When does a development arrangement get caught as a works contract? Matthew Mo analyses the key Court of Appeal ruling in Faraday.
The Court of Appeal’s decision in Faraday Development Ltd v West Berkshire Council  provides some guidance on the thorny issue of when a land development arrangement is to be classified as a works contract, to which the public procurement rules apply. The judgment also gives a steer on the way in which a “VEAT” notice needs to be drafted in order for a contracting authority to rely on that notice to de-risk the remedy of ineffectiveness. However quite a lot of uncertainty remains.
In this first of two articles we look at when a land development arrangement falls within the definition of a works contract.
The Faraday case concerned a decision by West Berkshire Council to enter into a development agreement with St.Modwen Developments Ltd (St.Modwen) for the redevelopment of an industrial estate in Newbury, much of which was owned by the Council. Whilst the development agreement was entered into following a competitive process, it was not a procurement process run under the Public Contracts Regulations  (PCR).
The development agreement was a long-term arrangement under which the Council and St. Modwen agreed a general route map for development of the site. St.Modwen were then to prepare more detailed development proposals which, if accepted by a joint steering group, gave St.Modwen the option to draw down parcels of the land under long leases. St.Modwen were required (from day 1) to deliver some services – such as those required to develop proposals – but at the point when they entered into the development agreement they were not under an obligation to execute any works. That obligation only arose when, and if, St.Modwen opted to draw down the parcels of land.
The Court of Appeal was asked to consider whether these arrangements constituted a works contract under the PCR. The High Court had previously decided that this arrangement was not a works contract and Faraday appealed that decision.
The Court of Appeal decided that the arrangements were unlawful (the Council had committed itself to entering into a works contract) and went on to declare the arrangement ineffective because it had not been advertised and awarded in compliance with the PCR.
Why did the Court of Appeal come to this decision?
Background: It is useful to understand a bit of background, including some of the EU and UK case law leading up to this decision.
The definition of a public works contract in the PCR looks deceptively simple on the surface. It is, in summary:
- a contract for the execution, or the design and execution, of a work / works; or
- “the realisation by whatever means of a work corresponding to requirements specified by the authority” where the authority exercises a decisive influence on the type or design of the work.
In short, procurement law applies when an authority wants to get the builders in to have something built for it.
However, given the spectrum of commercial arrangements concerning the use of land, procurement law has often struggled to delineate the boundaries between contracts which fall within the definition of a works contract and those that fall outside this definition.
This is a question which has been looked at over a number of years by courts at EU and national level. Two cases were looked at particularly closely by the Court of Appeal in coming to its decision in Faraday: Müller  a decision of the European Court of Justice, and Midlands Co-op , a decision of the English High Court.
Enforceable obligations, economic benefit and decisive influence: In Müller, the European Court of Justice looked at the definition of a works contract and confirmed that in order for an arrangement to be classified as such, three elements need to be considered:
- An enforceable obligation to build - which helps to distinguish the arrangement from an independent enterprise which a developer may or may not choose to pursue
- Economic benefit - which helps to distinguish the arrangement from one where, despite there being an enforceable obligation, the resulting works are not for the authority
- A decisive influence in specifying the requirements - which also helps in the assessment of whether the works are for the authority or whether they have a more dilute, regulatory role.
The Müller case improved the tools which procurement law had to analyse arrangements and decide whether they should be classified as a works contract.
In the UK, the Müller decision was applied in the Midlands Co-Op case. This case concerned a retail-led development on the site of a community centre owned by Birmingham City Council. The development was subject to a section 106 agreement the effect of which was that if (and only if) the developer chose to exercise the planning permission, the developer had to replace the community centre on another site. The High Court placed a strong emphasis on a lack of enforceable obligation to perform the works, thereby preserving an ability for the developer to “walk away”. The High Court held, on the facts of that case, that the lack of an enforceable obligation to carry out works was sufficient for the whole arrangement to fall outside the classification as a works contract.
This leads to the question of whether procurement rules can be avoided simply by using a contractual option provision to trigger the creation of a later contract, which would otherwise be a public contract subject to the procurement rules?
