New procurement risks when buying from sister commercial trading companies

Given that the Government failed to consult on the award of public contracts by contracting authorities to in-house controlled Teckal companies in its Green Paper consultation², the provisions on vertical arrangements in Schedule 2 of the Act are presumably intended to replicate the existing law. From a technical drafting perspective, however, there are a few issues.

Statutory guidance

Before the Government’s statutory guidance on exempted contracts³ came out last week, it was not clear that contract awards between sibling companies were covered at all. If you are interested in the drafting issues, we would recommend you look at paragraphs 2(1)(c) and (d) of Schedule 2 of the Act which are intended to cover this horizontal relationship and try to make them work. Confusion arises due to the positioning of some of the drafting and the mixed use of the terms, ‘contracting authority’ and ‘person’ in the schedule. However, the Government’s collection of diagrams in its statutory guidance indicates that these paragraphs do indeed cover such horizontal in-house relationships. A court might struggle to reconcile this clarification with the actual drafting, however.

The introduction of a new control test

Of more significance is the new holistic control test used in the Act and the implications for trading subsidiaries of contracting authorities. Without going into too much detail, Regulation 12(2) of the PCR 2015 currently enables a contracting authority subsidiary to award a contract to a sister commercial trading company subsidiary controlled by the same parent contracting authority. This appears to be the case (although it is a rather grey area) even where that commercial trading subsidiary does not satisfy the activities test (i.e. that ‘more than 80% of its activities are carried out in the performance of tasks entrusted to it by the controlling contracting authority or other legal persons controlled by that contracting authority’).

Subject to compliance with the general procurement principles, this provision has been relied upon by some contracting authorities to allow the direct award of a contract by a Regulation 12 entity to a sibling trading subsidiary where that sibling subsidiary is controlled by the parent contracting authority in the PCR 2015 sense but is neither a contracting authority nor does it satisfy the activities test.

The Procurement Act introduces a single control test that encompasses elements of both the control and activities tests that are kept separate under the PCR 2015. This means that contract awards between sibling subsidiaries will only be exempt from the Act if both subsidiaries meet all aspects of the new control test. This includes each of them carrying out more than 80% of their activities for or on behalf of the controlling contracting authority/authorities or another person/persons controlled by the contracting authority/authorities.

Provisions for controlled persons

Previous case law has clarified that Teckal companies are to be treated as contracting authorities for their own purchases⁴. The Act introduces a provision which indicates that a controlled person might need to be treated as a contracting authority for some of its purchases but not others. It includes a provision which affects situations where a controlled person operates on a commercial basis but is awarded an exempted contract in reliance on the vertical arrangements exemption. According to section 2(10) of the Act, such entities are to be treated as a contracting authority in relation to ‘any relevant sub-contract’. Therefore, commercial trading subsidiaries that are not contracting authorities will not be able to have their cake and eat it once the Procurement Act 2023 is in force. It seems that if you are currently a commercial trading subsidiary with a sister Regulation 12 entity, to take advantage of the vertical exemption to receive above-threshold awards of public contracts you will need to meet all aspects of the new control test and accept that in respect of your award of any contracts for goods, services or works related to that exempted contract, you would need to follow the procurement rules in the Act as though you were a regulated contracting authority.

<sub>1. https://www.legislation.gov.uk/ukpga/2023/54/contents/enacted
2. https://www.gov.uk/government/consultations/green-paper-transforming-public-procurement
3. https://www.gov.uk/government/publications/procurement-act-2023-guidance-documents
4. See our previous ebriefing</sub>

For more information on public procurement, please contact Dr Steven Brunning or Mark Cook.

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