by Kevin Harnett September-14-2022 in Property, Construction

The New Public Works Contract Inflation Co-Operation Agreement: Is the Contracting Authority’s ‘absolute discretion’ as absolute as it appears?

The single explanatory paragraph on the Office of Government Procurement’s (the “OGP”) Capital Works Management Framework homepage states that the website has been specifically developed to “implement the key outputs of the Government Decision of May 2004 in relation to the reform of public sector construction procurement”.

Leaving aside the emphasis in 2022 on a decision made by government in 2004, the first of the three primary objectives stated by the OGP under its reform agenda is “Cost certainty at tender award stage”. In broad terms, the public works forms of contract (the “PWC”) introduced to promote this objective took the approach of minimising the extent to which changes to a contractor’s input costs could be recoverable through the price variation mechanisms in the PWC. This is not exactly news.

Rampant inflation is, however, very much in the news. In a report issued on 22 July 2022, the Society of Chartered Surveyors Ireland (“SCSI”) says that the national annual rate of construction price inflation is now running at 14%. Over an eighteen month period, the SCSI says the rate is a record 22%. While inflation remains a pinch issue, the causes have been well-rehearsed over recent months, and require no repetition.

If construction inflation is now running at 14%, but the OGP’s primary objective ostensibly remains cost certainty, how can the circle be squared? The decision by the Minister for Public Expenditure and Reform, Michael McGrath in May 2022 to introduce the ‘Inflation / Supply Chain Delay Co-Operation Framework Agreement’ (the “Framework Agreement”) appears to reflect a recognition by the State that the headline principle of cost certainty must now give some ground to the reality of commercially unbearable cost inflation.

Further guidance to the operation of the Framework Agreement is set out in the “Guidance Note: Inflation / Supply Chain Delay Co-operation Framework Agreement for use with PW-CF1 – PW-CF5”, which was issued on 13 July 2022 (the “Guidance Note”)[1].

The publication of the Framework Agreement was broadly welcomed as a good thing, on the basis that it provides some potential relief for contractors. The Framework Agreement envisages a degree of burden transfer from the contractor to the contracting authority in respect of inflation costs and supply chain delays. It is expressed to be voluntary, and decisions are made in the contracting authority’s ‘absolute discretion’.

As the Framework Agreement beds in, the purpose of this note is to explore the extent to which the voluntary and discretionary nature of the Framework Agreement might be subject to constraints which may be legally enforceable by the contractor.

 

Voluntary Nature of the Framework Agreement

There is no legal obligation or compulsion on any contracting authority to enter into the Framework Agreement.

While there may be some political will at the highest level to be seen to assist the contracting sector, it is a matter entirely up to individual employers whether they wish to engage in the process. The contractor has no apparent legal basis on which it can insist on entry into the Framework Agreement. Whether a contractor may be able to exert a degree of leverage will depend on the particular circumstances of the project, the employer involved, and the broader budgetary constraints to which the employer is subject. In that regard, there is no additional exchequer funding allocation to this initiative, and contracting authorities will need to meet the cost of any additional payments within existing budget constraints. As they do so, difficult decisions may need to be made with regard to the funding of other projects which may be in the pipeline.

While entry into the Framework Agreement is voluntary, the decision by the contracting authority about whether or not to do so is taken outside of any contractual framework. Therefore, it is arguably subject to the overriding constraints applicable to public bodies in exercising their administrative decision-making functions. In other words, there may be an argument that this decision of the contracting authority may, at least in principle, be subject to judicial review.

Whether there might be good grounds for judicial review would turn on issues such as the process by which the decision was arrived at, the existence of a legitimate expectation, and whether the decision could be argued as having been arbitrary, capricious or irrational. While the decision to enter into the Framework Agreement is discretionary, it may not be untrammelled. That being said, as a general rule, there is a high bar for the pursuit of successful judicial review proceedings.

 

Entry into the Framework Agreement may be voluntary, but is it binding?

The Framework Agreement provides a structure within which the parties can negotiate on a without prejudice basis for the grant to the Contractor of ‘Ex Gratia Relief’. Thus, the parties can engage in such negotiations without fear that their contractual positions will be undermined.

‘Ex Gratia Relief’ under the Framework Agreement means either an ex gratia extension of time due to a supply chain delay (strictly defined) or an ex gratia payment by way of contribution to an increase in the Contractor’s costs due to inflation (outside of existing entitlements under PV1 or PV2).

