The UK's recent enactment of the Public Contracts Regulations makes it the first among the EU member states to implement Directive 2014/24/EU, the new public sector directive. Totis Kotsonis of Eversheds clarifies the complex rules that relate to the modification and termination of contracts.
On 26 February 2015, the Public Contracts Regulations 2015 (the Regulations) came into force in England, Wales and Northern Ireland. The Regulations implement Directive 2014/24/EU, the new public sector directive (the Directive) which, following extensive negotiations at EU level, was finalised and published in the Official Journal of the European Union (OJEU) a year earlier. The UK (with the exception of Scotland) is the first EU member state to have implemented the Directive. Behind the decision for prompt implementation lies the UK government’s desire to enable public bodies to take advantage of the greater flexibilities which the Directive provides in certain respects.
Among the key aspects of the new rules are provisions which for the first time regulate explicitly the circumstances in which it is permissible to amend a contract following its award without triggering obligations for a new tender process (Regulation 72). Also for the first time, the legislation includes provisions which require the incorporation of termination clauses in public contracts (Regulation 73).
The rules that apply to the modification and termination of contracts are complex, and the government has recently published guidance which seeks to clarify certain aspects of these rules. However, while providing some useful clarifications the guidance also raises further questions as to the correct interpretation of the law. This note considers these and other related issues in the context of setting out the new rules on the amendment and termination of contracts.
The rules on contract modification essentially prohibit “substantial” changes to contracts following their award. According to the legislation, a modification is substantial where the amendment:
The above principles essentially codify Pressetext (Case C-454/06) and other relevant jurisprudence of the Court of Justice of the EU (the EU Court), while also providing certain clarifications.
At the same time the legislation goes further and sets out the circumstances – generally referred to as the “safe harbours” – in which post-contract award modifications will not be deemed to be prohibited. In summary, these circumstances are where the amendments:
In either case, reliance on the safe harbour requires a contracting authority to publish a notice in the OJEU setting out details of the modification and the reasons for it;
Some of these “safe harbours” are effectively the reworking of principles which in one form or another where included in the previous public sector legislation (Directive 2004/18/EC), while others are new elements based on the elaboration of principles established in the EU Court’s jurisprudence. The incorporation of safe harbour provisions in the legislation effectively adds an element of flexibility and proportionality to an otherwise strict set of contract modification rules. In this regard, it is worth noting the following points.
Safe harbours for additional requirements or unforeseen circumstances
As regards the requirement that the value of the original contract should not increase by more than 50 per cent when modifying that contract to make provisions for additional requirements or unforeseen circumstances, the rules indicate that this is a condition which applies to each individual modification. In other words, in the event of several consecutive modifications, it is irrelevant as to whether their cumulative value exceeds more the 50 per cent the value of the original contract. This is the case despite the fact that, when viewed collectively, such consecutive modifications might have a material effect on the nature and scope of the contract as originally advertised which, on the basis of current EU Court jurisprudence alone, would not normally be deemed acceptable. At the same time, it is also a requirement that consecutive modifications must not be aimed at circumventing the rules. Accordingly, we can expect that the EU Court would interpret strictly this provision. As noted above, contracting authorities are required to publish notices in the OJEU, setting out the circumstances which have rendered such modifications necessary. In addition, the courts are likely to require that contracting authorities substantiate adequately and appropriately claims that the conditions for reliance on this exemption were met in each case.
As regards the “additional requirements” safe harbour, the UK’s implementation differs from the wording of the Directive in one important respect. The Directive indicates that, subject to the restriction on increasing the value of the original contract by more than 50 per cent, a modification of a contract is permissible in circumstances where this relates to the provision of additional goods, works or services by the original contractor, which are outside the scope of the original procurement but where a change of contractors:
(a) cannot be made for economic or technical reasons, such as requirements of interchangeability or interoperability with existing equipment, services or installations procured under the initial procurement; and
(b) would cause significant inconvenience or substantial duplication of costs for the contracting authority.
In implementing the Directive, the government changed the word “and” connecting conditions (a) and (b) to the word “or”. The obvious effect of this decision is to make this safe harbour more accessible as, under the Regulations it would be sufficient to satisfy either, rather than both, of these two conditions in order to be able to rely on this provision.
The government’s approach on this would seem in fact to be correct and consistent with the intention of the legislators. This is on the basis that conditions (a) and (b) as cumulative requirements would not seem to make good sense. For example, under such approach, in what way would the “economic reasons” in condition (a) need to be different from the “substantial duplication of costs” in condition (b)? Equally, if a contracting authority can demonstrate that there are technical reasons to do with the interoperability of existing equipment which make it impossible for it to procure different equipment, why would it also need to demonstrate separately significant inconvenience or substantial duplication of costs?
Safe harbour for small value changes
More uncertain perhaps is the government’s interpretation of the conditions for “minor changes”; that is to say, for modifications that are justifiable if their value is:
(a) below the value threshold triggering the application of the rules; and
(b) less than 10 per cent (for services or supplies) or 15 per cent (for works) of the value of the original contract.
