CJEU provides some clarification on functional limits to in-house exemption: no two bites of the cherry? (C-567/15)

In its Judgment of 5 October 2017 in LitSpecMet, C-567/15, EU:C:2017:736, the Court of Justice of the European Union (CJEU) has considered the limits of the in-house exemption from the procurement rules in scenarios where a contracting authority controls an in-house entity and, in turn, the in-house entity engages in activities with third parties--or, in other words, the CJEU has assessed the functional limits of the exemption in relatively complex public house situations.

The CJEU has not really followed the thrust of the Opinion of AG Campos (which was largely based on competition considerations, see here), but rather provided a clarification that focuses the assessment of the applicability of the EU procurement rules to the purchases by the in-house entity from third parties on an independent analysis of whether the in-house entity 'at the end of the public house chain' meets the definition of 'body governed by public law'. This offers some clarification that could be useful in the future, but the way the CJEU applies the tweaked test also creates new areas of uncertainty and opens up the case law to criticisms on the basis of the conflation of activities along the 'public house chain' despite setting out to avoid such conflation.

In LitSpecMet, more specifically, the CJEU considered "whether the second subparagraph of Article 1(9) of Directive 2004/18 must be interpreted as meaning that a company which, firstly, is wholly owned by a contracting authority the activity of which is to meet needs in the general interest and which, secondly, carries out both transactions for that contracting authority and transactions on the competitive market may be classified as a ‘body governed by public law’ within the meaning of that provision and if so, in that regard, what is the effect of the fact that the value of the in-house transactions may in future represent less than 90% or not the main part of the total financial turnover of the company" (C-567/15, para 23).

The case was decided on the basis of Art 1(9) of Directive 2004/18/EC but, given that its terms are largely coincidental with Article 2(1)(4) of Directive 2014/24/EU, it is of broad and future relevance. In the end, both provisions establish three cumulative conditions for the consideration of an entity as a 'body governed by public law': (a) be established for the specific purpose of meeting needs in the general interest, not having an industrial or commercial character; (b) have legal personality; and (c) (i) be financed, for the most part, by the State, regional or local authorities, or by other bodies governed by public law; or (ii) be subject to management supervision by those authorities or bodies; or (iii) have an administrative, managerial or supervisory board, more than half of whose members are appointed by the State, regional or local authorities, or by other bodies governed by public law.

In LitSpecMet, the CJEU started by reiterating its case law on the cumulative conditions that determine the status of 'body governed by public law' (paras 29-30) and on the functional and broad approach to the interpretation of the personal scope of application of EU procurement rules (para 31). Given that in LitSpecMet it was uncontroversial that the relevant entity had separate legal personality and was controlled by a contracting authority (para 32), the analysis rested on whether the entity constituted a "body established for the specific purpose of meeting needs in the general interest, not having an industrial or commercial character" (para 33).

Specific purpose of meeting needs in the public interest

In this analysis, and decoupling the different phases of the relevant test, the CJEU stressed that

34 It is clear ... that the requirement [for the entity to have been 'established for the specific purpose of meeting needs in the general interest, not having an industrial or commercial character'] must be satisfied by the entity whose classification is being examined and not by another entity, even if the latter is the parent company of the former which supplies the latter with goods or services. It is therefore not sufficient that an undertaking was established by a contracting authority or that its activities are financed by funds derived from activities pursued by a contracting authority in order for it to be regarded as a contracting authority itself (judgment of 15 January 1998, Mannesmann Anlagenbau Austria and Others, C‑44/96, EU:C:1998:4, paragraph 39).

35 In addition, it is necessary to take into consideration the fact that the use of the term ‘specific’ shows the EU legislature’s intention to make only entities established for the specific purpose (sic) of meeting needs in the general interest, not having an industrial or commercial character, the activity of which meets such needs, subject to the binding rules on public contracts.

