After some refreshing and thought-provoking discussions at the Global Revolution VII conference in Nottingham earlier this week [yes, we inadvertently showed up in the exact same attire... but presented different topics: Pedro's paper is here and mine is here], we now restart our procurement tennis. We have 52 regulations to go, so this will be an interesting summer and we hope that you will continue joining us in the debate.
Pedro's serve on reg.71 is available here. He rightly questions whether contracting authorities have the right incentives to actually engage in significant supply chian monitoring beyond limited obligations for works and services carried out in their premises. I agree. I also think that contracting authorities should not extensively use subcontracting powers to either mandate or prevent subcontracting (see below).
Reg.71 of the Public Contracts Regulations 2015 transposes Art 71 of Directive 2014/24 concerning rules applicable to subcontracting. This is an area where the Commission introduced novelties to foster SMEs' (indirect) participation in procurement through streamlined subcontracting opportunities, as well as some rules strengthening the supply/value added chain monitoring possibilities for contracting authorities [see rec (105) dir 2014/24].
In that regard, and without prejudice to the main contractor's liability vis-a-vis the
contracting authority [reg.71(2) PCR2015; that is, without establishing a direct contractual relationship between the subcontractor(s) and the contracting authority], the latter may ask tenderers
to indicate any share of the contract that they may intend to
subcontract to third parties and any proposed subcontractors [reg.71(1)], and it shall do so where works and/or services are to be provided at a facility under the direct oversight of the contracting authority [reg.71(3) PCR2015]. Any changes in the subcontracting structure for the contract need to be notified to the contracting authority promptly [reg.71(4) PCR2015]. Contracting authorities can extend this obligation to certain contracts not carried out in facilities under the direct oversight of the contracting authority, as well to suppliers involved in works or services contracts, and they can go down the chain beyond the first subcontracting tier [reg.71(7) PCR2015].
This immediately places the contracting authority in a situation where it can monitor and influence the subcontracting activity related to a given contract. However, the transposition of Art 71 Dir 2014/24 in reg.71 PCR2015 has not maximised the subcontracting management possibilities foreseen in the EU rule.
Reg.71 PCR2015 does not include some of the optional mechanisms in Art 71 Dir 2014/24, such as the possibility to create mechanisms of direct payment to subcontractors as per Art 71(3) and (7) Dir 2014/24. However, there are specific rules in reg.113 of Part 4 PCR2015 requiring that 30 day payment terms are flowed down the public sector supply chain, which may mitigate the effects of such transposition option (as we will discuss in due course).
The new rules in reg.71 PCR2015 also try to mitigate the burden of controlling the supply chain that contracting authorities may otherwise face. It is interesting to note that Art 71(1) Dir 2014/24 stresses that "Observance of the obligations referred to in Article 18(2) by subcontractors is ensured through appropriate action by the competent national authorities acting within the scope of their responsibility and remit." Consequently, the duty for contracting authorities to monitor and ensure compliance with environmental, social and labour law by subcontractors is limited to the general principle of reg.56(2) PCR2015, which refers to the tender itself and seems to restrict the scope of monitoring obligations in a significant way.
The new rules in reg.71 PCR2015 also try to mitigate the burden of controlling the supply chain that contracting authorities may otherwise face. It is interesting to note that Art 71(1) Dir 2014/24 stresses that "Observance of the obligations referred to in Article 18(2) by subcontractors is ensured through appropriate action by the competent national authorities acting within the scope of their responsibility and remit." Consequently, the duty for contracting authorities to monitor and ensure compliance with environmental, social and labour law by subcontractors is limited to the general principle of reg.56(2) PCR2015, which refers to the tender itself and seems to restrict the scope of monitoring obligations in a significant way.
This is without prejudice of their discretion to check that subcontractors are not affected by exclusion grounds under reg.57 PCR2015 [see reg.71(8) PCR2015] and seems to fall short from the possibilities foreseen in Art 71 Dir 2014/24 (and, particularly, the lack of transposition of rules imposing joint liability between subcontractors and the main contractor for compliance with environmental, social and labour law (which is, however, not excluded and thus subjected to general contract and tort law principles).
