Legal assessment of horizontal and vertical cooperation under the Public Procurement Act

Public Sector Cooperation: When Can You Skip a Procurement Procedure?

These mechanisms represent legal exemptions that, under precisely defined conditions, allow public contracting authorities to conclude contracts for supplies, services, or construction work without the need to conduct a standard procurement procedure.

It is crucial to understand that these are not legal loopholes, but fully-fledged legal instruments that codify practices verified by European legislation and case law. Vertical cooperation, also known as in-house awarding, is based on a hierarchical principle where the contracting authority awards a contract to an entity it directly controls. Horizontal cooperation, on the other hand, operates on a partnership basis, where two or more independent contracting authorities join forces to achieve a common goal.

Although the main objective of the law is to ensure the widest possible economic competition, the legislator has recognised that forcing public entities to compete for services they can effectively provide internally or in mutual synergy is uneconomical and administratively demanding. It is at this point that a key tension arises between the principle of transparency and the need for efficiency.

However, the correct assessment and setup of these models are critically important. Our Prague-based lawyers at ARROWS daily encounter cases where even a minor inaccuracy in interpreting the law or underestimating one of the conditions has led to fatal consequences in the form of invalid contracts and high penalties from the Office for the Protection of Competition (ÚOHS).

Vertical Cooperation (In-House): Do You Manage the Supplier Like Your Own Department?

Vertical cooperation, or the in-house exemption, is defined in Section 11 of the Public Procurement Act (PPA). It allows a public contracting authority (such as a city, region, or ministry) to award a public contract directly to a legal entity (typically a municipal company or state-owned enterprise) that it controls. For this procedure to be legal, three strict conditions, originating from the landmark judgment of the Court of Justice of the EU in the Teckal case, must be met cumulatively, i.e., simultaneously.

The Control Condition: What Does Control "Like Over Its Own Departments" Mean?

The first and most important condition is that the contracting authority controls the supplier in a manner similar to its own internal organisational units. This is not just about owning 100% of the shares or stakes. Case law and methodological guidelines emphasise that the contracting authority must have a decisive influence on the strategic objectives and significant decisions of the controlled person. In practice, this means the ability to appoint and dismiss statutory bodies, approve the strategic plan, budget, and key investments.

The No Private Capital Condition: Zero Tolerance

The second condition is categorical: there must be no direct capital participation of a private person in the controlled legal entity. Even a single share held by a private entity automatically disqualifies the use of the in-house exemption. The aim of this rule is to ensure that all activities of the controlled entity are directed exclusively towards fulfilling public interests, not generating profit for private investors.

The Activity Share Condition: More Than 80% for the Contracting Authority

The third condition requires that more than 80% of the total activity of the controlled person is carried out in the performance of tasks entrusted to it by the controlling contracting authority (or multiple authorities if they control it jointly). According to Section 13 of the PPA, this share is calculated as an average over the last three accounting periods. If the company was established more recently, it is sufficient if compliance with this condition is plausible, for example, based on business plans.

The key concept here is 'entrusted task'. It cannot be any commercial activity. It must be activities related to the fulfilment of the public law duties and objectives of the contracting authority itself, such as ensuring waste collection, operating public transport, or managing municipal property.

A recent amendment to the PPA, effective from 16 July 2023, redefines the Czech Republic as a single public contracting authority and its ministries and other organisational units of the state (OSS) as its 'operational units', fundamentally changing the rules of the game at the state level.

While it was previously difficult for a state-owned enterprise established by one ministry to provide services to another ministry under the in-house regime, the new regulation theoretically opens the door for broad inter-ministerial cooperation. However, this creates a new legal situation, not yet tested by case law, full of interpretative ambiguities, especially regarding who exactly exercises the decisive control on behalf of the 'state'.

Assessing whether your organisation truly exercises 'similar control' or whether a subsidiary's activity correctly meets the definition of an 'entrusted task' is a frequent subject of disputes. The lawyers at ARROWS will prepare a detailed legal opinion for you, which, based on an in-depth analysis, minimises the risk of being challenged by the ÚOHS.

Horizontal Cooperation: A Partnership of Equal Entities in the Public Interest

An alternative to the hierarchical in-house model is horizontal cooperation, regulated in Section 12 of the PPA. This involves a partnership between two or more independent public contracting authorities who decide to combine their resources and capacities to jointly provide a public service. This model, based on the CJEU's case law in Commission v. Germany (the so-called Hamburg case), is not based on control but on genuine cooperation. Here too, however, three cumulative conditions must be met.

Cooperation Towards a Common Goal

The contract must establish or implement genuine cooperation for the purpose of achieving common objectives related to their public duties. It must not be a disguised form of service purchase, where one contracting authority merely pays another for performance. It must be demonstrable that all participating partners contribute to the task, whether by providing equipment, personnel, know-how, or other resources.