36 Accordingly, it is necessary to determine, first of all, whether [the in-house entity] was established for the specific purpose of meeting needs in the general interest, the activity of which meets such needs before, if necessary, examining whether or not those needs have an industrial or commercial character (see, to that effect, judgment of 22 May 2003, Korhonen and Others, C‑18/01, EU:C:2003:300, paragraph 40) (C-567/15, paras 34-36, emphasis added).

Even if the drafting could have been clearer, particularly that of para 35 (which is tautological and, frankly, impossible for me to crack), the thrust of the test set out by the CJEU in LitSpecMet comes to assess the functional purpose of the in-house entity under consideration, rather than the nature of the activities it carries out. This comes to severe any intended chains of justification based on the activities in the general interest carried out by contracting authorities further up the 'public house chain' and concentrates on the purpose of the in-house entity 'at the end of the public house chain'--which must have been specifically established for general interest purposes.

This seems like the proper approach in abstract terms. However, the difficulty is that such a strict approach to the assessment of the activities of the in-house entity are likely to lead to the conclusion that it does not carry out activities in the general interest, which creates a difficult functional conundrum. This is visible in LitSpecMet where, in my view, the CJEU creates a great deal of confusion in the way it applies the test to the relevant entity in LitSpecMet in two ways.

First, in the way that the CJEU considers the purpose of the entity, which is to supply goods and services to enable its parent company to carry out the latter's activity (para 37), to be in the general interest because its "activity, in particular the manufacture and maintenance of locomotives and rolling stock and the supply of those goods and services to [the parent company], appears necessary for [the parent company] to be able to carry out its activity intended to meet needs in the general interest" (para 38).

To me, this seems wrong because the supply activity is not in the public interest, but in the interest of the parent company, which means that the entity whose classification is being examined does not meet the requirement (ie, in contravention of para 34) and because functionally it conflates the main activity of the parent company (in the general interest) with the ancillary (commercial/industrial) activity of the in-house entity 'at the bottom of the public house chain'. Otherwise, this would be tantamount to saying that a (private) supplier of the public sector carries out activities in the general interest where its supplies are necessary for a public authority to carry them out--quod non. In that regard, the test suggested by AG Campos concerning whether the in-house entity indirectly contributed to the general interest activities would seem preferable.

Second, and more importantly, the CJEU creates additional confusion when it indicates that, in the assessment of whether the in-house entity was specifically established for the purpose of meeting needs in the general interest, 

40 ... it is irrelevant that, in addition to the activities intended to meet needs in the general interest, the entity in question also carries out other activities for profit on the competitive market (see, to that effect, judgments of 15 January 1998, Mannesmann Anlagenbau Austria and Others, C‑44/96, EU:C:1998:4, paragraph 25, and of 10 April 2008, Ing. Aigner, C‑393/06, EU:C:2008:213, paragraph 46 and the case-law cited).

41      Thus, the fact that [the in-house entity] does not carry out only activities intended to meet needs in the general interest through internal transactions with [its parent company], so that [the parent company] may carry out its transport activities, but also other profit-making activities is irrelevant in that regard (C-567/15, paras 40-41, emphasis added).

Once more, with the ultimate goal of preventing an 'escape' from the procurement rules by in-house entities carrying out activities outside of the public house, this seems to me to wrongly ignore the focus previously put on the assessment of the activity of the entity whose classification is being examined. Functionally, where an entity carries out activities in the public interest and activities of a commercial or industrial nature, it makes no sense to treat all activities the same.

This is not the approach followed in the context of utilities procurement under Directive 2014/25/EU. Furthermore, in EU competition law, where entities carry out activities that represent the exercise of public powers and economic activities, their assessment is based on the severability of the activities. In my view, the same approach would be appropriate here and, even more, in keeping with the functional logic of the in-house and public-public cooperation exemptions from compliance with EU public procurement rules, it would seem that the opposite approach should be preferred--to the effect that, where an entity carries out a significant volume of its activities for the benefit of entities outside the public house, it should not be considered a 'body governed by public law' for the purposes of subjecting it to the procurement rules but at the same time, the exemption from compliance with public procurement rules in the award of public contracts by other entities in the public house should disappear. 

