When reviewing the portfolio of services, authorities are often faced with the question of how it can obtain more value for money for particular services. This usually involves considering whether to outsource a particular service to private sector. Sometimes authorities look to combine their respective operations of a particular service to achieve economies of scale (and/or scope) or to swap capacities or services with each other.  Sometimes an authority undertakes a public tender process in order to achieve the best price for the service even if the in-house team is the ultimate winner in the tender. Sometimes a decision is taken not to run a time consuming and costly tender exercise and simply to continue with the in-house service.

This has led over the past years to a growing number of cases that have looked at the question of whether a contract that is performed in-house should have been subject to the full procurement process.  The purpose of this article is to provide a high level outline of the principles underpinning those decisions and to discuss some of the tensions/inconsistencies that can easily become pitfalls for an authority reviewing a particular service.

The basic rule is quite simple:  the procurement rules do not require an authority to tender for a service where the authority decides to provide the service itself.  This is easy to apply in the situation where the service is provided by the same entity but the issue begins to become less clear where, as is often the case, the service is provided by another entity which is close to or controlled by the authority (e.g. a limited company).

For such situations, the European Court has established a two-pronged rule[1] whereby a contract between an authority a person legally distinct from that authority is still regarded as an internal contract if:

(i) the authority exercises a control which is similar to that which it exercises over its own departments ("the control requirement"); and

(ii) at the same time, that person carries out the essential part of its activities with the controlling local authority or authorities ("the essential activities requirement").

Each of these will be discussed below.

The key question in the first limb that has received the most scrutiny in the European Court is the question of what consitutes 'control'.  The European Court has defined it rather vaguely as "a power of decisive influence over both strategic objectives and significant decisions"[2] but a number of principles have developed in case law which are summarised below.

2.1               Multiple Shareholders

If all of the share capital in an authority then this tends to indicate that the authority exercises control over that company similar to that which it exercises over its own departments.[3]

However, when there are other shareholders, then the identity of those shareholders become important.  While the concept of "decisive influence" implies that a majority shareholding or voting rights might be sufficient, the European Court has firmly established that any private shareholder involvement in the entity will mean that it does not pass the control requirement irrespective of the level of shareholding or the existence or absence of voting rights.[4]

By contrast, if there are a number of authorities that seek to combine their resources in a joint venture, then the control requirement can still be satisfied even though each individual authority may not be able individually to force a decision in its favour.  The control exercised must be effective, but it is not essential that it be exercised individually.[5]  In other words, the level of shareholding which each individual authority is required to hold is regarded as irrelevant, as long as the subsidiary had no scope to operate in any way other than pursuant to orders received by the shareholding authorities collectively.[6]

2.2               Future participation

Where there is a legal or contractual mechanism, which provides for the introduction of a private shareholder in the near future (e.g. national legislation requiring the obligatory opening of the company to private capital) then the control requirement is unlikely to be met.[7] 

However, there is no requirement for the articles of a purely publicly owned entity to contain an explicit prohibition on private involvement. Where there is no real (de facto) prospect of private involvement the control requirement will be satisfied, although subsequent private sector involvement would constitute the alteration of a fundamental condition of the contract, which in turn would lead to a tender requirement.[8] 

It is also clear that where the public ownership test is only temporarily met in order to circumvent the application of the procurement rules, then the European Court will have little difficulty in finding that the control test is not met.[9]

Similarly, it is possible for a local authority to become a minority shareholder of a publicly owned company after it has been set up simply in order then to use it for a particular service.[10]

2.3               Other forms of cooperation

Authorities can also cooperate over and above forming new or joining pre-existing joint ventures.  This arose recently in the context of a waste management agreement between a number of German authorities.  The agreement, in essence, involved a swap of capacity: some authorities would make landfill capacity available in exchange of which another authority would make available a certain volume of waste incineration capacity at a facility to be built (and which was to be privately run).

It was undisputed that the authorities had no control over the incineration facility (or indeed the contractor or other operator of the facility). However, the European Court drew a distinction between the agreement amongst the authorities (which was not a procurement event) and the subsequent decision as to who was to operate the facility (which was not disputed to be a procurement event).[11]

It therefore follows that an agreement between a number of authorities to pool their resources or otherwise cooperate in a particular service delivery is unlikely of itself to be a procurement event even if the implementation of such agreement may be.

Much of the European Court's attention has been focussed on control requirement and arguably several of the conclusions could have been reached by being less restrictive on the control requirement and approaching the essential activities requirement slightly differently. However, this is not the path the European Court chose and whilst this would make little difference to the outcome of the above cases, the absence of significant guidance on the essential activities requirement gives rise to some practical issues. 

In Teckal the European Court gave little indication as to how much work can be undertaken for third parties without breaching the essential activities requirement adding little in Carbotermo by stating that third party activities must be “only of marginal significance”.[12]  In Asemfo[13] the European Court held that 10% of third party could be considered marginal and it is unclear whether there is much scope in increasing that proportion, given that the Advocate General already had reservations at that level.

However, Asemfo also clarified that activities will be considered devoted to the authority even if the service is provided to other users as long as the service is connected to the contract.[14]  Similarly, it is irrelevant whether the contracting authority pays for the service or the users.[15]  This could apply, for example, where a local authority provides a sports facility that is used by local residents who pay for the service through an entry fee.

Nevertheless, there are some unresolved questions that are likely to come to the fore. In particular, where there are third party activities then it is possible that the proportion may change over time. What happens if the third party proportion becomes more than marginal? In Asemfo the Advocate General suggested that the essential activities requirement would not be met unless there was some restriction on the proportion of other activities[16] but the European Court did not follow this approach in the final judgement.