Governed Solely by Public Interest

All activities within the cooperation must be governed exclusively by considerations related to the public interest. Any commercial character or attempt by one partner to profit at the expense of another is excluded. Remuneration for mutually provided performances should only cover actual and justified costs.

Market Activity Limit: Less Than 20%

Each of the participating contracting authorities must perform less than 20% of its activities covered by the cooperation on the open market. This is a crucial and often misunderstood difference compared to vertical cooperation. 

While the in-house test looks at more than 80% of the controlled company's total turnover, here the 20% limit applies only to the relevant segment of activity. Thus, if two municipalities cooperate on waste collection, the 20% limit is calculated only from their activities in the waste management sector provided to third parties, not from their total budgets.

The line between genuine 'cooperation' and a disguised 'public contract' is thin, and crossing it has fatal consequences. The lawyers at ARROWS specialise in drafting contracts that clearly define the common goal, cooperation mechanisms, and mutual contributions of all parties, ensuring the entire structure can withstand even the strictest scrutiny.

Vertical vs. Horizontal: Which Model to Choose and Avoid Mistakes?

The choice between the vertical and horizontal models depends on the specific situation, goals, and structure of the participating entities. A wrong decision at the beginning of a project can lead to its complete failure. Here is an overview of the key differences to help you navigate:

• Relationship of Entities:

• Vertical: A hierarchical relationship (controlling and controlled). Ideal for contracting authorities (city, region, state) who want to procure services through companies they own (technical services, transport company, state-owned enterprise).

• Horizontal: A partnership relationship of equal entities. Suitable for cooperation between municipalities on a joint project (e.g., shared IT centre, joint energy purchasing, regional waste management).

• Private Capital Participation:

• Vertical: Strictly prohibited in the controlled person.

• Horizontal: Possible if the entity with private participation is itself a public contracting authority under Section 4(1)(e) of the PPA. However, this aspect increases the risk of scrutiny.

• Calculation of Activity Share:

• Vertical: The controlled person must perform more than 80% of its total activity for the controlling contracting authority.

• Horizontal: Each partner must perform less than 20% of the activities covered by the cooperation on the open market.

Choosing the wrong cooperation model is one of the most common and costly mistakes. Let our experts at ARROWS advise you on which model is not only legally safe but also strategically the most advantageous for your specific project.

Consequences of Incorrect Procedure: Invalidity of Contracts, Fines, and Criminal Liability

Underestimating the strict conditions for vertical or horizontal cooperation is not just an administrative error. The consequences can be devastating for the organisation and its responsible persons. The ÚOHS has extensive powers in these cases and acts very strictly, as it considers the unauthorised use of an exemption to be a circumvention of the law and a distortion of economic competition.

If misconduct is found, the ÚOHS can prohibit the performance of an already concluded contract, which in practice means its immediate termination. Furthermore, there is a risk of financial penalties of up to 10% of the contract price. Given the value of public contracts, these fines can easily run into millions or tens of millions of crowns.

The most serious risk, however, is personal criminal liability. Conduct that meets the criteria of unlawfully favouring a particular supplier can be classified as a criminal offence. 

Specifically, this refers to arranging an advantage in the award of a public contract (Section 256 of the Criminal Code) or collusion in the award of a public contract (Section 257 of the Criminal Code). In such cases, criminal prosecution is a risk not only for statutory bodies but for all persons involved in the decision-making process.

Our lawyers will not only guide you through the process of setting up the cooperation but, in the event of an inspection, will effectively represent you in proceedings before the ÚOHS and subsequently before the administrative courts. Our experience from dozens of such proceedings is a key advantage and protection for our clients.

ARROWS: Your Partner for Effective and Secure Cooperation in the Public Sector

Vertical and horizontal cooperation are valuable and effective tools for implementing public projects. However, their legal complexity and strict conditions require top-tier legal advice to prevent their advantages from turning into a nightmare of penalties and criminal prosecution. At ARROWS, we have long-standing and profound experience with this issue.

Whether you need a legal opinion to assess compliance with conditions, the preparation or revision of cooperation agreements, the drafting of internal procurement directives, or representation before administrative authorities, our team is fully at your disposal. We provide expert training, including certification, for your employees and management, teaching them to recognise risks and correctly apply the law in practice.

Our services are used by more than 150 joint-stock companies, 250 limited liability companies (s.r.o.), and 51 municipalities and regions, who rely on our speed, precision, and deep knowledge of the subject matter. Thanks to our international network, ARROWS International, we can also effectively handle cross-border projects with a European element. 

But we are not just lawyers. Thanks to our extensive client network, we can connect you with interesting business or investment partners. We are also happy to listen to your business ideas.

Are you planning a project and considering using vertical or horizontal cooperation? Don't take risks. Contact us and arrange a no-obligation consultation. Together, we will find the best and safest solution for you.