A Councillor has successfully applied for judicial review of a decision by his own council to vary a contract for the development of a mixed retail, residential and transport hub in Winchester.

The High Court ruled that the variations to the contract were so significant they resulted in a contract which was materially different in character to the original Development Agreement. As such, the decision to proceed with the variations without conducting a procurement process as required by the Public Contract Regulations 2006 (“PCR 2006”) was unlawful.

Although this case is concerned with variations covered by the PCR 2006, it will also be of assistance when considering whether proposed future variations to contracts are likely to be permissable under Regulation 72(e) of the Public Contract Regulations 2015 (“PCR 2015”), which come into force on 26 February 2015.

Background

The Development Agreement was entered into in December 2004. The Council did not carry out a procurement exercise when it entered into the Development Agreement. The development opportunity was not advertised in the OJEU and no competition between developers was held. However, any challenge to the original decision to enter into the Development Agreement was out of time.

In mid-2014, the developer obtained the Council’s agreement to a number of variations to the Development Agreement, including variations reducing the developer’s obligations to provide affordable housing and a number of civic amenities. Mr Gottlieb was concerned by these variations and subsequently challenged the lawfulness of the Council’s decision.

Mr Gottlieb’s challenge was based on the argument that the Council had acted unlawfully by failing to carry out a procurement process in circumstances where the nature of the changes meant that it was obliged to do so under Directive 2004/18/EEC and the PCR 2006.

The Court’s approach

The Court quickly accepted that the Development Agreement fell within the scope of the PCR 2006. The question for the Court was therefore whether the variations to the Development Agreement were so substantial as to require a fresh procurement procedure.

Unlike the PCR 2015 (which come into force on 26 February 2015), the PCR 2006 do not contain provisions governing when agreements may be modified without the need to carry out a fresh procurement. As a result, the Court considered the guidance contained in the well known ECJ ruling in Pressetext Nachrichtenagentur GmbH v Republik Österreich [2008] ECR I-4401. In that case, the ECJ stated that a variation to an agreement should be considered to be a new agreement, requiring a fresh procurement, where the varied agreement would be “materially” different in character from the original agreement, such as to demonstrate an intention by the parties to renegotiate the essential terms of the agreement. The ECJ went on to suggest that an amendment will be usually be classed as “material” for these purposes in the following circumstances:

  • Where the variation introduces conditions which, had they been part of the initial award procedure, would have allowed for the admission of tenderers other than those initially admitted (or would have allowed for the acceptance of a tender other than the one initially accepted. 
  • Where it extends the scope of the contract considerably to encompass services not initially covered. 
  • Where the variation changes the economic balance of the contract in favour of the contractor in a manner which was not provided for in the terms of the initial contract.
  • It was accepted by the Court that the limbs of the test set out in the Pressetext judgment should be broadly interpreted, and not construed as if they were statutory provisions.

Decision

The Court ruled that the variations to the Development Agreement largely removed the unprofitable elements of the development, affording the developer a greater opportunity to increase its profits from third parties. In applying the Pressetext test, the Court confirmed that in the case of development agreements (or concession contracts), the commercial value to the developer will be judged by the potential profits to be obtained from third parties, such as rental income or profit from the sale of residential units, not just the value of the contract with the awarding authority. As such, the financial terms between the parties remain relevant but they are not the only factor to be taken into consideration when considering the impact a variation may have on the “economic balance” of a contract.

The Court held that the variation in this instance altered the economic balance in favour of the developer, such that the variation amounted to a fundamental change to the essential terms of the Development Agreement. Failure to carry out a fresh procurement process in such circumstances was a breach of the PCR 2006. On this basis, the Council’s decision to vary the contract without conducting a fresh procurement process was unlawful.

The Court did not accept the Council’s argument that, as the variations had been made in accordance with a variation clause in the Development Agreement, no procurement process was required. The Court ruled that the variation clause relied on by the Council was broad and unspecific. Allowing contracting authorities to rely on such clauses would enable authorities to avoid the requirements of the PCR 2006 (and the underlying EU law provisions) by simply amending or extending contracts after the original contract had been awarded. The Court ruled that this was contrary to the requirement for fairness and transparency.

