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New risks have presented themselves to developers and contractors as a result of a recent case, Faraday Development Ltd vs West Berkshire Council.

Although the judgment in Faraday was much anticipated, it has significant implications for contracting authorities and has provided developers with a number of new concerns. The Court of Appeal provided some useful guidance in its judgment, but there would appear to be a consensus that the ruling has also made the realm of public contracts more risky for contractors, with a heightened potential for them to be exposed to abortive costs and contractual liabilities. 

Declarations of ineffectiveness

Procurement law requires public bodies (such as government departments, schools, and NHS trusts) to follow strict procedures when awarding qualifying contracts. In certain circumstances, a public body’s award of a contract may entitle a third party to seek a declaration of ineffectiveness, which essentially cancels the contract. The legislation does contain steps that can be taken to mitigate the risk of a declaration of ineffectiveness, including publication of a valid voluntary transparency notice (VTN) and contract award notice (CAN).

It was held that the local authority should have complied with the public procurement regime and the VTN it published was not sufficient to remedy its failure to do so

The local authority at the centre of the Faraday case had concluded that the development agreement in question was an exempt land transaction (meaning it was not a public contract) but had, to be on the safe side, published a VTN. The basic structure of the agreement gave the developer an option to draw down land for development. If this option was exercised, the developer would be obliged to carry out approved works; if the option was not exercised, the developer would not be obliged to carry out works.

The Court of Appeal decided contracts must be considered as a whole and that a sequence of contractual arrangements (as occurred in this instance) could comprise a public works contract. It was held that the local authority should have complied with the public procurement regime and the VTN it published was not sufficient to remedy its failure to do so. The court concluded that a declaration of ineffectiveness was, in this case, the appropriate remedy.

Greater risk of challenge

Until the decision in Faraday, no English court had ever awarded a declaration of ineffectiveness and successful bidders and their advisers took comfort from this. The decision in Faraday has knocked that confidence not only by granting the declaration, but by also finding the VTN to be insufficiently clear and, as a result, useless. Add to this, the court signalled a need for greater scrutiny of public bodies’ justifications for departing from procurement legislation. 

The upshot is that successful challenges to public contract awards could be more likely in the future. As a result, contractors, funders and their advisers are being cautious, which is stalling contractual negotiation and jeopardising projects. Parties are increasingly exploring the option of public procurement indemnity insurance to mitigate the risks. 

Faraday has resulted in greater caution being exercised by developers and investors

The underwriting process for public procurement indemnity insurance has also changed as a result of Faraday. Greater emphasis is now placed on understanding the reasons why a procurement process was carried out in a particular manner, and what legal advice was obtained by the public body during the procurement process, as part of an underwriting risk assessment. 

Further, developers now appear to be assessing the risk period to be the six-month timeframe for challenge, as opposed to the shorter standstill period following publication of a VTN or CAN. Underwriters and brokers are therefore having to work with developers to understand the abortive costs and penalties that could be incurred during this period, to ensure that a developer is adequately protected in the event that a declaration is granted, and a contract made ineffective. 

In summary, Faraday has resulted in greater caution being exercised by developers and investors. With the traditional comforts relied upon by developers now gone, attention is being directed at how developers may not only protect themselves from increased abortive costs and contractual liabilities but also avoid delay and the associated additional costs.

Vanessa Babington-Monegard is underwriting counsel for CLS Risk Solutions