The Commercial Court holds contract with public body to be ultra vires and void

In School Facility Management Ltd & Others v Governing Body of Christ The King College & Isle of Wight Council [2020] EWHC 1118 (Comm), the High Court found that a contract was ultra vires and therefore void unless written consent was given by the Secretary of State.

KEY POINTS

• A contract with a public authority will be void if that public authority entered into it without capacity to do so.
• Where there is capacity: whether a finding of public law unlawfulness constitutes a defence in private law depends on factors such as the nature of that unlawfulness and whether the private counterparty is on notice of the public law breach.
• The “major risk” identified in Credit Suisse v Borough Council of Allerdale [1995] 1 Lloyd’s Rep 315 of private institutions finding out that they have entered into unenforceable contracts rests not only with banks and other lending and credit providing institutions but also with others, such as those who lease equipment, goods or buildings to local authorities.
• In the absence of clear factual evidence showing a relationship of agency, the court will be cautious about interpreting a legal framework to create a deemed one.

BACKGROUND

In 2009, the Isle of Wight Council (the “Council”) approved a request from the Governing Body of Christ the King College (the “College”), a voluntary-aided school maintained by the Council (a “VAS”), to open a sixth form. The College did not have sufficient capital to build accommodation for this sixth form and so entered into a 15-year hire contract (the “Contract”) in 2013 with School Facility Management and others (the “Claimants”) for the construction and hire of a building and associated equipment (the “Building”). The Claimants sought, and were provided with, letters from both the College and Council which stated that the College had the ability to enter into the Contract (the “Letters”).

Financial difficulties made it increasingly difficult for the College to meet its payments under the Contract. In September 2017 it failed to make its annual payment. This ultimately led to the Claimants terminating the Contract on 11 April 2018, informing the College that it no longer lawfully possessed the Building and should cease using it.

Proceedings commenced from 8 November 2018, involving various claims and counterclaims (the main ones of which are outlined below). These were considered in a two-week trial before the Commercial Court, with Foxton J giving judgment.

JUDGMENT

Had the College contracted as the Council’s agent?

It was clear that the College had not been acting as the Council’s agent as a matter of fact. The Contract named the College as the contracting party and “numerous contemporaneous documents” indicated the same. As such, the issue was whether the relevant legal framework created a deemed relationship of agency.

The Claimants and College both argued that the College had entered into the Contract as the Council’s agent by virtue of sections 22(1) and 49 of the School Standards and Framework Act 1998 (“SSFA”). It was suggested that “such an agency was implicit” in the Council’s duty to fund VASs set out in section 22(1) SSFA. They also relied on section 49(5) and (6) SSFA to establish this relationship. Section 49(5)(b) stated that “any amount made available by a [local authority] to the governing body of a maintained school…when spent by the governing body or the head teacher, shall be taken to be spent by them or him as the authority’s agent.” However, section 49(6) added that “subsection (5)(b) does not apply to any such amount where it is spent – (a) by way of repayment of the principal of, or interest on, a loan, or (b) (in the case of a [VAS]) to meet expenses payable by the governing body under [various provisions concerned with capital expenditure]” (emphasis added).

The court rejected these arguments. The Council’s general duty under section 22(1) SSFA to support VASs did not support the view that such schools always contracted as the Council’s agent. In this instance, this was particularly so as funding for sixth form education was the responsibility of the Young People’s Learning Agency and, therefore, the Education Funding Agency, not the Council. In addition, the court held that the College and Claimants had incorrectly construed section 49 SSFA. Section 49(5) did not create an agency relationship between the College and Council and, even if it had, this would have been excluded by the exceptions set out in section 49(6) SSFA.

Did the College have the power to enter into the Contract?

The College maintained that it had not had the statutory power to enter into the Contract and, as such, it was void and of no effect. It advanced a number of arguments on this basis, the primary one being that paragraph 3 to Schedule 1 of the Education Act 2002 (“EA02”) prevented the College from borrowing money and granting security without written consent from the Secretary of State – which had not been sought in this instance. The Court agreed with the College: it considered expert accounting and valuation evidence and accepted that the Contract constituted a finance lease rather than an operating lease. It therefore fell within scope of “borrow[ing]” at paragraph 3(1) to Schedule 1 EA02 and was prohibited without the Secretary of State’s consent.

The Court set out some significant principles. Foxton J thought that it was “clear that if a public body lacks statutory power to enter into a contract of a particular kind, then it will not have contractual capacity to do so as a matter of private law” (emphasis added). However, this did not mean that any decision by a public authority which might be impugned or quashed on public law grounds would serve as a defence to private law matters. Foxton J considered the extensive case law on this point. Looking at the issue from first principles, he concluded that “public law invalidity and private law incapacity [were] not co-extensive”. Where, for instance, a public body had capacity or vires to enter into a contract but acted unlawfully in reaching its decision to contract, the contract would not necessarily be voided. This could arise, for example, where a public authority acted irrationally or for an improper purpose. The private law consequences of this public law unlawfulness would depend on factors such as the nature of that unlawfulness and whether the private counterparty had notice of the public law breach.

Misrepresentation and misstatement

The court rejected the Claimants’ claims in the tort of negligent misstatement and under section 2(1) of the Misrepresentation Act 1967. The Claimants argued that they had entered into the Contract in reliance on the Letters and, if it were found that the College did not have capacity to enter into the Contract, these Letters had not been accurate. However, the court noted that the Claimants were well-informed about the risk prior to entering into the Contract and had not relied on the statements from the Council or College. Although the court accepted that the Claimants would not have gone ahead with the Contract had the Letters not been provided, this was simply because the Letters were required to secure investment. This was not enough to constitute reliance. Ultimately, “this was not a case in which [the Claimants] looked to the College for advice on the law, or for information as to what the legal constraints on the College’s power to contract were.”

Unjust enrichment

The Claimants and College each advanced an unjust enrichment claim against the other. The Claimants argued that the College had been unjustly enriched at their expense through the retention and use of the Building. The College claimed reimbursement of the payments it had already made on the same basis. The Claimants’ claim against the College was successful but the payment was quantified at the market value of the Building which was significantly less than the value of the Building under the Contract. Conversely, the College’s claim was unsuccessful as it was subject to a change of position defence. The Claimants had already spent the sums it had received from the College to date on its financial obligations in respect of the Contract in good faith that the Contract was valid. The judge decided that it was therefore inequitable to ask the Claimants to repay these sums to the College.

COMMENT

This judgment has significant implications for the growing number of companies who engage in construction and / or hire arrangements with public bodies. This particular market has built up in response to the financial limits that are placed on public authorities seeking to make capital payments. Such arrangements are intended to allow the private company to meet the capital costs, which will then be paid back periodically by the public authority in order to ensure that it is not classified as capital expenditure. Classifying such arrangements as “borrowing” therefore exposes public bodies’ counterparties to an increased risk that they will be considered void. The market will need to consider whether arrangements will need to be structured differently in order to mitigate such risks or if they are even still possible.

More broadly, the judgment clarifies the extent to which public law defences can operate in a private law context. Foxton J has analysed in detail the wealth of (sometimes conflicting) case law in the area and his clear conclusion is that only public law breaches on the basis of capacity will necessarily constitute a defence in private law: in other cases, it depends on the circumstances of the public law breach. This is a reminder of the wide-ranging implications across the board for cases which involve both private and public law issues.