In relation to the enforcement of exclusion grounds on subcontractors, reg. 71(9) PCR2015 determines that the contracting authority shall require that the economic operator replaces a subcontractor in respect of which the verification has shown that there are compulsory grounds for exclusion; and may require the economic operator to do so where there are non-compulsory grounds for exclusion.
Subcontracting and competition
Beyond these supply/value added chain management issues, subcontracting can trigger competition-related concerns that, in my view, also deserve some thought. In that regard, this is what I have submitted in my Public Procurement and the EU Competition Rules, 2nd edn (Oxford, Hart, 215) 353-355.
EU public procurement directives establish
rules on subcontracting with the specific ‘secondary’
policy objective of encouraging the involvement of small and medium-sized
undertakings in the public contracts procurement market (eg, recital (78) dir
2014/24). In this regard, article 71(2) of Directive 2014/24 establishes that
contracting authorities may ask tenderers to indicate any share of the contract
they may intend to subcontract to third parties and any proposed subcontractors—with
the aim of providing transparency in the subcontracting chain (rec (105) dir
2014/24). It also makes it clear that subcontracting does not alter the principal
economic operator’s liability (art 71(4) dir 2014/24) and, in any case, leaving
Member States’ discretion to opt for more stringent liability rules under
national law (art 71(7) dir 2014/24).
The rest of article 71 introduces new
rules on the control of subcontractors and their compliance with exclusion and
qualitative selection criteria and, particularly, compliance with the
environmental and social rules indicated in article 18(2) of Directive 2014/24 (art
71(6) dir 2014/24), as well as new rules on the required checks when
subcontractors are to perform contractual obligations at a facility under the
direct oversight of the contracting authority (art 71(5) dir 2014/24). It also introduces
new rules concerning the direct payment to subcontractors by the contracting
authority. Firstly, it facilitates the establishment of mechanisms of direct
payment to subcontractors upon their request (art 71(3) dir 2014/24) and,
secondly, it allows Member States to go further, for instance, by providing for
direct payments to subcontractors without it being necessary for them to
request such direct payment (art 71(7) dir 2014/24). Therefore, the directive does not impose, but
seems to favour, buying strategies aimed at inducing or mandating the
subcontracting of significant parts of the tendered contracts.[1]
In this regard, it should be stressed
that, although there is no express indication in the directive to that effect,
the percentage of work to be subcontracted by tenderers could in principle be
used as an award criterion in determining the most economically advantageous
tender (ex art 67(2) dir 2014/24)—although doubts can be harboured as to the
relevance of this criterion, particularly for its questionable link to the
subject-matter of the contract (which should not be affected by direct
execution or subcontracting of the works, as long as the undertaking entrusted with
the activity meets the relevant suitability criteria), and for the difficulties
in envisaging the economic advantage that can derive from different levels of subcontracting
(for further details as regards the requirements applicable to award criteria).
Finally, it is also worth underlining
that, according to the interpreting case law of the EU judicature—and largely in
the opposite direction of the approach followed by Directive 2014/24 in article
71, but in line with what is established in article 63(2)[2]—contracting
authorities can prohibit or restrict
the
use of subcontracting for the performance of essential parts of the contract
[more] precisely in the case where the contracting authority has not been in a
position to verify the technical and economic capacities of the subcontractors
when examining the tenders and selecting the lowest tenderer.[3]
Indeed, unchecked subcontracting could
be used to circumvent the controls set up by the public procurement system, particularly
as regards the evaluation of the professional, economic and technical standing
of tenderers. Therefore, restrictions on subcontracting can be justified under
certain circumstances.
