Procurement case note: Stagecoach East Midlands Trains Ltd & Ors v The Secretary of State for Transport (2020)

Considering the principles of transparency and fairness in the exercise of discretion

On 17 June 2020, the High Court handed down its judgment in a case with important implications for the contracting authorities undertaking procurement exercises, Stagecoach East Midlands Trains Ltd & Ors v The Secretary of State for Transport [2020] EWHC 1568 (TCC). The case concerns claims brought by Stagecoach in respect of the Secretary of State for Transport’s (“DfT”) decision to disqualify it from bidding in the East Midlands, West Coast and South Eastern rail franchise procurement competitions because of its unwillingness to accept the DfT’s proposed risk allocation for pensions liabilities. This is a significant judgment following a judicial review rather than a procurement challenge under the procurement regulations but there are a number of points of note and important reminders for contracting authorities, including in terms of drafting procurement documents, running a procurement exercise and in making decisions in a procurement.

The High Court ruled against Stagecoach and found that the DfT’s decision to disqualify it from the competition for non-compliance on the pension liabilities was lawful.

The judgment is lengthy and covers a number of issues. We highlight the main issues here that we consider have application generally to contracting authorities and utilities running procurements.

Background

The DfT was conducting three rail franchise procurement competitions. The DfT offered contract terms which ultimately placed the risk of pension liabilities on the successful bidder. The pension issue was substantial, as the intervention by the Pensions Regulator (“TPR”) had caused considerable uncertainty about the scope of potential pension liabilities. This risk was considered a “big ticket” issue because of the sums involved and the fact that the DfT would not tolerate negotiating a re-allocation of risk.

Stagecoach determined the potential liabilities that flowed from TPR’s intervention as causing the pension risk to be unquantifiable. This led to Stagecoach’s decision to bid on the basis of an alternative risk allocation. The ITT included a broad power of discretion allowing the DfT to exclude bidders for non-compliance and the ITT made clear that if a bidder did not accept the proposed commercial terms the DfT could (may) disqualify. Some bidders accepted the commercial terms but Stagecoach did not. The DfT disqualified Stagecoach from the procurement exercise.

Proceedings were initially issued by three claimants: Arriva, Stagecoach and the West Coast Train Partnership Limited (a consortium of Stagecoach, Virgin and SNCF), but Arriva settled before the case began. The Court held that the DfT’s decision to disqualify Stagecoach was lawful including because the non-compliance on the pension issue was “sufficiently serious to merit disqualification”[1].

Judgment

1. Duty of transparency and fairness

In conducting the procurement exercise, the DfT is subject to the general principles of EU law. Stagecoach claimed the breadth of discretion provided in the ITT, which granted the DfT the discretion to disqualify a bidder for non-compliance, was “exceedingly broad”. In particular, Stagecoach sought to rely on the Law Society[2] case, which held that where the power to make an amendment in a contract is so wide that it amounts to a power to rewrite the contract then it will be unlawful.

The Court found in favour of the DfT as the terms of the ITT did not breach the duty of transparency and fairness. The DfT discretion to disqualify bidders present in the ITT was not considered a power to rewrite the terms of the contract. A contracting authority which exercises discretion which is “arbitrary or excessive” may breach the principle of equal treatment, but primarily there is a wide margin of discretion. The Court concluded that the terms of the ITT were “clear, precise and unequivocal in stating that a contractual amendment which sought to transfer risk from the franchisee to the Secretary of State would mean that the bid was deemed non-compliant[3]. Crucially, contracting authorities are granted a wide margin of discretion in determining the contractual allocation of risk.

The clear terms of the ITT meant that a “reasonably well informed and normally diligent”[4] tenderer would have realised that material non-compliance on pensions would give rise to a risk of disqualification. The Court also took into account the fact that no bidders (including the Claimant) had asked for clarification on the risk allocation, in deciding that there was no breach of the duties of transparency and fairness.