In the first instance decision in Faraday, the High Court built on the principles in the Müller case. The High Court considered another test, the "main object" test, in addition to looking at the question of whether there was a legally enforceable obligation.
Main object test: The High Court decided that the development arrangement would only constitute a public contract falling within the scope of the procurement rules where (1) the “main object” of the development agreement corresponded with the definition of a public works, supplies or services contract; and (2) where there was a legally enforceable obligation on the contractor to carry out that main object. The question of what is the main object must be determined by an objective examination of the entire transaction to which the contract relates. That assessment must be made in the light of, or having regard to, the essential obligations which predominate and characterise the transaction.
The High Court concluded that the main object of the entire transaction was to facilitate the regeneration of the site and maximise income and receipts for the Council. This was a “works” object. However the High Court concluded that the contractor was not under a legally enforceable obligation to carry out works and therefore the arrangement was not a “public works contract”. It did not therefore have to be advertised under the PCR. It did not matter that the contractor was under an obligation to provide services from day 1 – the services were not the main object.
Court of Appeal - Stepping back from the detail
The Court of Appeal took a different approach. It decided that the development agreement was not a public works contract at the time when it was signed, because it did not contain any immediate enforceable obligation to carry out works. However, the Court of Appeal stepped back and looked at the transaction as a whole and decided that the development agreement was nevertheless unlawful.
This was because the longer term result of the development agreement was the procurement of a works contract without a lawful procurement procedure. The development agreement clearly did commit the Council to procuring works from a particular contractor. No further act of procurement by the Council remained to be done in order for the works requirements to crystallise into a binding obligation to deliver works for consideration. In other words, the Council had “put the matter out of its hands” and all that remained was for the developer to decide whether to trigger its option to develop. By entering the development agreement the Council effectively agreed to act unlawfully in the future.
The Court of Appeal strongly emphasised that the section 106 planning obligations in the Midlands Co-Op case constituted a very different kind of agreement. The section 106 agreement had a distinct status and role in the statutory planning scheme and, by its very nature, was not a public works contract. The development agreement in Faraday, however, was not entered into by the Council in the exercise of its planning functions.
Was it a sham?
The Court of Appeal also looked at whether the Council had deliberately and unlawfully avoided the procurement regime. The Court of Appeal, however, found in favour of the Council on this point: “It cannot be said that the underlying purpose of the option provisions in the development agreement or the development agreement as a whole was an unlawful purpose even if the development agreement itself ought to have been the subject of a procurement process.” The economic and commercial reality was fully apparent from the development agreement and had not been disguised. It was not a sham. It was not inherently unlawful for the Council to seek to achieve, if it could, a lawful contractual relationship with a developer, that falls outside of the reach of the public procurement.
Where does this leave us?
The Court of Appeal’s decision highlights the importance of reviewing the arrangements as a whole. It flags up the dangers of assuming that the procurement rules do not apply just because there is no enforceable obligation at the time the deal is signed. However, uncertainty remains as to what commercial forms of “walk-away” would be accepted by the courts as legitimately falling outside of the PCR.
The position of section 106 agreements also remains uncertain. Whilst the Court of Appeal in Faraday was at pains to distinguish the situation in Midlands Co-op, the basis for that distinction remains a little unclear. The key is to take a step back and look at the arrangement as a whole – however that type of approach inevitably leads to some grey areas.
Contracting authorities will no doubt draw some comfort from the Court of Appeal’s comments that it is not inherently unlawful to enter into arrangements that fall outside of the procurement regime. However uncertainty remains as to precisely how the three “Muller” elements should be applied – and in particular whether it is always necessary for the authority to have a decisive influence on the type or design of the works for procurement rules to be triggered.
In our second article on the Faraday decision we will look at what the Court of Appeal said about how a “VEAT” notice should be drafted, in order for a contracting authority to rely on that notice to de-risk the remedy of ineffectiveness.
 Faraday Development Ltd v West Berkshire Council EWCA Civ 2532
 Public Contracts Regulations 2015 SI no. 102 (as amended).
 C-451/08 - Helmut Müller ECLI:EU:C:2010:168
 R (Midlands Co-Operative Society) v Birmingham City Council  EWHC 620 (Admin)