In other words, functionally, I do not think it makes sense to take such a strict approach to the assessment of the existence of activities in the general interest for the purpose of assessing the classification of the in-house entity as a 'body governed by public law', but rather to take a more holistic approach to the assessment of the position of the entity within the public house--ie, the entity must be either in or out of the public house.

Thus, in my opinion, the formulation of the test (and its sequencing) seems appropriate, but its application and the conflation of activities--both (i) the conflation of the activities of the controlling and the controlled entity, and (ii) the conflation of the activities in the general interest and the commercial or industrial activities of the latter inter se--is erroneous and comes to create significant confusion that muddies the waters of the intended clarification.

Needs not having an industrial or commercial character

Moreover, given that the CJEU considered the in-house entity 'at the bottom of the public house chain' to have been established specifically to meet needs in the general interest, the Court continued setting out the detailed test, and established that

43 ... in the assessment of [needs in the general interest, not having an industrial or commercial] character account must be taken of relevant legal and factual circumstances, such as those prevailing when the body concerned was formed and the conditions in which it carries on its activity, including, inter alia, lack of competition on the market, the fact that its primary aim is not the making of profits, the fact that it does not bear the risks associated with the activity, and any public financing of the activity in question.

44 ... if, with regard to the activities intended to meet needs in the general interest, the body operates in normal market conditions, aims to make a profit and bears the losses associated with the exercise of its activity, it is unlikely that the needs it seeks to meet are not of an industrial or commercial nature (judgment of 16 October 2003, Commission v Spain, C‑283/00, EU:C:2003:544, paragraphs 81 and 82 and the case-law cited).

45 That being the case, the existence of significant competition does not, of itself, allow the conclusion to be drawn that there is no need in the general interest, which is not of an industrial or commercial character.

46      In those circumstances, it is for the referring court to ascertain ... whether... the activities carried out by [the in-house entity], seeking to meet needs in the general interest, were exercised in competitive conditions and in particular whether [the in-house entity] was able ... to be guided by non-economic considerations (C-567/15, paras 43-46, emphasis added). 

I also find the formulation of this part of the test confusing, not least due to the unclear position that the existence of competitive markets assumes. As I mentioned when discussing the Opinion of AG Campos, the sole fact that the controlling entities within the public house are directly awarding contracts to the in-house entity without having to comply with the procurement rules suffices to exclude a consideration that those entities are actually exposed to the vagaries of the market because they have a captive demand from the controlling entities--which significantly insulates them from market risk where such demand is enough to absorb 80% of the entities' turnover. Ultimately, then, either there is an exemption at the level of the relationship between the contracting authority and the in-house entity, or there is an obligation to tender at that level (which then frees the otherwise in-house entity from public procurement duties). But, either way, the logic of exposition to competition in the market does not allow for both exclusions. In addition to that consideration, I think that the position of the CJEU in LitSpecMet creates additional issues.

First, it is not clear to me whether the analysis in this second step needs to be constrained to the activities "intended to meet needs in the general interest" (para 44, particularly in relation to para 40) or to all the activities of the in-house entity (as suggested in para 46?), particularly where the in-house entity carries out for-profit activities with third parties, but also carries out not-for-profit (or not fully commercial) activities with the controlling entity and/or other entities within the public house. Would profit-seeking activities with third parties (even if of a relatively small volume, say 10% or 20% of the turnover of the in-house entity) suffice to make it fall foul of the definition of 'body governed by public law'? Second, it is not clear to me how to assess whether an entity is "able to be guided by non-economic considerations". Third, it is also unclear to me whether transactions are carried out in competitive conditions where the mere existence of the in-house entity may suppress any relevant comparator. 

Ultimately, I guess that what is relevant is to try to understand the functional rationale and implications of the second part of the test. The situation here is one where an in-house entity carries out procurement activities ancillary to the activity in the general interest of its parent company (first step of the test) and, at this point, the assessment of whether its activities are competitive or not, and whether it can be guided by non-economic factors, determine the applicability of procurement rules to its purchases from third parties (second step of the test).

