Tuesday, 4 May 2021

The tug o’ war for subcontracting in public procurement

 



 

Trygve Harlem Losnedahl, Doctoral Research Fellow at the University of Oslo, Centre for European Law.

 

Current interest

 

Brussels’ internal market watchdogs are communicating diverging views on subcontracting in public procurement.

 

In a large report on good practice for socially responsible procurement from May 2020, the Commission praises the Norwegian municipality of Skien’s model to combat social dumping and work related crime in public procurement.* Among the measures taken by the municipality is to limit the length of the contract chain to increase transparency and control, by requiring that every sub-contractor must be under the direct control of the main contractor.

 

At the same time, the EFTA Surveillance Authority (ESA), which corresponds to the Commission with regard to the EEA-states of Iceland, Liechtenstein and Norway, has sent a letter of formal notice to Norway claiming that a less restrictive national limitation on subcontracting chains is contrary to EU law. The Norwegian national rule applies to the construction and cleaning sectors, and sets the maximum length of three links in the contract chain, i.e. main contractor, sub-contractors and sub-sub-contractors. In the letter of formal notice, ESA leans heavily on a CJEU preliminary ruling from 26 September 2019, C-63/18 Vitali (see brief comments on the judgment by David McGowan in PPLR 2020 issue 1). Vitali was the first ruling from CJEU under the “new” procurement directives of 2014 regarding limitations on subcontracting. The ruling has apparently left quite some uncertainty.

 

In the following, I will give a brief background of the conflicting interests in limitations on subcontracting in public procurement, and case law up until the adoption of the new procurement directives of 2014. A presentation of the Vitali-case will then follow before I (critically) assess ESAs interpretation of the Vitali-case and ESA’s application of the Vitali-case on the Norwegian legislation.

 

The background – getting to the Vitali-case

 

To subcontract or not to subcontract, that has been the question in a number of judgments from the CJEU during the last thirty years (especially Cases C-389/92 Ballast Nedam Groep I, C-5/97 Ballast Nedam Groep II, C-176/98 Holst Italia, C-314/01 Siemens AG Ă–sterreich and ARGE Telekom & Partner, C-94/12 Swm Costruzioni 2 and Mannocchi Luigino). There has been a kind of tug-o-war where public buyers have been pulling for a right to limit subcontracting, for such reasons as preventing work related crime (Vitali) and quality control of the procured services (C-406/14 Wroclaw and C-94/12 Swm Costruzioni 2 SpA and Mannocchi Luigino DI). On the other side, supporters of unrestricted competition on the internal market have been pulling to reduce any limitations which could make public contracts less attractive for businesses. From an internal market perspective, limitations on subcontracting are seen as restrictions on the right to provide services. It has especially been seen as restraining small and medium sized enterprises (SMEs). Because SMEs are unable to compete for large public contracts, the only way for SMEs to get a slice of the larger public contracts is via the main contractor, i.e. via the main contractor’s right to subcontract.

 

The interpretation in favour of open competition reached a peak in the Wroclaw-case (C-406/14 Wroclaw), which was decided under the now repealed 2004-directive, and has similar facts as the Vitali-case. The Polish city Wroclaw initiated a procurement procedure for a roadworks contract. The tender specifications set out that tenderers were “obliged to perform at least 25% of the works covered by the contract using its own resources”. In other words, no more than 75% of the works for the specific contract could be subcontracted. Such a tender requirement was compatible with the Polish law at the time, and the Polish government argued that it was compatible with the 2004-directive article 26. Article 26 allowed contracting authorities to “lay down special conditions relating to the performance of a contract, provided that these are compatible with Community law and are indicated in the contract notice or in the specifications.” Article 26 also stated that such conditions relating to the performance of a contract could concern social and environmental considerations.

 

The CJEU found that the 25%-stipulation was contrary to EU law, i.e. the stipulation that the main contractor had to perform 25% of the works itself. The court ruled that the 2004-directive art. 48(3) provided a right to subcontract which was “in principle, unlimited” (para 33). As regards to the argument set out by the Polish government that the 25%-stipulation was a “special condition” allowed under article 26, the court rejected the view. The court stated that “since [the 25%-stipulation] is contrary to Article 48(3)”, the stipulation “is contrary to EU law”. As mentioned, the wording of art. 26 contains the reservation that special contract conditions have to be “compatible with Community law”. Thus, the court must be understood as concluding that since another article of the directive gives a right to subcontract, special conditions under art. 26 which limits that right, are incompatible with union law. As one can see, the court gave the general right to subcontract according to article 48(3) precedence over art. 26, and left art. 26 basically without any substance in relation to setting conditions which could limit subcontracting.