The Court also ruled that it was not necessary for Mr Gottlieb to identify other economic operators who would have competed for the opportunity presented by the varied Development Agreement had it been put out to tender. Challengers to decisions of this nature are required to satisfy the Court, on the balance of probabilities, that a realistic hypothetical bidder would have applied for the contract had it been advertised, but no more.

Comment

As the Court found that the Council had committed serious breaches of the relevant procurement regulations, the outcome of this case should not be surprising. However, this case is useful in that it provides an indication as to how the tests contained in Regulation 75(8) PCR 2015 (which essentially replicate the test for “material change” set out inPressetext) are likely to be interpreted by the Courts. The points below are of particular interest:

  • In relation to development and concession agreements, profit derived from third parties (such as rental income or income from the sale of properties under development) should be taken into consideration when assessing the impact a variation may have on the economic balance of a contract. 
  • Contrary to statements made in Edenred (UK Group) Ltd v HM Treasury [2015] EWHC 90 (QB), it will not necessarily be fatal to a claim if a person seeking to challenge a contract award cannot identify specific tenderers who would have (or may have) competed for the modified contract had it been put out to tender. It may be sufficient to demonstrate that a “realistic hypothetical bidder” would have applied if the contract had been advertised. 
  • The inclusion of a variation clause in a public contract may not provide a way to circumvent the need for a new procurement process. Under Regulation 75(8) of the PCR 2015, variation clauses should be clear, precise and unequivocal in order to protect variations made pursuant to such clauses from subsequent challenges. It should also be recalled that in R (The Law Society) v Legal Services Commission [2007] EWCA Civ 1264 the Court of Appeal had already considered that contractual clauses providing for wide powers of amendment are incompatible with the transparency principle. 
  • The existence of a specific remedy regime under the PCR 2006 (and PCR 2015) does not preclude claims for Judicial Review by non-economic operators. However, where the applicant does not have a direct commercial interest in the decision in question, the motive for bringing a challenge is likely to influence the Court’s decision as to whether or not an application for Judicial Review will be allowed to proceed. Those who have a genuine interest in having procurement decisions taken in an open and fair manner, such as the Councillor in this case, will generally have standing to bring an application for Judicial Review. This can be contrasted with those seeking to apply for Judicial Review for political motives, such as the applicant in R (Chandler) v Secretary of State for Children, Schools and Families [2010] LGR1, in which the Court found that the application was primarily motivated by political opposition to academy schools. 
  • This is a rare example of the Courts granting Judicial Review of a decision to vary a contract in breach of the relevant procurement regulations. The precise effect of the Court’s order quashing the Council’s decision to vary the Development Agreement in these circumstances is, as a result, not entirely clear. In a public statement the Council has suggested it is considering its ability to continue to work with the developer within the constraints of the pre-existing Development Agreement. However, given the Court’s conclusion that the original contract should have been the subject of a procurement process, both parties will no doubt be concerned that the original contract may be ultra vires and therefore unenforceable. Eric Pickles, the Secretary of State for Communities and Local Government, is apparently considering whether to call-in the planning application given concerns over changes to schemes to remove affordable housing provision. 
  • A more common scenario is where a contract is entered into following a competitive procurement but is then varied without a further procurement process taking place. If the variations amount to a material change, the amended contract may be susceptible to a declaration of ineffectiveness, which would involve, among other things, the prospective cancellation of obligations under the contract. The Court also has power to make such other order as it thinks appropriate for addressing the implications of an ineffectiveness order, or to deal with any consequential matters arising from that order. This could impact on the original agreement and the services delivered under it. The procurement regulations make it clear that, when making a declaration of ineffectiveness, the Court should take into account any agreement between the parties addressing the consequences of such a declaration. However, such side agreements will only be taken into account by the Court to the extent that they are compatible with the requirements of an ineffectiveness order. Contracting authorities should also be aware that under PCR 2015 they are under an obligation to ensure that public contracts which they award contain provisions enabling them to terminate the contract when the contract has been subject to a material modification which would have required a new procurement process.