup does only create rights and obligations for the parties, its existence will not prevent the court from making paragraph (3) orders (provided that those orders are not inconsistent with the pre-nup).
The content and form of a pre-nup
The subject matter and terms of a pre-nup will be particular to the subject matter of the main contract: it is not possible to make general rules about what it should say. However a checklist might include matters such as:
- The provision of TUPE information by the contractor.
- Indemnities for third party liabilities such as redundancy payments or damages to subcontractors or suppliers.
- The disposition of assets (this may be particularly important where one party has licensed intellectual property to the other: it is not unusual for contractors to license IPR to contracting authorities for use beyond the purposes of the contract itself).
- The status of any express or implied conditions, warranties or financial guarantees;.
- Liability for compensation to be paid to third parties (and probably the concomitant right for the parties to participate in litigation to defend their interests).
- Rights of access to premises.
- Rights of audit (particularly in the case of “open book” arrangements).
- Practical exit management provisions.
Such contracts should not be part of the main contract. Otherwise there must be some risk that, forming part of the contract declared ineffective, they will themselves be treated as ineffective: the Regulations do not empower the court to declare part of a contract ineffective. Common sense might suggest that terms addressing the consequences of ineffectiveness, probably set out in a schedule, should be treated as severable. However there seems no reason to run this particular risk if the pre-nup can be set up as a separate agreement.
The pre-nup will benefit from the protection of paragraph (6) if it has been concluded at any time prior to the making of the declaration of ineffectiveness. It need not have been agreed at the time the ineffective contract was awarded. It would therefore be possible validly to make such a contract when the contracting authority first becomes aware of the threat of proceedings seeking a declaration.
Why and how
It is important to remember that ineffectiveness is available not only where a contract has been awarded without publication of a contract notice – the first ground. A contract may also be declared ineffective where the more complicated (and less likely) conditions set out in the second or third grounds apply. In these cases – where there has been a contract notice but something has gone wrong subsequently – the contracting authority would be wise, if contemplating the use of a pre-nup, to refer to the pre-nup in the contract notice and to set out its terms in the contract documents. Otherwise there must be some risk that entering into the pre-nup would itself be treated as illegal.
Pre-nups: worth the trouble
As the contract itself will often be extremely difficult to finalise, the thought of having to agree a further contract based on a hypothetical situation may not seem like the most appealing idea. However, given the potentially devastating consequences of a declaration, contracting authorities and contractors should, in any case where there is a risk of a declaration of ineffectiveness, consider concluding a pre-nup.
Suppliers and sub-contractors to economic operators may also wish to consider whether their position needs to be protected, although in many cases the power they have to influence the marriage planning process may well be limited – all the more reason for the courts to accept any application from such a party to join proceedings where a declaration of ineffectiveness is being sought.