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Don’t Take Subsidies for Granted: Procurement Legal Battle May Leave Contractor Out of Pocket

June 2024

Introduction

Frequently, companies active in the engineering, construction, or ICT sectors will participate in publicly subsidised projects. This may include, for example, projects related to environmentally friendly technologies. The provision of public money comes with strings attached, notably regarding the conditions with which beneficiaries must comply when conducting project activities or disbursing grants or subsidies.

These conditions may be problematic for private sector companies, who are usually unaccustomed to public law duties or running public tender processes. The cost of getting it wrong may be that grants are clawed back, or beneficiaries are denied the provision of funds to recover amounts already disbursed from their own resources. That can spell disaster for a company’s cash flow or solvency position.

The recent ruling in R. v Norfolk County Council ex parte Cambrian Offshore South West Limited[1] (COSW) dealt with a situation where a contractor expected certain grants to be paid in connection with its project work. Ultimately, the managing authority for the scheme (Norfolk County Council) denied reimbursement.  It considered that COSW had not met its grant agreement duties to award a contracts in accordance with UK procurement law and rules related to the European Regional Development Fund (ERDF).  COSW challenged the decision by seeking a judicial review before the High Court.

The High Court’s preliminary judgment, delivered on 7 May, has decided which parts of COSW’s case may advance to a review hearing.  The ruling of Mr Justice Linden includes important lessons for project grant recipients to ensure that they conduct operations in line with the “small print” of grant agreements.  Frequently, this will include requirements to follow the principles of public procurement law when selecting sub-contractors for the project.

Background

The Tidal Stream Industry Energiser Project, known as TIGER, is a €48.4 million project, with €32.05 million (66%) funded by the ERDF. The project aims to foster collaboration between organisations in southern UK and northern France in the field of carbon technologies.

To be eligible for grant payments, project partners needed to adhere to the terms of grant offer letters, which stipulated that any contracts awarded by those partners in connection with the project must be made in accordance with public procurement rules.  Grants would not be disbursed all at once but through a series of reimbursements paid to the successful project partners for qualifying expenditures related to the project.

COSW, a selected project partner, held several responsibilities related to the Project, including the removal and replacement of a tidal stream turbine in Ramsey Sound and establishing an open access data centre. It engaged a subcontractor, KMW, to carry out part of this scope of works.

COSW then sought reimbursement of around £1.4 million from Norfolk County Council, the managing authority for the scheme, related to KMW’s work under the subcontract. The Council refused the request, considering that KMW had not been selected by means of a compliant competitive tender process. It was also concerned that the contract had been subject to several variations which were not on commercial terms.

Even more seriously, the Council noted the existence of certain links between COSW and KMW, which had created a serious conflict of interest in the tender process. This included COSW’s sole director also being a director of KMW and KMW also holding an investment in COSW.

Council’s Decision

The Council withheld £1.4 million from COSW, citing failures in the competitive procurement process and conflicts of interest. The Decision Letter outlined five reasons for this refusal:

• Procurement Obligations Breach: COSW had advertised the contract on Contracts Finder instead of the Official Journal of the European Union (OJEU), misclassifying it as a below-threshold works contract instead of an above-threshold services contract. A 25% correction rate was applied.
• Inadequate Mitigation of Conflict of Interest: COSW did not adequately mitigate a conflict of interest involving Mr R, a director in both COSW and KML, the contracted company. A 100% correction rate was applied.
• Further Conflict of Interest Issues and Inadequate Conflict Declarations: The involvement of Mr. P, a consultant to both companies, was declared but had been insufficiently mitigated, leading to another 100% correction rate.
• Contract Variations Conflict of Interest: Variations to the contract were agreed upon without mitigating conflicts of interest, also attracting a 100% correction rate.
• National Rule Breach: Variations increased the contract value by more than 50%, breaching national rules, leading to a 25% correction for the initial contract and a 100% correction for variations exceeding the threshold.

Correction rates are effectively penalties imposed on beneficiaries, reducing the payments available to them for failing to comply with the applicable grant conditions.

Grounds of Challenge

COSW sought a judicial review of the Council’s decision before the High Court on seven grounds, focusing on the misapplication of procurement rules, mischaracterisation of the contract, and failure to mitigate conflicts of interest, among others. The judgment that has just been delivered is a “permission” decision, setting out which of the pleaded grounds has sufficient merit to proceed to a full review hearing.

The court granted permission for judicial review on three grounds (2, 3, and 5), while dismissing the others.

• Ground 2: Applicability of ESIF Requirements The relevant grant agreement required compliance with “national rules” related to public procurement. The parties differed on whether this included the European Structural and Investment Funds (ESIF) rules as well as the UK Public Contracts Regulations 2015. The ESIF rules set strict requirements on conflicts of interest, which may also bite on below threshold contracts. The Court agreed that this point should be considered at a full hearing.
• Ground 3: Works Contract or Services Contract: COSW maintained the contract was correctly classified as a works contract, meaning it was “below threshold” and did not attract the need to advertise the opportunity in OJEU. The court considered this arguable due to the complex language of the relevant provisions and allowed it to proceed to a full hearing.
• Ground 5: Error of Law in Contract Modifications: COSW contended that applying ESIF requirements was legally erroneous. The court acknowledged this ground due to its connection with Ground 2 and the importance of determining applicable correction rates.

Among the dismissed grounds was an argument by COSW that the Council had been wrong to conclude there was a conflict of interest which vitiated COSW’s procurement process. The Court supported the Council’s findings of an improper conflict and agreed COSW had failed either to remove or mitigate it effectively in the evaluation of the subcontractor’s bid and when allowing contract variations.

Lessons Learned

This case underscores the critical importance of effectively managing and mitigating conflicts of interest. COSW’s failure to adequately address conflicts involving key personnel resulted in severe financial penalties. Grant recipients must ensure all potential conflicts are fully disclosed and robustly managed to maintain the integrity of the procurement process.

The decision also highlights the necessity for grant beneficiaries to meticulously understand and comply with all relevant procurement rules. Misclassification of contracts and failure to adhere to correct advertising procedures can lead to substantial financial corrections and the withholding of grant funds.  There may be genuine ambiguity as to whether a particular contract should be construed as a works or services opportunity.

Often it will be wise to err on the side of caution, assume the rules apply and avoid the adverse funding consequences of failing to procure properly.  Communication with the managing authority and seeking to agree on procedure or tricky legal issues in advance may help to avoid nasty surprises at a later stage.

Grant recipients should therefore proactively engage with funding bodies to clarify applicable rules and ensure compliance. This includes thorough documentation of procurement processes and justifications for decisions made.  Specialist legal advice should be taken to ensure compliance with the relevant rules.

There are lessons also for grant bodies and managing authorities. They should be wary of setting grant recipients up to fail by laying down conditions that are onerous or unclear with regard to procurement obligations.  Private sector bodies, struggling through this terra incognita, may stumble.  The unfortunate effect could be to chill the desire of private sector partners to engage with projects that are important from a policy perspective, such as those relating to the development of technologies to reduce emissions.  They may decide they simply cannot risk being in COSW’s position, committing to projects and subcontractors but then refused reimbursements.

COSW faces a high hurdle at the trial. To secure funding, it may need to convince the judge not only that it was correct to treat the KMW contract as a works contract but also that, on a proper construction of the grant agreement, the ESIF requirements were inapplicable. Succeeding on one point but not the other may be insufficient to ensure access to the grant funding.

[1] Mr Justice Linden.  Neutral citation: [2024] EWHC 1042 (Admin).

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