In general, then, according to the rules
of the EU public procurement directives and the relevant case law, contracting
authorities enjoy substantial discretion to induce, mandate or prohibit
(depending on the circumstances) the subcontracting of significant parts of the
tendered contracts. However, as economic theory has shown and as experts have
rightly warned, ‘measures to facilitate sub-contracting (or an explicit
requirement to subcontract) may have undesirable competition effects because
they could reduce participation and facilitate collusion’.[4] Consequently,
it seems appropriate to undertake an assessment of these rules in the light of
the principle of competition.
From an economic perspective, it is important
to stress that it has been shown that subcontracting does not usually
reallocate work in an efficient manner and provides the main contractor with
the ability to extract rents from its subcontractors.[5] Consequently,
contrary to the common wisdom encapsulated in recital (78) of Directive 2014/24
(and previously in recital (32) of Directive 2004/18),[6] induced
or mandatory subcontracting is an inadequate instrument to ‘spread’ work or
foster efficient SME participation in public procurement—or, at least, is inferior
to alternative measures such as lot division.[7] Moreover,
subcontracting amongst competitors can be an effective way to enforce collusive
agreements,[8]
or to impose restrictions of competition that could go beyond the indispensible
limits to ensure the proper deployment of the subcontract.[9] Therefore,
in general terms, there seems to be no good reason for contracting authorities to
induce or mandate tenderers to subcontract any significant amount of the works,
services or supplies involved in the tendered contract—particularly taking into
account that the alternative (and less restrictive) mechanism of lot division
is available to them in order to increase competition and foster participation,
specially by SMEs.
In the light of the potential
distortions of competition that can arise from subcontracting requirements, and
as yet another instance of application of the competition principle embedded in
the EU public procurement directives, it is submitted that contracting
authorities should refrain from mandating or inducing subcontracting (in
particular, by using the percentage of subcontracted work as an award
criterion) if this could result in restrictions or distortions of
competition—which is a highly probable situation. It could be argued that, in such
scenario, a general prohibition of subcontracting could be preferable as the default
rule—which could be waived where the subject matter of the contract or the
industry structure so requires. However, this more restrictive rule would
require the contracting authority to second-guess the subcontracting decisions of
the market. Therefore, it is submitted that an obligation to abstain from requiring
or mandating subcontracting is preferable to banning it altogether.
[1] See: S Arrowsmith, The Law of Public and Utilities Procurement. Regulation in the EU and
the UK, Vol. 1, 3rd edn (London, Sweet & Maxwell,2014) 1325–28.
[2] Indeed, it should be taken into
consideration that in the case of works contracts, service contracts and siting
or installation operations in the context of a supply contract, contracting
authorities may require that certain critical tasks be performed directly by
the tenderer itself or by a participant in a group of economic operators as
referred to in article 19(2) of Directive 2014/24, which seems to run contrary
to the facilitation or mandate of subcontracting, at least under specific
circumstances.
[3] Case C-314/01 ARGE [2004] ECR
I-2549 45; and Opinion of AG Kokott in case C-454/06 Pressetext Nachrichtenagentur 56.
[4] OFT (n 13) 19 and 125–27. Along the same
lines, OECD, Public Procurement: Role of Competition Authorities (2007)
9.
[5] Adams and Gray, Monopoly in America (1955)
104. For some empirical support in the same direction, see L Moretti and P
Valbonesi, Subcontracting in Public
Procurement: an empirical investigation (Department of Economics and
Management, University of Padova, Working Paper No. 158, 2012) available at works.bepress.com/paola_valbonesi/24.
[7] Grimm et al (n 386) 174 and 180; also V
Grimm, ‘Sequential versus Bundle Auctions for Recurring
Procurement’ (2007) 90 Journal of Economics 1, 2 and 18.
[8] See: OFT (n 13) 19 and 125–27; Carpineti
et al (n 214) 34; and MJ Shockro, ‘An Antitrust Analysis of the Relationship between Primer Contractors and Their
Subcontractors under a Government Contract’ (1982) 51
Antitrust Law Journal 725.