In my reading, that means that (a) if the in-house entity carries out its relevant activities in competitive conditions, it falls foul of the definition of 'body governed by public law' and does not need to comply with the procurement rules in its acquisitions from third parties; and (b) if the in-house entity does not carry out its relevant activities in competitive conditions and/or can be guided by non-economic considerations, then it will be classed as a 'body governed by public law' and thus obliged to comply with the procurement rules. At least (a) can be problematic in some scenarios--although (b) can also be problematic where the analysis is constrained to solely part of the activities of the in-house entity.

Regarding (a)-type situations, where the in-house entity that receives the direct award of contracts from other entities in the public house without subjection to public procurement rules carries out competitive activities, the test seems to allow it to benefit from its in-house position to compete in the market without having to comply with procurement rules in its purchases--which is functionally opposite to the restrictions on market activities of the in-house entity under Art 12 Dir 2014/24/EU (as mentioned above).

Overall consideration

I think that my uneasiness with the Judgment in LitSpecMet primarily derives from the fact that, where assessing the activities of in-house entities 'at the bottom of the in-house chain', the first part of the test ignores whether, in addition to (indirect) activities in the general interest, the entities carry out additional for-profit activities with third parties. And, subsequently, the second part of the test (potentially) concentrates on the existence of such activities (and the existence of profit goals and business risk) to exclude the non-commercial and non-industrial nature of those activities. Even if I cannot say exactly why, I sense a disconnection between both parts of the test. I will have to give this case some additional thought but, for now, I think that the CJEU would have been better off by adopting a functional approach to the in-house exemption and its limits, rather than a functional approach to the concept of 'body governed by public law', which implementation creates confusion.

New Paper on Extraterritoriality of EU Procurement Rules

I am presenting a paper on the extraterritoriality of EU public procurement rules at the research workshop "Extraterritoriality of EU Law & Human Rights after Lisbon: Scope and Boundaries", held at the Sussex European Institute on 13 & 14 July 2017.

The paper is entitled "An Ever-Changing Scope? The Expansive Boundaries of EU Public Procurement Rules, Extraterritoriality and the Court of Justice", and is available at SSRN: https://ssrn.com/abstract=3000256.

As the abstract indicates:

This paper looks at how the EU public procurement rules have shown a tendency to permanently expand their scope of application, both within and outside the EU. Inside the EU, the expansion has primarily resulted from blurred coverage boundaries and a creeping application outside their explicit scope. Outside the EU, the extraterritoriality has concerned scenarios such as the applicability of EU financial rules to procurement carried out as part of the EU’s external action in other areas (such as common foreign and security policy), or the regulatory transfer (or ‘export’) of EU procurement rules as part of trade deals—notably, the EU-Canada CETA, but also the EU-Ukraine DCFTA.

Concentrating solely on the ‘external’ dimension of the expansive scope of EU public procurement rules, in trying to explore some of the impacts of the extraterritorial effects of EU public procurement law on the legal and regulatory systems of third countries, this paper focuses on the implications that this expansion and extraterritoriality can have in terms of jurisdiction of the Court of Justice, as well as in terms of difficulties for the coordination of remedies systems in the area of public procurement. The paper concludes that the extraterritorial expansiveness of the EU’s public procurement rules is creating areas of potential legal uncertainty that deserve further analysis. Given the highly speculative nature of those scenarios at this stage, however, the paper does not attempt to provide any specific answers or tentative solutions to the issues it raises.

I intend to review the paper after the workshop and will appreciate any additional feedback that helps me improve it so, if you have the time and inclination to read the paper, please email me any comments to a.sanchez-graells@bristol.ac.uk, or feel free to post them in the comments section. Thank you in advance for any input.