2. Allocation of risk

Stagecoach further claimed that the allocation of the pension risk breached the principles of transparency and fairness as well as the DfT’s duties under Articles 4(1) and/or 5(3) of the Railway Regulation[5] (clearly setting out the public service obligations and the nature and extent of those rights). It was argued that the scale of the uncertainty and difficulty to price the risk meant that Stagecoach was unsure of the contractual requirements and the value of the contract.

The Court recognised that the allocation of risk is one of the “key functions of any ITT”[6] and went on to clarify that there is no legal principle that limits the size of a risk which may be allocated to one contracting party or another in a public procurement. Equally, there is no principle that a contracting authority must ensure every potential bidder can bid. Bidders must deal with the commercial risks and can always decide not to bid. Although the allocation of the pensions risk was uncertain it remained a risk that could be estimated and priced.

Throughout the judgment the scale and uncertainty of the pension risk was recognised as the “monster problem” it was, but the DfT’s decision to allocate that risk did not breach any principles of transparency, fairness or relevant EU duties.

3. Proportionality

Stagecoach cited a key recommendation from the Brown Review of the Rail Franchising Programme, that franchisees should not be expected to take external macroeconomic, or exogenous, revenue risk. However, the Court was quick to confirm that it is “conventional and not intrinsically unlawful for a concession contract to allocate exogenous risks to a contractor[7].

The Court concluded that the allocation of the pension risk did not breach the principles of proportionality and fairness. The Court set a high threshold for what risk would be determined to be exogenous and reiterated the contracting authority’s wide discretion in allocating risk in a procurement.

Stagecoach claimed the scale of the pension risk would deter bidders to such an extent that it would breach the freedoms guaranteed by Articles 49 and 56 of the Treaty on the Functioning of the European Union. The Court was unsympathetic in this regard as Stagecoach was not barred from bidding on the DfT’s terms, but rather had weighed up the risks for itself and chosen not to, and the procurement competition had received substantial transnational engagement.

The Court also considered whether the DfT had more proportionate options open to it than disqualification. The Court addressed the alternative options (such as seeking a rebid or even abandoning the procurement) but concluded that the DfT’s justification in deciding to disqualify Stagecoach rather than take other options available to it was proportionate. The Court recognised the difficulty in the alternatives in terms of practicality and causing inconsistencies with the principles of equal treatment, fairness, transparency, non-discrimination and proportionality. In this case, a decision to invite rebids would have been unfair to those bidders who had been willing to accept the DfT’s proposed risk allocation on pensions.

In summary, the principle of proportionality is highly fact dependent and does not require a contracting authority to contract on the terms that are most favourable to bidders, and so the DfT did not breach its wide margin of discretion.

Additional issues arising from the judgment

Undisclosed criteria: The DfT maintained a non-compliance log during the evaluation process. The log provided for non-compliances to be rated on a scale of 1-5. Stagecoach sought to claim that the use of this log equated to an undisclosed policy or criterion for the evaluation of bids. However, the Court held that the log represented an administrative tool used for prioritising internal resources, and played no part in determining the evaluation. This serves as a useful reminder to contracting authorities to ensure that there is a rigid separation between internal administrative prioritisation tools or similar and the substantive evaluation process. This decision was very fact specific and in some senses appears to go against other decisions on disclosure of evaluation materials. We would strongly urge contracting authorities/utilities to avoid internal tools that could be considered undisclosed criteria.

Insufficient reasons for disqualification: Following the decision to disqualify Stagecoach, the DfT provided disqualification letters outlining the reasons for the decision. Stagecoach claimed that the DfT had failed to provide adequate reasons. However, the Court found the reasoning was “concise, clear and sufficient to enable the Claimants to know that they had been disqualified for serious non-compliance on pensions”[8]. Contracting authorities are reminded that reasoning provided for a decision should:

  • Make the bidder aware of the reasons for their disqualification so they can defend their rights; and
  • Enable the court to exercise its supervisory jurisdiction.