 

To further underscore the court’s view on the right to use subcontractors as a strongly protected right, AG Sharpston argued that in her view, there was only one permissible restriction on subcontracting (paras 31-34). Namely, when contracting authorities are not in a position to verify the technical and economic capacities of the subcontractors and those subcontractors are to perform essential parts of the public contract. The court had opened for such an exception in C‑314/01 Siemens and ARGE Telekom (para 45-46).

 

As I will comment on further below, the 2014-directives intended to put more emphasis on social, environmental and labour protective considerations, thus tilting the balance back from the unrestricted market position.

 

The Vitali-case

 

On 18 April 2016, the Italian legislature adopted legislation which set out that “any subcontracting shall not exceed 30% of the total amount of the contract for works, services or supplies” (para. 9). In other words, 70% of the contract value had to be performed by the main contractor, and there were no exceptions from this 30% limitation. The legislation’s main objective was to combat Italy’s many criminal organizations, which regularly made use of subcontracting in public contracts due to the reduced transparency and division of responsibility that comes with subcontracting. (Reduced transparency and control in contract chains is also highlighted in the Commission report on socially responsible procurement in a case study from Copenhagen (page 240).)

 

The Vitali-case (C‑63/18) treated a restricted tendering procedure launched by the publicly owned Autostrade per l’Italia SpA in August 2016, for the award of works on a motorway close to Milan. The contract value was roughly 85 million euros. Vitali SpA placed an offer in which more than 30% of the service was to be performed by subcontractors. Vitali was excluded since the offer did not comply with the new national 30%-limitation on subcontracting.

 

One does not have to be a trained lawyer to see the apparent discordance between the ruling of the Wroclaw-case and the new Italian 30%-limitation. It follows from the Vitali-judgment that the Italian legislature was aware of the conflict between the ECJ case law and the 30%-limitation, but that the legislature took the new 2014-directives as an opportunity to adopt measures which the former directives prohibited (paragraph 16). However, Italy’s view fell on deaf ears at the court. The court chose to render its judgment without an Opinion from the Advocate General.

 

The CJEUs main reasoning is found in paragraph 38 to 42 of the judgment. The court presents its conclusion (somewhat pre-emptively) in paragraph 38, that the Italian limitation “goes beyond what is necessary” to combat criminal organizations. In paragraph 39, the court presents the legal basis for the necessity condition, namely that article 18 of the directive obliges the contracting authority to observe the principle of proportionality. In paragraph 40 and 41, the court presents arguments for the disproportionality of the Italian 30%-limitation, before it in paragraph 42 argues that combating crime could be achieved with less restrictive measures, thus returning in paragraph 43 to the conclusion that “a restriction on the use of subcontracting such as that at issue in the main proceedings cannot be regarded as compatible with Directive 2014/24”.

 

Since ESAs proceedings against Norway is based on an interpretation especially of the Courts reasoning in paragraph 40 and 41, I cite them in full:

 

“40  In particular, as pointed out in paragraph 30 of the present judgment, the national legislation at issue in the main proceedings prohibits, in general and abstract terms, use of subcontracting which exceeds a fixed percentage of the public contract concerned, so that that prohibition applies whatever the economic sector concerned by the contract at issue, the nature of the works or the identity of the subcontractors. Furthermore, such a general prohibition does not allow for any assessment on a case-by-case basis by the contracting entity (see, by analogy, judgment of 5 April 2017, Borta, C‑298/15, EU:C:2017:266, paragraphs 54 and 55).

 

41 It follows that, in the context of national legislation such as that at issue in the main proceedings, in respect of all contracts, a significant part of the works, supplies or services concerned must be performed by the tenderer itself, failing which it will be automatically excluded from the procurement procedure, including where the contracting entity would be able to verify the identity of the subcontractors concerned and would take the view, after verification, that such a prohibition is not necessary in order to combat organised crime in the context of the contract in question.”