The meaning of ex gratia in the Framework Agreement bears further consideration. In its normal usage, the term means a payment which is voluntary and without binding legal obligation or compulsion. The Framework Agreement retains maximal discretion for the contracting authority in terms of whether to grant any Ex Gratia Relief. The Framework Agreement is explicit in stating that the mere fact of its execution does not mean that the Employer has any responsibility in relation to inflation-related costs or supply-chain delays, and does not alter either party’s rights, duties or obligations under the building contract.

One could be forgiven for asking the question: what, then, is the point of the Framework Agreement? From a contractor’s perspective, the best way to think about it is perhaps that it provides, as the name suggests, a ‘framework’ or negotiating structure within which the Employer may grant additional entitlements, but subject always to the Employer’s overriding discretion.

Once the Employer (not the Employer’s Representative) has made a decision in relation to Ex Gratia Relief, the position changes: such decisions are ‘final and binding’ on the parties. Thus, the Employer cannot arbitrarily rescind or withdraw the relief, once granted. At first glance, it is difficult to see how any decision might be challenged – as a matter of contract, the parties agree that it is final and binding against a background that all negotiations are without prejudice, and the decision about whether to grant relief is discretionary.

Notwithstanding the ‘final and binding’ nature of the decision, there is a significant clawback provision in clause 10, of the Framework Agreement, which bears quotation in full:

“… in the event that the Contractor is in breach of any of its commitments made in this Supplemental Letter and/or if any of the warranties and/or representations given by the Contractor in this Supplemental Letter are incorrect or untrue, the Employer, without prejudice to any other rights and remedies, has the right to a refund of the Ex Gratia Payment and to withdraw any Ex Gratia Extension of Time already agreed.”

The warranties under the Framework Agreement are sweeping, including a general warranty that the Contractor remains compliant with its obligations under the contract. In the context of the standard form PWC, this can be a tall order. The broad potential for clawback is, from a contractor’s perspective, worrisome, particularly where the asserted refund of ex gratia payments has the potential to be set off against other sums due to the contractor. The otherwise ‘final and binding’ nature of the decision is, in this regard, provisional, and subject to rigorous contractual adherence on the part of the contractor.

On its face, this is an onerous provision, which raises a question as to whether it could be construed as an impermissible penalty, on the basis that it is difficult to see how it could be said to meet the test of constituting a genuine attempt by the parties to pre-estimate the loss which will result from the breach.

 

Is the Employer’s Discretion Absolute?

The intention of the Framework Agreement is undoubtedly to this effect. Clause 6 provides that the parties will share any applicable inflation costs “with the Employer bearing such amounts as it considers, in its absolute discretion, appropriate but in any event, no more than 70% of the approved inflation costs”.

The Employer has an ‘absolute discretion’ whether to grant relief, and if it decides to do so, the range of decision-making (from 0 – 70% of applicable inflation costs) is broad. Given that the entire process is structured as discretionary, it is not clear whether there would be any difficulty with the Employer making a decision to grant more than 70% relief.

It can readily be anticipated that contractors will in some cases be aggrieved at the decisions being made by contracting authorities. There may be scenarios where a contractor, rightly or wrongly, views a decision as harsh, unreasonable, unfair or out of keeping with the contractor’s expectations. A question naturally arises as to whether there are any legal remedies open to contractors who find themselves in that scenario.  

 

Potential Grounds for Challenge

On its face, the existence of a contractually agreed ‘absolute discretion’ makes for a gloomy outlook for contractors. However, there is an argument, based primarily on UK case law, that the contracting authority’s discretion might not be so absolute as first appears.

The decision of the UK Supreme Court in Braganza v BP Shipping Limited[2] (“Braganza”) gives rise, in the context of the exercise of contractual discretion, to a duty on the decision-maker to exercise its discretion in a manner which is informed by the absence of arbitrariness, capriciousness, perversity and irrationality. This has come to be known as the ‘Braganza duty’ (or duty of rationality) and the courts will consider two issues when considering whether the duty has been fulfilled:

  1. Did the decision-maker neglect or refuse to take something into account that they should have taken into account, or conversely, did the decision-maker consider something that was irrelevant?
  2. Was the decision so perverse that no reasonable person, acting reasonably, could have made it, even though the decision-making process itself could not be faulted?