A second look at the CJEU's public procurement activity--and a reflection on its implications in terms of remedies and the effectiveness of eu judicial activity

The Court of Justice of the European Union (CJEU) has now published the final version of its Judicial Activity 2015 Annual Report. The release of these final statistics on the CJEU activity for the past year provides a chance to take a second look at the evolution of procurement cases over a long(ish) time period--statistics are now available for a full decade regarding the General Court (GC) and for the period since 2010 for the Court of Justice (ECJ). A quick look at the the statistics shows a continuation of the trend of increasing backlog in this area (see here), and a closer look reveals how the backlog at the ECJ level has been deteriorating rather quickly in recent years.

There are some limitations of the statistical information that need to be stressed from the outset. First, as with previous editions of the judicial activity report (see previous comments of the 2012 and 2014 reports), having had more information on the status of pending cases would have helped gain a better understanding of the situation, particularly at ECJ level. It is still hard to understand why the GC explicitly reports on pending cases, while the ECJ does not. Second, not all cases are exactly comparable. While the activity at GC level is limited to challenges to procurement procedures carried out by the EU Institutions, the activity of the ECJ includes a mix of preliminary references (the vast majority of new cases) and appeals against GC decisions. In 2015, of the 26 new cases before the ECJ, 22 were preliminary references and 4 were appeals. This makes the assessment of the overall evolution of public procurement activity not very meaningful. Thus, I will rather discuss the evolution at the GC and ECJ level separately.

Evolution of procurement cases at GC level--what are the implications in terms of the effectiveness of remedies for eu institutions' procurement?

The GC has been managing to slightly reduce its backlog of pending cases in the last 5 years and the trend seemed to roughly remain stationary in 2015, when it opened 23 new cases and completed another 22. Provided that no cases are "left at the bottom of the pile", it would thus seem that the GC is in a position to manage and cope with its public procurement docket.

However, this should not be too surprising, given the low pressure that being the review court for all the procurement activities developed by the EU Institutions creates. According to the recent Special Report No 17/2016 of the European Court of Auditors (ECA) on EU institutional procurement (see here), the EU Institutions carried out procurement for a value of €4.2 bn in 2014. According to ECA: "In the 6‑year period from 2009 to 2014 the General Court completed 3,419 cases of which 106 dealt with public procurement by the EU institutions (3.1 %), or on average 17.6 cases per year. The 106 cases relating to public procurement gave rise to a total of 123 decisions: 66 judgments and 57 orders" (p. 44).

The Commission generally estimates that it awards more than 9,000 contracts per year. However, on average, there are less than 20 challenges of those procurement decisions per year. This would roughly indicate that less than 0.25% of procurement decisions of the EU Institutions get challenged before the GC. This is a very low caseload for a court in charge of reviewing procurement activity of a value of €4.2 bn. Searching for valid comparators is difficult because each jurisdiction organises procurement remedies in different ways and there are important cultural and practical factors that can determine very different litigation rates (going from the possible extreme of high litigation in Italy, where around 40% of the cases in the administrative courts are public procurement cases, to the UK, where there is only a handful of public procurement cases every year).

However, one gets the sense that 20 cases per year is a very low litigation rate by taking into consideration that EU Member States with similar or lower estimated procurement expenditure show more intense litigation. For example, based on the Commission's data, Bulgaria has over 1,000 cases per year (estimated procurement covered by the EU rules of €2.83 bn), Latvia has over 200 cases (€3.55 bn), Luxembourg has over 50 cases (€0.56 bn), and the Slovak Republic has over 1,000 cases (€3.98 bn). If we calculate the incidence of litigation by volume of (estimated) expenditure (covered by the EU rules), we would get the (very, very) rough measure of cases by billion Euro of expenditure. Using the information available (which is far from ideal), we can construct the table on the left-handside column.

This information should be taken with immense caution, and none of the specific figures for any of the countries of the list should be used as an indication of the actual intensity of litigation in that jurisdiction. However, I think that his serves to make the broader point that the level of litigation of procurement decisions adopted by the EU Institutions is indeed very low, at least by an order of magnitude.