 

ESA’s (mistaken) reasoning

 

As mentioned, ESA has sent a letter for formal notice to Norway claiming that a national legislation which limits subcontracting chains, is contrary to EU/EEA-law. Norway has rejected ESA’s view, and ESA is currently assessing whether to instigate infringement proceedings before the EFTA court (the EFTA equivalent of the CJEU under the EEA Agreement). ESA states in the letter that it “relies on the judgment of the CJEU in Vitali to conclude that the necessity condition is not met”, i.e. that the Norwegian three chain limitation on subcontracting in public procurement is not necessary to combat work related crime.

 

In my opinion, ESA makes three mistakes in its interpretation and application of the Vitali-case. Firstly, ESA cherry-picks legal sources, not taking sufficiently into account amendments in the new directive. Secondly, ESA mistakes a characterization by the CJEU for criterion. Thirdly, ESA fails in its assessment of the similarities and differences between the Italian and the Norwegian rule. I will substantiate these three claims in the following.

 

Mistake 1: Cherry picking legal sources from the 2004-directive, and ignoring changes to the new directive

 

The “new” 2014-directives intended to open more for social, environmental and labour protective considerations, thus tilting the scale a bit back from pursuing the goal of an ever less restricted competition on the internal market. The Commission report addresses this in its introduction:

 

“The 2014 Public Procurement Directives make it clear that social aspects can be taken into account throughout the procurement cycle, from preliminary market consultation, through to the use of reservations and the light regime, and to social award criteria and contract performance conditions. Public buyers across Europe are starting to take advantage of these opportunities and demonstrate real social impact in their purchasing. Despite this, Member States are not yet fully exploiting the possibilities of public procurement as a strategic tool to support social policy objectives.”

 

The most important amendment of the directives in this regard, was the articles on principles of procurement. The “principles-clause” in the 2004/18-directive (article 2) only included the principle of equality, transparency and non-discrimination. When the EU legislator adopted the 2014-directives, it included in the new “principles-clause” (article 18 of the 2014/24 directive) a requirement that economic operators must comply with applicable obligations in the fields of environmental, social and labour law. In Tim SpA (C-395/18) paragraph 38, the CJEU underlined that “the Union legislature sought to establish” the requirement to comply with social, environmental and labour law as a principle of procurement law, “like the other principles”, i.e. equal treatment, non-discrimination, transparency, proportionality and prohibiting the exclusion of a contract from the scope of Directive 2014/24 or artificially narrowing competition. In other words, the CJEU understood (and accepted) the EU legislators’ view that these social principles should be on the same foot as the traditional inner-market principles.

 

Through article 18, the EU-legislator also clarified and limited what had been argued to be a (wide) principle of competition in public procurement law. (See especially Sanchez Graells “Public Procurement and the EU Competition Rules”, 2nd edition, 2015, and for an opposing view, Sue Arrowsmith, "Purpose of the EU Procurement Directives: Ends, Means and the Implications for National Regulatory Space for Commercial and Horizontal Procurement Policies, The," Cambridge Yearbook of European Legal Studies 14 (2011-2012): 1-48.) Article 18 now establishes that “[t]he design of the procurement shall not be made with the intention of excluding it from the scope of this Directive or of artificially narrowing competition.” By including “intention” and “artificially” in the wording of the “principles clause”, it is clear that the competition principle includes a subjective element. Even though it is not clear how this will be interpreted and operationalized, there must be an “intention” in some form by the public buyer to “artificially narrowing” competition.

 

Unlike the Commission report, ESA does not appear to take this development in legislation, nor new case law, into account. ESA does not comment on the development of the directive’s “principles clause”, nor on Tim SpA.

 

Quite to the contrary, ESA appears to cherry pick some of the more “competition friendly” case law from the CJEU, even though this case law concerns the now repealed 2004-directives and despise the fact there exists relevant case law concerning the 2014-directives. An example is that ESA chooses to cite Borta (C-298/15) when it argues that the Norwegian sub-contracting limitation puts unjustified restrictions on competition, even though the CJEU explicitly states in Borta that the new 2014-directive “cannot be taken into consideration in order to answer the questions referred” (para. 29). In Borta the CJEU strongly underscored the interest of competition, as it wrote that “it is the concern of the European Union to ensure the widest possible participation by tenderers in a call for tenders” (para. 48). As to relevant case law under the 2014-directive, Vitali itself addresses the goal of competition under 2014-directive, but the wording that CJEU uses in Vitali (para. 27) is that it is “in the interests of the European Union to ensure, in the field of public procurement, that the opening up of competition in tendering procedures is enhanced.” – in other words, a quite more reserved formulation.