When it comes to several consecutive modifications, the legislation seems to require (in a way which does in fact make good sense) that the value for each of these conditions is assessed on a cumulative basis. The obvious implication of this approach is that if either condition (a) or (b) are not met as a result of this cumulative assessment the exemption will not be available.
However, the government has interpreted this requirement differently and has indicated in its guidance that, where there are multiple changes, the need for a cumulative value assessment relates to the 10 or 15 per cent limit (condition (a)) alone. On the basis of this interpretation, the fact that in aggregate the value of multiple changes meets or exceeds the value threshold that triggers the application of the rules (condition (b)) is irrelevant, provided that: individually they do not exceed this threshold; and in aggregate the value of the changes is below the relevant 10 or 15 per cent limit.
Such interpretation is not obvious from a reading of the relevant provisions in the Directive or indeed the Regulations. Also, as noted above, unlike the situation in relation to the “additional requirements” safe harbour provisions, requiring the cumulative assessment of the value in conditions (a) and (b) in this case does make good sense. Whether this more permissive interpretation of the rules should be accepted on the basis that it is consistent with the intention of EU legislators is questionable, given that the wording of the Directive is seemingly unambiguous on this point. Until such time as this issue is clarified, the government’s preferred approach is not without risk.
Determining which contracts are subject to these provisions
Separately, it is worth noting that government guidance indicates that the legislative provisions on contract modifications apply to all modifications made on or after the date on which the Regulations came into force. That means that they apply both to new contracts awarded after the Regulations came into force and to existing contracts awarded prior to that date. This approach is arguably correct, although not evident from a reading of the transitional provisions in the Regulations. This issue is discussed further in the next section of this note.
Finally, it is also relevant to note that the EU Court has applied the Pressetext “material amendments” principles after contract award, in the context of considering the legality of amendments to the scope of a contracting authority’s requirements before contract award (Commission v the Netherlands, Case C-576/10). The extent to which the EU Court would consider it appropriate to adopt a similar approach in relation to the new legislative provisions on contract modifications post award and apply these mutatis mutandis in the context of changes to requirements, pre-contract award, is less clear. It is certainly arguable that it would be consistent with the EU Court’s strict interpretation of exemptions for it to adopt a more nuanced approach when it comes to the possible application of at least some of the safe harbour provisions to changes to a contracting authority’s requirements before contract award.
Another important aspect of the new rules is the introduction of an obligation on contracting authorities to include in their contracts provisions enabling them to terminate those contacts where:
The legislation indicates that if such termination provisions are not included expressly in a contract which is subject to the Regulations, the power to terminate the contract on reasonable notice will be an implied term of that contract.
As to the question of which public contracts must incorporate these new termination provisions, government guidance suggests that the right to terminate must be included in all contracts awarded on or after 26 February 2015. The guidance also goes further and takes the view that a termination right will be implied into public contracts awarded before that date. There are arguments in favour of this approach. However, the problem is that the approach is inconsistent with the transitional provisions in the Regulations (Regulation 118). These provisions indicate, among other things, that nothing in the Regulations affects a contract awarded before 26 February 2015, the date on which the Regulations came into force, or indeed a contract awarded after that date in certain circumstances, including when the contract award procedure which led to its award commenced before that date.
Separately, it is important to emphasise that the Regulations provide the right, rather than the obligation, to terminate a contract in the circumstances set out above. However, in its guidance the government expresses the view that at least in certain circumstances contracting authorities should in fact exercise that right. The guidance does not explain the rationale behind this position (and there are a number of inconsistencies with the way in which that position is expressed which in any event render it problematic).
However, ultimately, a contracting authority might not have much of a choice in the matter. For example, in circumstances where there has been a substantial modification to a concluded contract, such that it amounts to a new contract which should have been advertised by means of a contact notice in the OJEU, a challenger may seek a declaration of ineffectiveness from the court. The effect of a declaration of ineffectiveness would be the prospective cancellation of any outstanding obligations under that contract and therefore its termination. In addition, the contracting authority would normally be required to pay a penalty which must be “effective, proportionate and dissuasive”. Accordingly, it may be that at least in these circumstances contracting authorities would choose to terminate the contract in line with the express or implied provisions which would permit them to do so, rather than have the court declare it ineffective and be exposed to additional penalties.
Separately, one cannot exclude the possibility that, at least in certain specific cases where a contracting authority refuses to exercise the right to terminate a contract in the circumstances which trigger the right to do so, the court might find it appropriate to grant an order setting aside the contracting authority’s decision not to do so, or indeed, to require the contracting authority to exercise its express or implied right to terminate that contract.
As it should be obvious from the above, various aspects of the new rules on contract modification and termination remain unclear. Current government guidance on these issues while helpful in certain respects is not as clear as it could be and indeed raises further questions. Ultimately, most of these issues must await further clarification from the courts. In the meantime, contracting authorities would do well to interpret the Regulations and apply any related guidance with caution.