The implication of this insight in terms of a potential review of the remedies mechanisms available to challenge procurement decisions by the EU Institutions--which has been advocated by ECA and should be strongly supported (see here)--is that the GC (in its current configuration and without a significant expansion of resources) is probably incapable of digesting any relevant increase of procurement litigation to a level in line with the jurisdictions of the Member States, except those with a lower intensity of procurement litigation. 

In my view, thus, it would seem advisable to explore suitable alternatives, such as the creation of a procurement review agency in charge of the oversight of the procurement carried out by the EU Institutions, the submission of the procurement of the EU Institutions to the procurement remedies system of the relevant Member State, or some other similar option--including the possibility of creating a specialised chamber within the General Court, in case the provision of additional resources to this entity was considered preferable than a more substantial reform of the remedies system.

Evolution of procurement cases at ECJ level--will a new wave of preliminary references flood the court and dampen the papers?

The ECJ has been accumulating a significant backlog of procurement cases over the last 5 years (no earlier statistics are available). What seems worrying is that, for the last 3 years, the backlog has been increasing at a pace of approximately 10 cases per year, and the total backlog at the end of 2015 trebled the level in 2010.

In view of the expiry of deadline for the transposition of the 2014 Public Procurement Package in 2016 (and even if a significant number of Member States are delayed), it seems reasonable to expect a new wave of preliminary references for the interpretation of the ever so complex new rules and their coordination with the previous case law in this area of EU economic law. Thus, it would seem reasonable to expect the ECJ to consider strategies to cope not only with the existing backlog, but also with the likely increase in referrals in the period between now and, say, 2020.

Of course, it is difficult to develop a strategy that prioritises public procurement over other areas of judicial activity, and there may be good reasons to consider other types of cases (including within EU economic law, such as tax avoidance cases) equally or more relevant or urgent. However, the advantage of procurement is that, it being a very specialistic and relatively self-contained area, it would not be too difficult to create a task force to deal with procurement cases in a swift manner. This would require an investment in human capital for a temporary period.

The European Commission did this in the wake of the financial crisis in order to deal with the increased volume of State aid cases [for discussion, see A Sanchez-Graells, “Digging itself out of the hole? A critical assessment of the Commission’s attempt to revitalise State aid enforcement after the crisis” (2016) Journal of Antitrust Enforcement, forthcoming]. The possibility of introducing similar flexibility at ECJ level could help boost the effectiveness of EU law (and public procurement law in particular) through a swifter process for the clarification of new rules that, otherwise, may remain in legal limbo for quite some time.

In terms of looking for resource to do so, of course, the elephant in the room is the issue of the cost of language management (as in translation and interpretation) at the CJEU. This is probably heretical, but I think that a reduction of the resource dedicated to language management would be the easiest and quickest way of boosting the ability of the CJEU to deal with a larger docket of legal issues. The Management Report in the 2015 Annual Report makes this overwhelmingly clear. To my mind, the fact that 37.4% of the posts at the CJEU are judicial (including Cabinets, Registries, Research and Documentation, Library, Protocol, Communication and Publications), while 51.0% of the posts are languages positions (including Translation and Interpretation), is troubling. Basically, because this heaviness of language management has the combined effect of: a) draining resource that could be put to a different use and, b) delaying the functioning of the CJEU.

Overall conclusion

It is probably not surprising that a look at the statistical information on judicial activity shows that the CJEU is not prepared for the likely developments in litigation in the area of public procurement law. It may well be overwhelmed by developments at the EU level that triggered a higher intensity of procurement litigation--should the remedies system for EU Institutional procurement be developed along the lines proposed by the European Court of Auditors; and it is most certainly in a bad position to absorb any significant increase in the number of questions referred for a preliminary ruling that results from the Member States application of the 2014 Public Procurement Package in a systematic manner.

In my opinion, the CJEU (and the EU Institutions more generally) should look for creative ways of preparing for these changes. Otherwise, the effectiveness of the EU public procurement rules may be jeopardised and/or significantly delayed, particularly concerning the interpretation of the 2014 Public Procurement Package, which is certainly not without legal controversy.