 

ESA’s choosing and interpretation of legal sources, as opposed to the Commission’s, directs ESA to a view which excessively emphasizes the interest of unrestricted competition. This naturally affects ESA’s assessment of the proportionality of the Norwegian limitation.

 

Mistake 2: Characterization, not criteria

 

The other mistake is that ESA takes Vitali’s characterization of the Italian rule as “general and abstract” for criteria. Under the heading “Assessment of the necessity condition”, ESA begins:

 

“The Authority [i.e. ESA] relies on the judgment of the CJEU in Vitali to conclude that the necessity condition is not met… In reaching its conclusion, the CJEU relied on the fact that the [Italian] provision was in general and abstract terms, so that the prohibition applied whatever the economic sector concerned by the contract at issue, the nature of the works or the identity of the subcontractors, and that it did not allow for any assessment on a case-by-case basis by the contracting entity.

 

The Authority considers [the Norwegian provisions] to be materially similar to the provision in Vitali in that they are also in general and abstract terms and do not allow for any case-by-case assessment as to whether or not they are necessary to meet their objective.”

 

In the letter, ESA returns to an assessment of whether the Norwegian rule is set in “general and abstract” terms and if it allows for a proper case-by-case assessment. ESA holds that the Vitali-judgment establishes these as two criteria, which each is sufficient to conclude that at national limitation on the right to subcontract in public procurement is contrary to the proportionality principle, i.e. the necessity condition. The two criteria are (1) that the limitation is set “in general and abstract terms”, or (2) does “not allow for a case-by-case assessment”.

 

As to the first of these two, i.e. “general and abstract terms”, ESA has mistaken a characterization for criteria. When the CJEU writes that the Italian provision was set "in general and abstract terms", it must be understood as a characterization of the Italian percentage rule, not as a criterion for what types of provisions that are (always) considered to fall short of the necessity condition. In law making, general and abstract rules have been an ideal ever since the first (and less successful) codifications of the Enlightenment, such as the very detailed style of the Prussian ALR of 1794, with its 19 160 articles at a detailing level such as “to a library is to be counted the shelves and cabinets where the books are located” (Anners, Erik: ''europeiske rettens historie''. Utg. Universitetsforl.. 1983. Page 211-212).

 

More importantly, such a criterion would be quite impossible to apply. What does it mean that a rule is general or abstract? How do you measure generalness or abstractness of a provision? When does a rule tip to general and abstract from, I suppose, specific and concrete?

 

ESA does not try to develop or elaborate how it understands the criteria of “general and abstract”. ESA does however conclude that the Norwegian three-chain limitation is not “general”, since it is limited to the sectors of construction and cleaning services. Even so, ESA finds that the limitations “are otherwise in abstract terms”, as they “apply limitations on subcontracting based on the number of links in the chain without any further assessment of the nature of the works/services or the identity of the subcontractors.”

 

In my view, neither “general” nor “abstract” are criteria that the CJEU established to assess the necessity of limitations on subcontracting. What the CJEU did in Vitali was to look at the specific traits of the national limitation, to assess whether the limitation was necessary to achieve the limitation’s goal of combatting organized crime. The specific traits that the CJEU highlighted in Vitali paragraph 40, were that it “prohibits, in general and abstract terms, use of subcontracting which exceeds [1] a fixed percentage of the public contract concerned, so that that prohibition [2] applies whatever the economic sector concerned by the contract at issue, [3] the nature of the works or [4] the identity of the subcontractors. Furthermore, such a general prohibition [5] does not allow for any assessment on a case-by-case basis by the contracting entity…” [Numbers added to clarify the different elements].

 

As is often the case when the CJEU undertakes a proportionality assessment, it does not state whether each of the elements in its reasoning are to be understood as criteria that are necessary and/or sufficient for reaching the same conclusion in similar cases. As I have shown above, ESA understands “general and abstract terms” as criteria that are sufficient to conclude that a limitation on subcontracting falls short of the proportionality test. This leads ESA to an all too narrow approach to the necessity condition, instead of a comprehensive assessment where all relevant traits of a national limitation are taken into account.