Award of pension compliant bids a breach: Finally, Stagecoach raised a collection of issues which sought to demonstrate that the DfT breached its public law duties by failing to take proper account of the pension-compliant bids’ exposure to risk and their financial robustness. The Court assessed the adoption of certain pensions figures and a commissioned report into the pension risks. The Court found that the DfT had not offended the principles of fairness and transparency by relying on these figures. Further, there is no obligation to specify what the most credible financial outcome is in advance of bids being submitted, nor is there a legal requirement to undertake a fully comprehensive financial robustness test that addresses all possible risks, “provided that the limitations of the work that was in fact commissioned were known and did not materially mislead”[9].

Comment

The judgment is quite fact specific but nevertheless will be welcomed by contracting authorities as it confirms (i) the wide discretion granted to public bodies in allocating commercial risk, and (ii) that as long as a fair and transparent process is followed then the decision to disqualify bidders remains a viable option for non-compliance. The case provides a number of practical lessons on conducting a procurement exercise and is a very useful reminder of key principles and key case law, including:

  • Allocation of risk: When preparing the terms of a procurement and the accompanying commercial terms of contracts, the decision to allocate a significant risk to the successful bidder may lead to the real risk that bidders consider that risk allocation unacceptable and choose not to bid. Allocation of risk is ultimately a strategic commercial decision for which the contracting authority is given a wide margin of discretion. However, risk allocation will be an important decision for a contracting authority: a balance between making a procurement attractive and maximising competition on the one hand and, on the other, arriving at a risk allocation that protects the authorities interests in a manner that also delivers value for money.
  • Clear instructions: Ensuring the terms of an ITT and procurement documentation are clear is crucial to ensure that bidders are in no doubt of when their bid contains material non-compliance and of the resultant consequences. In this case, the ITT contained express terms stating both that a qualified bid on pensions risk would be ‘non-compliant’, and that it was open to the contracting authority to disqualify a non-compliant bid at its discretion. Although in this case the Court did not find difficulty with the broad discretion reserved to the DfT, the general principle and advice in drafting procurement documents is to be as clear and transparent as possible in the ITT about the basis on which the contracting authority will make decisions (e.g. what factors it will take into account in exercising its discretion one way or another).
  • Reasoning: When a contracting authority prepares proof of reasons for key decisions in a procurement, it must be clear and unequivocal. In communicating reasons, it must demonstrate the reasons and reasoning followed in deciding to adopt the measure and it must have sufficient detail to enable the person concerned to defend their rights and the court to exercise its jurisdiction. The judgment is also a useful reminder that in making a procurement decision or exercising a discretion in a procurement exercise, a contracting authority/utility must keep records to demonstrate its decision-making process, that it considered alternatives and ultimately came to a reasonable decision in the circumstances.
  • Alternatives to disqualification: A common scenario faced by contracting authorities is how to proceed when faced with a bidder’s non-compliance. Contracting authorities should consider all alternatives, not least to ensure they are acting fairly and proportionately, in terms of all the bidders. Ultimately, however, disqualification may be the appropriate (and in some cases, the most reasonable) decision as long as that decision is justified by reference to the ITT and the factual matrix.

Sharpe Pritchard has a highly experienced public procurement team with an outstanding reputation for commercial and pragmatic advice on the Public Contracts Regulations, the Utilities Contracts Regulations and concession procurements. If you require any advice in relation to the matters raised in this case or anything else concerning contentious or non-contentious procurement issues, please do not hesitate to contact the authors of this article.

This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published. If you would like further advice and assistance in relation to any of the issues raised in this article, please contact us today by telephone or email  enquiries@sharpepritchard.co.uk.

[1] Para 373

[2] R (Law Society) v Legal Services Commission [2008] QB 737

[3] Para 379

[4] Healthcare at Home v Common Services Agency [2014] UKSC 49

[5] Regulation 1370/2007

[6] Para 395

[7] Para 410

[8] Para 520

[9] Para 593

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