Procurement Bill – Teckal truncated and the group structure exemption endangered

The latest iteration of the Teckal test[1] in the Procurement Bill potentially involves a significant narrowing of the Teckal exemption. This has major implications for group structures and the ability to exempt contracts between group members from having to be put out to tender.

Teckal was the first case that exempted contracts within a group structure (between parent organisations and their ‘Teckal subsidiaries’) from having to be put out to tender. The Teckal decision has now been codified in Regulation 12 Public Contracts Regulations 2015 (PCR 2015).

There are two significant issues with what is proposed in the Procurement Bill in relation to this.

Activities test narrowed
The first issue is the most alarming. The Procurement Bill now requires more than 80% of the turnover of the subsidiary to be derived from activities carried out ‘for or on behalf of’ the contracting authority. In legal terms, the use of such language is usually confined to agency or representative-type relationships and does not seem appropriate for the Teckal–based, in-house co-operation arrangements which do not have any distortive effects on the market that the current Regulation 12 is designed to cater for.

This wording is a significant restriction even on the original Teckal test. Under Teckal turnover could be included if it was derived from activities carried out ‘with’ the contracting authority.

The current test in Regulation 12(1)(a) PCR 2015 refers to turnover derived from ‘the performance of tasks entrusted to [the subsidiary] by the controlling contracting authority or other organisations controlled by that contracting authority’.

If the only turnover that ‘counts’ for the new Teckal test is limited to that derived from activities carried out ‘for and on behalf’ of the parent, this calls into question many common group structure and collaboration arrangements. A couple of examples illustrate this:

• Example 1: Registered provider group structure

Two registered providers decide to form a group structure and form a non-asset owning parent of which they both become subsidiaries. Both providers retain their own properties but central services (finance, company secretarial, chief executive) are located in the parent.

Each registered provider will derive most of its turnover from delivering services to its own residents in properties that it owns. Given this fact, can it really be said that those activities are being carried out ‘on behalf of’ the non-asset-owning parent? If not, then each subsidiary will need to put the service level agreements it has with the parent out to tender (assuming that the amount payable for them is above the services threshold).

• Example 2: Trading company subsidiary

A local authority sets up a trading company subsidiary to provide market rent new-build housing (this example would apply equally to a charitable housing association setting up a market rent subsidiary). The subsidiary derives the majority of its turnover from the ‘market rents’ from those properties. In this example, the subsidiary is a contracting authority (rather than a ‘wholly commercial’ subsidiary) since its primary function is to support the parent local authority in its ‘mission’ to deliver new housing with a range of tenures.

Housing management is provided by the local authority. The subsidiary would not be able to obtain those housing management services from the authority (assuming their value is ‘above threshold’) without running a tender process unless the income the subsidiary derives from the market rent properties is regarded as being derived from activities carried out ‘for or on behalf of’ the authority. However, can this activity really be said to be carried out ‘for or on behalf of’ the authority when it is an activity that the authority would not be able to carry out itself without the tenancies becoming secure tenancies? There could also be an argument that the right to buy might apply because those properties are being treated as managed ‘on behalf of’ the authority.

Under example 2, it is perhaps arguable that the activity of developing ‘market sale’ properties is being carried out ‘on behalf of’ the parent organisation (but recognising the risks of this). With example 1, this is much more problematic.

With both examples there would be no issue if the wording used were ‘with’ (as in Teckal) or ‘in the performance of activities entrusted to’ (as in PCR 2015).

This is a situation where a gratuitous and unnecessary word change from what was perfectly adequate wording in PCR 2015 could lead to real practical difficulties in the future if the Procurement Bill is enacted in its current form.

New barriers to collaboration – multiple Teckal ignored
In relation to collaborative arrangements and joint ventures, the European Court had developed the Teckal case law through cases such as Carbotermo, Tragsa and Econord[2] so that ‘multiple Teckal’ was regarded as nothing exceptional. This covered the case where a number of contracting authorities jointly controlled a subsidiary. This model was also recognised in the UK by the Supreme Court in Risk Management Partners v Brent[3]. It is now specifically authorised through Regulation 12(4) PCR 2015.

It is therefore both striking and curious that there is no equivalent to Regulation 12(4) PCR 2015 in the Procurement Bill.

Paragraph 2 of schedule 2 to the Procurement Bill limits the Teckal exemption to organisations which are ‘subsidiary undertakings’ (under company law) of a contracting authority. In order for an organisation to be a ‘subsidiary undertaking’ of a contracting authority, the contracting authority must:

• ‘hold a majority of the voting rights in it;
• be a member of it and has the right to appoint or remove a majority of its board of directors;
• have a right to exercise a dominant influence over it because of either provisions in the company’s articles or a ‘control contract’; or
• be a member of it and control alone, pursuant to an agreement with other members, a majority of the voting rights in it’. [4]

The detailed application of this test is beyond the scope of this ebriefing (as is the potential for confusion between the ‘dominant influence’ test in company law under paragraph 2(2)(a) and the ‘decisive influence’ test in paragraph 2(2)(b)). However, given this definition, it is difficult to see how it would be possible for an organisation to be a Companies Act subsidiary undertaking of more than one parent contracting authority at the same time (other than where a contracting authority is itself a subsidiary undertaking of another contracting authority). There might be a possible argument from the Interpretation Act 1978 that ‘the singular is deemed to include the plural’ but this argument is untested. There is therefore considerable uncertainty as to whether it is possible for an organisation being a Teckal subsidiary of more than one contracting authority.

This has major implications for public sector and registered provider collaboration arrangements including joint committee companies, public sector joint ventures and VAT cost-sharing groups.

We cannot understand why the Government would want to require organisations to follow a tender process to enter into these kinds of arrangements, especially as it would be inappropriate to allow private sector organisations to participate in many of them.

We believe this is an accidental oversight by those drafting the legislation, rather than a deliberate intention to restrict these kinds of collaborative arrangements. If we are right, this is an omission that the Government needs to correct as soon as possible. Unless the Government does so, this will be a major blow for future public sector and registered provider collaboration arrangements.

Need to retender contracts
A further potential headache for contracting authorities that jointly control a Teckal company is posed by the Severn Trent v Dwr Cymru[5] case. This case said that if an organisation that was a Teckal subsidiary ceases to be a Teckal subsidiary, any contracts between them have to be put out to tender from the point at which the organisation ceases to be a Teckal subsidiary.

A recent European case has confirmed that the analysis in the Severn Trent case is correct, at least as far as European law is concerned. In the Lerici case[6], the Teckal company was forced to agree restructuring arrangements with its creditors, meaning that it was no longer wholly owned by contracting authorities. The European Court confirmed that this meant that the contracts between those contracting authorities and the company had to be put out to tender. Whilst this is not binding in the UK courts, it is consistent with the Severn Trent case and does suggest that contracts within existing groups and joint ventures may need to be retendered if the revised Teckal test ceases to apply to that group.

Let’s hope that it doesn’t come to this and the Government fills both of these gaps.

For more information

If you would like to find out more about the Procurement Bill, please contact Andrew Millross.

[1] From the case of Teckal v Comune di Viano Case C-107/98

[2] Carbotermo, Case C-340/04, Tragsa Case C-295/05  and  Econord Case 182 & 183/11 

[3] Risk Management Partners v Brent [2011] UKSC 7

[4] Under section 1162 and Schedule 7 Companies Act 2006

[5] Severn Trent Plc v Dwr Cymru Cyfyngedig (Welsh Water Limited) [2000] EWHC 190

[6] Comune di Lerici v Provincial di La Spezia Case C-719/20

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