In a contractual context, terms like ‘capriciousness’, ‘perversity’ and ‘irrationality’ may seem unusual. They are more typically associated with the grounds for judicial review of discretionary decision-making by public bodies (see above). Braganza effectively imports a judicial review standard into a contractual context to allow a challenge to the exercise of a public body’s decision-making discretion.

This resonates with our scenario under the Framework Agreement. A number of further factors were emphasized in Braganza and in subsequent UK case law as giving rise to the duty:

  1. Where a party, who was charged with making decisions which affected the rights of both parties to the contract, had a clear conflict of interest. Again, that resonates with the Framework Agreement, where, in a direct economic sense, the contracting authority’s interest is in minimising its outlay. The fact that the Framework Agreement does not use the standard contractual mechanism of determinations being made by the Employer’s Representative – which would have mitigated the conflicts issue – might be considered a further bolster for the argument that a Braganza duty ought to be imposed. (That being said, one can readily see the difficulties an Employer’s Representative would face in trying to reach a decision on whether to grant relief, given the lack of any objective contractual criteria to follow.)
  2. Where the party exercising the discretion has a range of options it can impose on the other.[3] Under the Framework Agreement, the contracting authority has a burden sharing option of anywhere between zero and 70%.
  3. Where one party to the contractual relationship has significant autonomy over the relationship. The structure of the Framework Agreement is on a ‘take-it-or-leave-it’ basis, with no scope for the contractor to negotiate the terms.

It does not appear that the Irish courts have decided whether the Braganza duty arises in this jurisdiction, or indeed that Braganza has been considered.

While the Court of Appeal in Ireland has held that there is no general implied duty of good faith in contract[4], in the specific context of bank lending the Irish courts have given some consideration to the narrower question of whether the exercise of an ‘absolute discretion’ is subject to any external constraints. It appears to be accepted by the Irish High Court in Grant v Laois County Council[5] (“Grant”) that the existence of a variable interest rate term is subject to an implied contractual term that it will not be exercised “dishonestly”, for an improper purpose, capriciously or arbitrarily.

This principle is very similar to the principles set out  in Braganza. It is also striking how closely the scenario of the Framework Agreement mirrors the context in which the Braganza duty was said to arise.

 

Conclusion

Collectively, the decisions in Braganza and Grant give rise to a strong argument that, in exercising its ‘absolute discretion’ under the Framework Agreement, the contracting authority is subject to an obligation not to do so irrationally, arbitrarily or capriciously. What might amount to arbitrary or capricious use of that discretion will depend on the particular circumstances of the project at the time. In making its decision, the contracting authority should be obliged to take into account relevant considerations, and exclude any irrelevant considerations.

There are wider open questions about whether (a) an outright decision by a contracting authority to refuse to enter into a Framework Agreement might be a decision which is judicially reviewable under the usual criteria for such review, and (b) the constraints of procurement law might operate as any kind of brake on the process [6].

Given the amounts at stake, these questions stand a fair chance of finding answers in the months ahead.

 

A way forward?

Inevitably, the introduction of the Framework Agreement raises a broader long-term question about the appropriateness of the current distribution of supply chain and cost inflation risk under the PWC. The public sector wants certainty, but the voluntary, and therefore precarious, nature of the Framework Agreement introduces fresh uncertainty. It raises, but does not answer, the question of whether cost certainty should be an overriding objective of the exchequer. If the price of that cost certainty is a significant financial destabilisation of the contracting supply chain and a potential flight of high quality contractors from public sector tendering, there is a broader debate to be had about whether a more fundamental overhaul of burden sharing is overdue.

 

[1] The guidance was originally issued in May 2022, with minor typographical errors corrected in the version issued in July 2022.

[2] 2015 UK SC 17.

[3] BHL v Leumi ABL Limited [2017] EWHC 1871 (QB).

[4] Flynn v Breccia [2017] IECA 74. This arose in the context of a shareholders’ dispute.

[5] [2019] IEHC 185, citing the English case of Paragon Finance plc v Nash [2002] 1 WLR 685.

[6] For example, regulation 72 of the European Union (Award of Public Authority Contracts) Regulations 2016 sets out constraints on the extent to which contracts can be modified during their term.

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