Taking Control of In-house Procurement

– A guiding penalty proposal from the Finnish Competition and Consumer Authority

D&I Alert

Posted on

6 Jun

2023

Dittmar & Indrenius > Insight > Taking Control of In-house Procurement

On 23 May 2023, the Finnish Competition and Consumer Authority proposed that the Finnish Market Court would intervene in a direct procurement by the Wellbeing services county of Vantaa and Kerava. According to the Authority, the Wellbeing services county’s procurement of HR services without tendering from Sarastia Oy was an illegitimate direct procurement, as the conditions for an in-house procurement were not met. With its enforcement action, the Authority seeks to clarify guidelines regarding the assessment of whether a contracting authority can be considered to exercise joint control in a separate entity, and hereby clarify when procurements from companies in which contracting entities have holdings are actually in-house.

In-house procurement – control of an in-house entity is essential

To tender or not to tender – that is the question public authorities and other contracting entities face when they are planning to procure almost anything. The question becomes even more complex when a contracting entity has holdings in a separate company and wishes to procure a product or service from that company. The Finnish Act on Public Procurement and Concession Contracts (the “Procurement Act”) does not mandate a competitive tender for in-house procurements between contracting entities and their affiliates. However, as the line between and in-house procurement and external purchases is not always that clear cut, it can be challenging to recognise when the in-house procurement exemption is at hand.

There are three conditions relating to a contracting entity’s affiliate that must be met for the affiliate to constitute an in-house entity within the meaning of the Procurement Act. An affiliate is regarded as an in-house entity where it is formally separate and independent from the contracting entity and does not perform a large part of its business operations with other parties than the contracting entity. Furthermore, the contracting entity must exercise a “controlling interest” in the affiliate, meaning that the contracting entity must have decisive influence over the affiliate’s strategic objectives and important decisions. A controlling interest can be exercised jointly with other contracting entities. In such cases, the affiliate’s executive organs must consist of representatives from all the controlling contracting entities, and they must jointly exercise decisive influence in the affiliate. Moreover, the affiliate must act in the interests of all the entities controlling it.

The Procurement Act does not define “controlling interest”, “decisive influence”, or the relevant degree of influence on decisions or presence in executive organs. Several focal aspects of these concepts are hereby left to contracting entities for self-assessment.

The Finnish Competition and Consumer Authority aims to clarify the concept of a controlling interest

On 12 January 2022, the Wellbeing services county of Vantaa and Kerava (the “Wellbeing County” or the “County”) acquired 1500 shares in Sarastia Oy (“Sarastia” or the “Company”) and ratified the Shareholders’ Agreement (the “SHA”) between Sarastia’s shareholders. Pursuant to the acquisition, the Wellbeing County came to hold 0.04 percent of the total shares in Sarastia and became one of its 290 shareholders. In May 2022, the Wellbeing County accepted an indicative offer from Sarastia for HR services, and in December of the same year, the Wellbeing County decided to purchase, without tendering, HR services from Sarastia for a period of four years for a total price of approximately EUR 9.3 million. In January 2023, the two parties concluded a framework agreement to that end. The Finnish Competition and Consumer Authority (the “FCCA”), the authority responsible for monitoring public procurement practises, received a complaint in November 2022 from the Confederation of Finnish Industries and three other organisations concerning the Wellbeing County’s procurement from Sarastia.

During the proceedings, the Wellbeing County argued that there were several different organs through which it could influence Sarastia’s decision-making, most importantly Sarastia’s General Assembly (the “GA”), its Board of Directors (the “Board”), and the so-called Advisory and Nominating Committees, through which the County could both advise Sarastia’s Board members and propose Board members to the GA for nomination. According to the County, all Sarastia’s shareholders were able to exercise control in Sarastia through the Advisory Committee and the GA. The County argued that “control” does not presuppose a board seat or actual control of an entity, but merely the possibility thereto.

The FCCA was not sympathetic to these arguments. Regarding the Nominating Committee, the FCCA found that neither the SHA nor Sarastia’s Articles of Association guaranteed that the Committee members represented all shareholders. The County had not even had a representative in the Committee. In addition, the FCCA found that the County had not participated in the proposal or choice of any of Sarastia’s Board members. Even though the SHA stated that the Board members were to promote the interests of all the shareholders, the SHA had no stipulations on how all the shareholders could in fact influence the Board’s executive powers. The FCCA stated that the mere possibility to engage in discussions with the Board members did not constitute sufficient influence, especially since the reconciliation of the 290 shareholders’ interests was practically impossible. In practice, the interests of minority shareholders like the County were accommodated only if they happened to correspond to those of the major shareholders. Sarastia’s five largest shareholders held a combined share of approximately 52 percent of Sarastia’s shares, while there were approximately 200 shareholders that had a holding of less than a permille.

