The tenders trap
11 June 2001
Procurement issues were dragged from blissful obscurity last summer when the European Commission challenged the process of negotiation used in UK PFI projects. EC officials questioned the use of the 'negotiated procedure' - where short-listed bidders start detailed discussions with the contracting body about project cost and structure - in the negotiation for the now defunct Pimlico School project in London, on which CMS Cameron McKenna and Berwin Leighton (now Berwin Leighton Paisner) were the lead advisers.`In its "reasoned opinion", sent to the Office of Government Commerce (OGC) last July, the EC said using negotiated procedure contravened procurement rules because the schemes were not sufficiently complicated to merit its use.`"The Public Procurement of Construction Works Directive established strict rules to ensure that public contracts are awarded only after an open and transparent tender process," the EC stated. Under European Union rules, construction works or service projects should use the "open" or "restricted" procedure - where dialogue between the parties is severely limited - unless project contents cannot be determined at the outset.`The EC's judgment sent shock waves through the industry. In PFI projects the procuring authority - usually a government department or local authority - specifies its objectives and seeks proposals from private sector bidders on how those might be best achieved. Negotiated procedure is therefore the standard procedure used in these projects as it gives bidders the flexibility to use their expertise to offer innovative solutions.`The OGC challenged the EC's conclusions in a formal reply sent to Brussels in January. Although the document is not in the public domain, a Government source said the reply asserts that PFI schemes "necessitate the negotiated procedure as these transactions are inherently complex and require more flexibility for the public authority than is required under other forms of procurement".`Most lawyers in the PFI industry back the Government's view. It is believed the ability of PFI to deliver value for money - one of the key criteria for using this financing mechanism - would be jeopardised by a ban, as private sector innovation would be limited if exact service specifications were determined at the outset.`Though the OGC is advising contracting authorities that it is "business as usual", and has not issued formal guidance on the matter, the EC's reasoned opinion has left procurers in a distinctly sticky situation. They know they have Government backing to use the procedure, but legally their position is far from clear. Litigation from disgruntled bidders is considered a real threat.`At Pimlico, the EC showed it was willing to flex its muscles where it did not consider authorities were playing by the rules. The UK Government has shown it is willing to resist. If the Government and the EC cannot resolve their differences, they will face each other in court in the next six to 12 months.`Meanwhile, the uncertainty brought about by the dispute is causing chaos for practitioners working on PFI projects. Jan Middleton, public law partner at Denton Wilde Sapte, says: "Public authorities are jumpy. They are scared that if they adopt the wrong procedure, they may face millions of pounds in compensation pay-outs to losing bidders, or face intervention from the EC."`Ed Marlow, head of the PFI group at Denton Wilde Sapte, agrees. "We spend many hours advising clients on how these EU regulations affect the process they want to adopt to select a contractor. I find it very frustrating and I think it's a priority to have in place a straightforward set of rules governing that process," he says.`The situation is not unique to the UK and, indeed, the Continent gives us a useful insight into our possible future. To take an extreme example, in Germany, challenges to public procurement decisions on the basis of breach of EU rules are already common. The German procurement tribunal hears several hundred cases a year, and complaints are resolved within six months. Decisions are made by the procurement tribunal - a body to which the UK has no equivalent, having opted to use the court system - and, if necessary, by the appeal court.`The cost of making a complaint need not be great. The parties need not be represented by lawyers, although most are. Unless it is inappropriate for confidentiality reasons, a party has a right to see the authority's files, making it easier to foresee what arguments might be raised.`Despite the high bid costs on PFI/PPP projects, the UK situation is different. Between 1994 and 1998 there were only 10 court decisions relating to breach of EU procurement rules. A major reason may be reluctance to bite the hand that feeds: in other words, the fear that bidders would be blacklisted against winning future contracts in the UK.`In addition, as the UK complainant has to go through the civil justice system, with its associated costs and burden of proof, it may think twice before embarking on the process. Certainly, challenges in the UK are unlikely to reach the scale of those in Germany for some time.`But authorities are not taking this lightly. In Pimlico, it was a member of the public that informed the EC that the rules were not being followed - demonstrating that even if companies are unwilling to kick up a stink, others might intervene. Authorities may also find the culture of silence being swept away as companies from EU countries where challenging the process is more common become increasingly involved in the UK market.`Meanwhile the PFI industry battles with the current problem. Can PFI work within the constraints of the restricted procedure? One leading academic has written that the selection of a preferred bidder is not possible under the restricted procedure because it envisages complete bids against a fixed specification. This would be a major body blow to the PFI process, in which negotiations with preferred bidders can take several years to get the right contract for both parties.`Others think that the challenge over Pimlico was a simple mistake by the EC, which was misled into thinking that the narrow interpretation on the use of the negotiated procedure "without notice" should be extended to the use of the negotiated procedure "with notice". Whatever the truth, lawyers are having to treat this situation with kid gloves.