When is a public body’s subsidiary company subject to the public procurement rules?

Angelica Hymers, Browne Jacobson

Introduction

The question of whether or not a company established by a public body will be a contracting authority or not (and therefore whether such a company is subject to the procurement rules) is an important consideration for those establishing subsidiaries. This recent opinion from the Advocate General (‘AG’) of the Court of Justice of the European Union (‘CJEU’) analyses the circumstances in which a subsidiary of a public body may also be a contracting authority.

It should be noted that the CJEU is not obliged to follow the opinion of the AG, and therefore the judgment to follow may come to a different conclusion or analyse the facts differently.

Facts

VLRD was a company established by the Lithuanian state railway company (‘LG’). VLRD was wholly owned by LG and 90% of its work was carried out for LG. In 2013, VLRD ran a procurement process, in accordance with its own Interim Procurement Regulations. The claimant in the case, LitSpecMet UAB (‘LSM’) submitted a tender and was awarded a contract for some (but not all) parts of the procured contract. LSM subsequently sought to have the procurement process set aside and a new process started, on the basis that the procurement should have been subject to the rules of public procurement in force at the time.

To support its claim, LSM argued that VLRD had been established to meet the needs of LG (a public body and contracting authority for the purposes of the procurement rules) and that it was providing services to LG in a manner which did not reflect normal competitive conditions. This is relevant because the definition of a contracting authority under Directive 2014/24 EC (the ‘Directive’) includes ‘bodies governed by public law’, which in turn means “bodies that have all of the following characteristics:

“(a) They are established for the specific purpose of meeting needs in the general interest, not having an industrial or commercial character;

“(b) They have legal personality; and

“(c) They are financed, for the most part, by the State, regional or local authorities, or by other bodies governed by public law; or are subject to management supervision by those authorities or bodies; or have an administrative, managerial or supervisory board, more than half of whose members are appointed by the State, regional or local authorities, or by other bodies governed by public law.”

(It should be noted that this case was brought under Directive 2004/18 EC, but the wording in the Directive currently in force is substantially the same with respect to these points and so reference has been made to the current Directive.)

Therefore, if VLRD met the above criteria, it would be considered a ‘body governed by public law’ for the purposes of the Directive and accordingly a contracting authority which is obliged to run procurement processes in accordance with procurement law.

The question of whether a company in VLRD’s position should be considered a contracting authority for the purposes of the Directive was referred to the CJEU by the Lithuanian Supreme Court.

Analysis

The parties agreed that VLRD met the second two conditions of the definition of a ‘body governed by public law’, in that it has legal personality and LG has a role in its financing and supervision. The question was therefore whether VLRD was established “for the specific purpose of meeting needs in the general interest, not having an industrial or commercial character”.

The AG considers that analysis of this question should be split into two separate parts; first, does VLRD meet needs in the general interest and, if it does; whether the industrial or commercial nature of those needs are their predominant character.

VLRD is a company engaged in the manufacture and maintenance of trains and rolling stock. It carries out work which is closely linked to the business of its parent company (LG) which operates a rail network. However, the AG did not consider that VLRD’s work had the purpose of meeting needs that were “closely linked to the institutional operation of the State, the promotion and development of the conditions of social welfare which it is the duty of the State to provide, or other similar purposes”.

The AG argued that the key factor in answering the question posed by the Lithuanian Supreme Court is not so much whether the relevant company meets a need in the public interest, but the conditions in which this is to be done (i.e. Does the company operate in normal market conditions?) This is because the purpose of EU procurement law is to protect competition within the single market, and to prevent anti-competitive activity by companies which may take a protectionist approach. Therefore, if a company is operating on the same commercial basis as its competitors, then it has ‘industrial or commercial character’ and is subject to commercial pressures which should prevent it from being able to take an anti-competitive approach. Consequently, such a company would not be considered to be a ‘body governed by public law’ or a contracting authority, and would not be subject to the procurement rules.

What about the in house exemptions?

The AG also considered the relationship between a contracting authority and a subsidiary company set up by it in order to take advantage of one of the in house exemptions codified in the procurement rules (commonly known as the Teckal exemption). In circumstances where the relevant conditions set out in the exemption are met (the relevant English and Welsh law is set out at Regulation 12 of the Public Contracts Regulations 2015), then the subsidiary company is in effect an extension of its parent body. This means that it will also be a contracting authority for the purposes of the procurement rules.

Conclusion

The AG’s conclusion was that:

  • a company that is connected to a contracting authority sufficiently closely for the in-house exemption to apply will be a contracting authority and therefore subject to the public procurement rules
  • a company may also be considered to be a contracting authority where it has legal personality, is controlled by a contracting authority and where “the essential part of its activity is to supply the contracting authority [with goods, works or services], free of any pressure from competitors and not in free market conditions… to enable the authority to provide its designated service…”

Relevant considerations

In practice, analysing whether a company is ‘established for the specific purpose of meeting needs in the general interest’ and whether it has ‘industrial or commercial character’ is not always straightforward. Relevant considerations include:

  • is the company operating in competition with other organisations?
  • does the company bear the risk associated with its activities?
  • is the company publically financed or supported by another public body or state funds?

In some cases, analysis of this point will lead to an uncertain conclusion – for example in the case of companies established by contracting authorities which compete with other organisations in the market, but are not for profit entities. In such circumstances, it may be unclear whether the true nature of the company is ‘industrial or commercial’ because of the lack of a profit driven motive which may mean that the company is not subject to commercial pressures in the same way as its competitors. In such circumstances it is important to look at the remainder of the test set out in the Directive; to consider whether the company meets the conditions with respect to control and financing; and whether on balance it appears that the nature of the activities and the relationship between the subsidiary and parent contracting authority suggest that the subsidiary is subject to market pressures or not.