 

Mistake 3: Not identifying the differences

 

I will here highlight three important differences between the Italian rule in the Vitali-case and the Norwegian rule, which ESA, as opposed to the Commission, misses and/or misjudges.

 

Firstly, the Italian rule applied to all sectors and all contracts. The Norwegian rule is limited to the construction and cleaning sectors, which are sectors especially troubled with work related crime. As shown above, ESA finds that this sectorial limitation does not make the Norwegian rule as “general” as the Italian, but since ESA means that the Norwegian rule is otherwise set in “abstract terms”, it concludes that it has similar shortfalls as the Italian rule. In my view, this is a misjudgement by ESA, which follows from ESA’s own form of Begriffsjurisprudenz, where “abstract” is mistakenly applied as a legal criteria. The differences in sectorial scope of the Norwegian and Italian rules is highly relevant in a normal proportionality assessment. Since the Norwegian rule only applies to two sectors, it is a less restrictive measure than the Italian pan-sectorial rule.

 

The second important difference is that the Italian rule prohibited main contractors from subcontracting more than 70 % of the value of the contract to subcontractors, whereas the Norwegian rule prohibited tenderers from allowing more than two links of subcontractors in the contract chain, i.e. the main contractor, subcontractors and sub-subcontractors. The Norwegian rule sets limitations neither on the value that can be sub-contracted nor on the total numbers for subcontractors or sub-subcontractors, just the length of each chain.

 

The Commission report highlights both these two traits of the Norwegian rule in its presentation of the procurement policy of the municipality of Skien. The municipality has established a main rule of maximum one level of subcontracting under the main supplier, i.e. an even more restrictive rule than the national two-level-limitation. The Commission report argues:

 

“While there is no restriction on the number of subcontractors or the proportion of the contract subcontracted, all subcontractors must be under direct control of the main contractor in order to avoid fragmentation of responsibility. This provision accounts for possible specialisation needs within a contract and does not impair access to public procurement by smaller operators.”

 

Under the Norwegian limitation, subcontractors can carry out 100 % of the works. That was impossible under Italian law, where 70 % had to be carried out by the main contractor itself. So, where the Italian rule effectively removes 70% of the public procurement market of large contracts from SMEs, the same cannot be said of the Norwegian rule. This is a major difference between the Norwegian and Italian limitations.

 

ESA does identify that the Italian provision “limited the proportion of the contract which could be subcontracted”, but ESA does not appear to see, or does not find it of relevance, that the consequence of such a 30 % proportional limitation is that 30 % of the public procurement market is made unavailable to SMEs.

 

The third important difference between the Norwegian and Italian rule, is that the Norwegian rule, unlike the Italian, has exceptions. Norwegian contracting authorities can accept longer supply chains in construction and cleaning contracts when it is “necessary to ensure adequate competition” and where unforeseen circumstances mean that more links are necessary for the contract to be performed. ESA dismisses the relevance of the second since it only addresses practical issues. ESA dismisses the first, since the condition for the exception is “to ensure adequate competition”. ESA means that the condition for the case-by-case assessment should not be conditioned upon the necessity of “adequate competition”, but on the necessity to achieve the objective of the restrictive measure, i.e. to combat work related crime. I agree with ESA that such an exception would better encompass the elements of the EU/EEA proportionality test. In the overall proportionality assessment however, I mean that the case-by-case possibility adds to the conclusion that the Norwegian limitation is in accordance with the proportionality principle in Article 18 of the directive.

 

Conclusion

 

The procedure is still ongoing between ESA and Norway. ESA required more information from Norway on the applicability of the exception, which was provided by the Government in mid-February. ESA is now assessing whether to file an infringement procedure before the EFTA court. Given the uncertainty ESA’s position has stirred up, at least in the EFTA-states, and especially among municipalities and labour unions, we can hope ESA actually files a lawsuit – and loses.

 

* The Report is by the Executive Agency for Small and Medium-sized Enterprises, published 4 June 2020, page 63-64. The report was updated in September 2020, where it is stated on page 63: “This updated version of the report omits a paragraph on subcontracting elements of this practice, which was included in the original version. The paragraph has been removed pursuant to doubts which arose with respect to the lawfulness of such elements.”

 

Photo credit: Erik den yngre, via Wikimedia commons