`Paul Mountain, a partner at Birmingham-based Martineau Johnson, says: "If the EC is right and the contract for the design, build, finance and operation of a public facility is simply not complex enough to justify the negotiated procedure, the implications are very far reaching.`"Radical change in established practice wouldn't happen immediately and might even depend upon the outcome of legal proceedings between the EC and the UK Government. Clients in both public and private sectors deserve to understand what those implications could be in the medium term."`As the reasoned opinion is a confidential communication between the EC and the OGC, the Government has been unable to help confused authorities and their lawyers. Denton Wilde Sapte's Middleton says: "Given the state of the upheaval in the market it is incredible that we are in a situation where matters which are hugely significant to commercial decisions have to be treated as confidential and details are only available in dribs and drabs via leaks and industry gossip. Guidance is desperately needed on this matter but there is no indication that anything is on the way."`Partly to address these difficulties, the EC has proposed amendments to the directives and these revisions are working their slow way through the various circles of European Union power. However, many lawyers believe these proposals are set to make the situation even worse.`"Revisions to the procurement rules are certainly to be welcomed but I don't think the revisions will achieve the certainty and simplicity we need to see," says Marlow.`Furthermore, the revisions do not address the central problem: that of the UK's "requirement" to use the negotiated procedure as a matter of course in PFI.`An EC source says: "We would no longer be pursuing the [Pimlico] case if we thought that the UK's interpretation of the current directives would no longer be a problem with the new amendments."`One proposal calls for the negotiated procedure to be modified, permitting a "competitive dialogue" between clients and contractors in "particularly complex contracts". This will limit talks between both parties to the initial stages of the contracting awards procedure and in effect end all dialogue when bidders have submitted tenders. The emphasis is on "open" and "transparent" tendering - and negotiated procedure.`Robyn Herzberg, of one of the leading PFI players Carillion, and who chairs the CBI committee on Europe, says: "The competitive dialogue will bar any negotiation between the client and private sector after the appointment of preferred bidder. This will push up bid costs and lower the incentive to innovate as bidders will be unhappy about revealing intellectual knowledge at short-list stage."`Tender procedures for PFI work are expensive and time consuming - bidders for the PPP to upgrade the London Underground, for example, claim total bid costs are as high as £50m. Negotiated procedure generally brings a one-in-three chance of success, as three bidders are invited on to the short list in order to negotiate the project. This is seen as acceptable where the prize is a highly profitable contract stretching 25-40 years, as is typical in PFI transactions.`In contrast, the EC wants there to be a minimum of five bidders invited to participate. If more participants are required to be involved in an expensive procedure with reduced odds of being awarded a contract - from one in three to one in five - this is bound to affect how attractive PFI projects are to the private sector. The fear is that investors will walk away from the process.`A leading City banker says: "If the proposed amendments are implemented there's a serious risk you would not be able to reduce short lists to manageable proportions. It would make the whole system unworkable."`And there is another, more central problem. In PFI, the focus is on partnering. In order to allow the private sector to innovate - and thereby manage the risks that as a PFI partner it must assume - it must be able to negotiate the most crucial aspects of a project.`Particularly at preferred bidder stage, this may involve open discussion between the bidder and the procurer of the bidder's proposed business practice, preferred payment mechanism, the allocation of risk and so on.`This is far from guaranteed under the "competitive dialogue" regime, under which negotiations on "fundamental aspects of contract" - in particular price - are not permitted after receipt of tender documents. These aspects are considered to be crucial to achieving value for money and best value, two key criteria in project evaluation.`The fear is that a ban on negotiated procedure may challenge the rationale behind PFI itself, substantially weakening the case for using it over traditional procurement.`The proposals have led to a row between the EC and the European Council - the real powerhouse in the EU. The council wants to see more flexibility but the EC is standing firm, threatening to withdraw the revised procurement package if member states continue to demand the negotiated procedure for all public procurement contracts.`The EC has drawn its line in the sand and, at present, it looks like things are going its way.`But there are rays of hope. The Major Contractors Group, the construction industry body, is to send a delegation to the EC later this month. With the full backing of the OGC, it will pack some punch.`Herzberg, who will lead the delegation, says: "I have talked to many EC officials who acknowledge and understand our problem - the situation is not insoluble. And even if we fail to persuade the EC, we'll go to the European Parliament. This legislation isn't passed yet."`All this uncertainty is very interesting for journalists and academics. The reality for those at the industry coalface is not so appealing. PFI has already felt the minor tremors of speculation about the impact of the Human Rights Act, and European regulations will continue to cause concern as long as PFI is around. If the issue on the use of negotiated procedure in PFI is not concluded by the forthcoming court battle, it will be up to the EC to propose revisions which can iron out the difficulties.`However, it will be at least two years before any legislation is brought through. That's two years of misery for procurement lawyers.