updated on 16 September 2014
QuestionWhat are Teckal companies and why are they attractive to local authorities, among others?
The current rules governing public procurement are complex, time consuming and worryingly prone to judicial review. Every time a public body wishes to procure goods, services or construction works above the threshold values as stated in the Public Contracts Regulations 2006 (the UK face of EU Council Directive 2004/18, sometimes known as the procurement rules), they must follow one of its procedures (ie, Open, Restricted, Negotiated or Competitive Dialogue).
The procedures are not simple, but it is essential that they are both followed and documented. To give an example of their complexity, the typical stages which make up a Competitive Dialogue procedure are as follows:
Not surprisingly, the process detailed above is an expensive one. Extensive legal advice is required throughout, in addition to the attendance of the procuring authority's own staff and legal team at a long series of meetings, workshops and training sessions. One of the options available to a public authority wishing to avoid the time and expense involved is to procure internally, thereby keeping the procurement outside the reach of the rules entirely. However, this has historically been problematic where authorities wish to merge shared services or where a department is to be run at arms' length in preparation for spinning out as a staff or community mutual. What if multiple authorities wish to procure a shared facility, designed to achieve economies of scale in areas such as highways maintenance or waste recycling? Does it make sense for each of several separate authorities to spend the cost of procuring the same facility from the same ultimate purse (ours!)?
The procurement rules' non-application to internal procurement has led public authorities to explore the range of structures that might qualify as an internal transaction. The European Court of Justice (ECJ) has been very reluctant to stretch the definition beyond the literal interpretation of the directive, but the willingness of public authorities to interpret the rules in their own favour has led to several challenges by private businesses where they feel that they have been deprived of the opportunity to tender for lucrative public contracts. In a very small number of these cases, the ECJ has granted some latitude to procuring authorities (in line with the purposive approach taken by the ECJ), resulting in the emergence of two reasonably well-defined exceptions.
Based on the case of Teckal Srl v Commune di Viano (1999), the Teckal exception allows a public authority, in specified circumstances, to procure direct from an external company in which it has control similar to that which it exerts over its own departments. If the company satisfies the Teckal criteria, the procurement will be outside of the rules. A Teckal company must have no private financial involvement in its ownership (although a local authority owner may have borrowed private money which he or she now wishes to invest). This is a strict requirement; even prospective private investment will defeat the defence of being exempt under Teckal (Carbotermo & Consorzio v Commune Di Busto Arsizio (2004)). Such a company does not however need to provide 100% of its output to the public parent(s); a maximum of 10% of total output may be allocated elsewhere. This makes a Teckal set-up ideal where incidental profit-making services are in the frame (eg, a company used to maintain roads and pavements that also lowers kerbs for a fee).
Cases that have arisen regarding the Teckal exception have limited, rather than defined, the legal shape of such companies. The European courts have repeatedly declined to allow any departure from the parameters established by the original case. There are several defining cases, including as an example Brent LBC v Risk Management Partners Ltd (2011). This was the first case to be heard by the UK Supreme Court dealing with the procurement rules. It confirmed that a Teckal construct was an exception to application of the Public Contracts Regulations 2006. Further, it was confirmed that collective control of a Teckal company is permitted (here a group of 10 local authorities) provided the Teckal company is doing what the procuring authority wishes.
Although reluctant to allow the Teckal exemption to cover anything other than its original scope, in almost any judgment or opinion dealing with application of the rules the ECJ restates their core purpose; to ensure that no private undertaking is placed at a disadvantage by a relationship of proximity between procurer and contractor. Therefore, the other exception allowed by the ECJ, as detailed below, comes as something of a surprise.
Often, public authorities will have similar needs for similar services. An example of this is the collection and processing of waste: there is a minimum size that a waste plant needs to be to work efficiently, particularly if recyclate is to provide an income stream. A standard Teckal set-up is not ideal where authorities share a single objective, but lack the competence or strength individually to achieve that purpose. In the Hamburg Case (European Commission v Germany (2009)) a group of four public authorities used a fifth larger public authority, not controlled by any of them, as a procurement vehicle; the ECJ found that this was a valid non-rules procurement, giving rise to a second established exception.