Furthermore, while the purpose of the Advisory Committee was to propose matters to the Board that would be dealt with by the GA, and each shareholder, regardless of the extent of her holdings, was guaranteed one vote in the Committee, the FCCA considered that the Committee did not guarantee the shareholders sufficient control of the Company. The Committee did not exercise control, but was, according to the FCCA, merely an attempt at establishing control for all the shareholders within the meaning of the Procurement Act. One of the decisive factors was that the Committee could only make non-binding proposals to the Board, while the ultimate decisions were taken by the Board.

Finally, the FCCA was not convinced that the County had a real, concrete possibility to exercise control through the GA. It concluded that the mere ownership and the corresponding right to vote in the GA could not establish an in-house relationship. The fact that some decisions belonging to the Board’s discretion had been transferred to the GA did not affect the assessment.

Thus, based on an overall assessment, the FCCA concluded that Sarastia was not an in-house affiliate of the Wellbeing County, since the latter had not exercised, and did not have a possibility to exercise, on its own or jointly with the other shareholders, control in the former. The FCCA considered that the procurement constituted an illegal direct procurement, and, on 23 May 2023, issued a proposal to the Finnish Market Court to shorten the agreement period to expire within 12 months of the Market Court’s eventual judgment and order the Wellbeing County to pay a penalty fine of EUR 1 000.

Potential implications of the FCCA’s assessment – when is an in-house entity controlled?

This is only the second time that the FCCA has taken a stance on the condition of control in relation to in-house procurements. In 2018, the FCCA proposed that the Market Court would order the Town of Pargas to pay EUR 200 000 in penalties for an illegal direct procurement from a company in which Pargas had a shareholding of 0.12 percent. While question of the status of in-house entities were not in focus in the case, the FCCA explicitly stated that Pargas did not exercise control in the company, as it had no representatives in the company’s organs.

Due to the lack of definitions of “controlling interest” and “decisive influence” in the FCCA’s decisional practice, the FCCA justified a symbolic fine in the case of the Wellbeing County of Vantaa and Kerava with the uncertainties concerning control required for in-house procurement. However, the FCCA noted that the Wellbeing County’s procurement was a part of a larger phenomenon resulting from a flawed and excessively broad interpretation of the in-house procurement rules. Thus, it is unlikely that the FCCA would employ a similarly lenient approach with low fines to other similar cases concerning in-house procurement in the future.

In any case, the FCCA’s fining proposal against the Wellbeing County of Vantaa and Kerava sheds some light on two aspects of how the Authority assesses the condition of control. First, while it stresses that the conditions for in-house procurement must be interpreted narrowly, the FCCA went nearly out of its way to emphasize that the assessment of control requires an overall assessment. This means that, in principle, no one aspect alone can determine whether an affiliate is an in-house entity or not, but that all relevant aspects must be considered. Second, the FCCA seems to argue that an in-house relationship presupposes not only that the contracting entities have the possibility to exercise control, but that they also in fact exercise that control. According to the FCCA’s interpretation, for an in-house relationship to exist, contracting entities must utilize their possibilities for influencing the affiliate’s conduct that is granted to them.

As the case is now pending before the Market Court, its decision will bring much needed clarity on the condition of control in in-house relationships. For example, the Confederation of Finnish Industries issued a press release where it stated that buying minimal holdings in large companies and thereafter claiming that an in-house relationship existed based on that holding is a widespread practice by the wellbeing counties. Moreover, in its 2022 annual report concerning the enforcement of public procurement rules, the FCCA said that it had received several contacts concerning procurements by wellbeing counties, and specifically mentioned in-house procurements as one of the topics for the contacts. The issue has also been reported in Finnish news outlets, latest immediately after the FCCA’s proposal in the editorial of the largest Finnish newspaper. All of this indicates that, regardless of the outcome of the case at hand, the rising attention on in-house procurements should encourage all contracting entities to not let their affiliates run on cruise control, but thoroughly ensure that the conditions set for in-house entities are met before skipping the procurement process set out in the Procurement Act.

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