The four authorities each needed a facility to process their waste, but none of them required either the actual facility or enough capacity to make an individual facility of their own a practical possibility. Each of the procuring authorities was a borough of the City of Hamburg, and so they agreed the much larger and more influential City of Hamburg Cleansing Department should procure the construction of a facility from the private sector, with each of them taking a pre-allotted share of total capacity.
On the face of it, this was absolutely nothing like a Teckal arrangement. None of the authorities had control, none of them had ownership and each of them had a separate requirement to procure . However, the ECJ decided that this arrangement was outside of the procurement rules. It is worth noting certain special circumstances that may have made some difference, as follows:
Continued attempts by procuring authorities to stretch Teckal/Hamburg show the need for additional options when a public authority chooses to keep its operation internal. The issue here is a serious one; the procurement rules are in place to ensure that large public contracts are awarded fairly, with no advantage gained due to entrenched relationships or presumed suitability. There is no doubt that when the cost of the process itself is excluded from calculations, the rules present a fair, competitive and reliable system. However, public authorities need to be in a position to choose alternatives, particularly where standard procurement timings and costs are disproportionate to the contract value, and the Teckal and Hamburg exceptions have offered options.
Procuring authorities can now be assured that the exceptions are here to stay, as they have been codified into the new EU Directive 2014/24, which will replace Council Directive 2004/18. The Cabinet Office has stated an intention to take a copy-out approach to the articles dealing with Teckal/Hamburg procurement situations, with the new directive intended to be implemented in early 2015.
The preamble of the directive, as is usual with EU legislation, details what it intends to achieve and includes the implementation of legislation regarding Teckal arrangements, joint ventures and Hamburg procurement. The treatment of Teckal described in the preamble is reflected in Article 12 of the directive proper and this article will form the basis of the UK regulations. The directive does more than just mirror the Teckal case, however, enhancing it in ways that are likely to lead to a significant increase in their use, particularly where procuring authorities have a view to commercially leaning ventures.
First, the new directive lowers the bar for authority-focused output: "…providing the controlled legal person carries out more than 80% of its activities in the tasks entrusted to it by the controlling contracting authority or by other legal persons controlled by that contracting authority."
The increase from the current 10% to 20% makes a big difference. This will allow hospitals, prisons, schools and other publically owned assets to consider the opportunities available where they wish to provide a service in house for which there is a commercial demand for any surplus capacity (eg, power generation, back-office services or private medical facilities). Often the cost of increasing production capacity of such services is less than the pro-rata value per unit of more modest production (eg, the cost to generate 1.25MW of power is usually considerably less than 125% of the cost of 1MW), making it financially attractive to increase production/capacity specifically to produce a profitable surplus.
The directive answers a question that has been repeatedly avoided by the ECJ: can one subsidiary provide services to another subsidiary where they share the same parent within the Teckal exception? Article 12(2) tells us that such arrangements are exempt, even though the previously necessary "case of power of decisive influence over both strategic objectives and significant decisions" is not present. Also expressly included is the "reverse Teckal" relationship, where a subsidiary awards a contract to its parent.
At present, although severely limited in its application, the Teckal company allows public authorities a route by which to avoid application of the procurement rules where they need to provide services internally via a limited company, but not a great deal else. Following implementation of the new directive, it may be possible for new facilities, built primarily for the benefit of public authorities, to pay for a sizeable chunk of their own upkeep. Furthermore, thanks to Article 12(2), larger public bodies (eg, county councils or NHS England) will be able to create construction or supply companies. These companies will not only be able to contract with the parent, but also with every other subsidiary of the parent.
This will surely be appealing to even more cautious authorities. The opportunity to raise income, avoid the procurement rules process and ensure maximum benefit for the public (by recycling the profits and savings back into the authority) will make good use of limited funding, something that is at the forefront of planning for many public service providers already. Furthermore, for many authorities saddled with costly or ineffective private finance initiative facilities, they now have a new and realistic option when considering service provider option: do it yourself and do 20% of it for somebody else.
Neil Window is a trainee in the construction litigation department of Addleshaw Goddard.