In late September, the Advocate General of the European Court of Justice issued a proposal for a decision in case C-578/23. The case concerns the right to directly award a contract to an existing IT supplier as a result of the so-called “lock-in” effect. Lock-in effect refers to the situation where the contracting authority is bound to continuing using products or services from a particular supplier.

Such a lock-in effect typically arises due to factors such as intellectual property rights and/or high switching costs, or other technical risks. In practice, it is not uncommon for the contracting authority to have invested substantial amounts of time and money in implementing an IT system in their operations. The benefits from these investments often materialize well into the contract period, once the system has been properly implemented and users have gained sufficient competence and experience in using the system. Additionally, the system is often integrated with various internal and external systems of the contracting authority. Consequently, changing systems will entail significant costs in terms of restructuring, even if it is technically and theoretically possible to do so. Nonetheless, an actual lock-in and dependence on the existing supplier has occurred. 

According to the Advocate General’s opinion, if the contracting authority itself has caused this lock-in effect, there will be no basis for directly awarding the contract to the existing IT supplier. In our view, the Advocate General establishes stringent requirements for the actions that the contracting authority must undertake to alleviate a self-induced lock-in effect and facilitate competition.

If the European Court of Justice follows the proposal from the Advocate General, it implies that the requirements placed on the contracting authority when procuring IT services will become even more stringent. Moreover, it is likely to pose several challenges for the contracting authorities when there is a need to purchase operation, maintenance and further development of existing systems. In practice, it is likely that, the threshold for when lock-in justifies additional purchases from existing suppliers without competition will be raised.

What was the case about?

In 1992, before the Czech Republic joined the EU, the Czech Ministry of Finance directly procured an IT system for tax administration from IBM without conducting a competitive procurement process. After the warranty period for the system expired in 2016, the Czech tax authority (GTD) awarded a new maintenance contract directly to the existing supplier, IBM.

The new contract was awarded through the negotiated procedure without prior publication of a contract notice, pursuant to Article 31 of the former Public Procurement Directive (Directive 2004/18/EC). This provision allows for the direct award of a contract when, due to technical or artistic reasons or the existence of an exclusive right, the contract can only be performed by a specific supplier. A more or less similar provision can be found in Article 32 of the current procurement directive (Directive 2014/24/EU). In Norway, this provision is implemented in the Procurement Act section 13-4 letter b – the so-called sole-supplier exception.

In this case, GTD believed that, due to IBM’s exclusive rights to the source code, the maintenance services could only be performed by IBM.

The key question in the case was whether the exemption provision could be invoked when it was the contracting authority itself that, through the initial conclusion of the contract with IBM, was responsible for the exclusivity.

The Advocate General’s assessment

The Advocate General concludes that there was no permission to directly award the contract. The Advocate General firmly asserts that exclusivity cannot justify a competitive negotiation procedure without prior publication when the contracting authority itself has caused the lock-in effect.

Even though the present case was to be decided according to the previous procurement directive, the Advocate General still refers to the current directive. Article 32 of the current directive explicitly states that this procedure without prior publication can only be utilized “when no reasonable alternative or substitute exists and the absence of competition is not the result of an artificial narrowing down of the parameters of the procurement “. Additionally, the preamble to the Directive (paragraph 50) states that this provision only applies “where the situation of exclusivity has not been created by the contracting authority itself with a view to the future procurement procedure“. The Advocate General states that if the case had been decided in accordance with the 2014 Directive, it would have been evident that the conditions were not met.

Furthermore, the Advocate General concludes that the same requirements must be applied to procurements conducted under the 2004 Procurement Directive, even though this is not explicitly stated in the directive itself: The lock-in effect that existed in this case could not justify the direct award to IBM.

The Advocate General comes to this rather stringent conclusion despite the presence of several “mitigating” circumstances.

Firstly, the procurement of the IT system was carried out prior to the Czech Republic joining the EU, and thus before the Czech Republic became subject to the EU procurement regulations. The Advocate General in principle acknowledges that GTD could not be held responsible for entering into the original contract that established the lock-in effect. However, the Advocate General is of the opinion that from the moment the Czech Republic became part of the EU in 2004 and until the procurement of the maintenance services in 2016, GTD had an obligation to take measures to alleviate the dependence that had arisen on IBM. The Advocate General highlights several possible measures. The Advocate General for example points to acquiring the rights to the software through negotiations with the supplier, to enable other suppliers to perform maintenance services on the IT system. The contracting authority could also conduct serious investigations to determine whether there are alternative suppliers in the market capable of delivering such an IT system. Although these measures would entail increased costs in the short term, the Advocate General considered that this would result in long-term financial savings.

Secondly, GTD had made attempts to acquire the rights to the software prior to procuring the maintenance services directly from IBM but had not succeeded in doing so. The Advocate General still did not consider this effort sufficient, particularly in light of the fact that GTD had ample time over the years to take the necessary measures.

Therefore, it is difficult to interpret the Advocate General’s statement in any other manner than that once the lock-in effect has occurred, the contracting authority is obliged to investigate whether alternative suppliers can provide the IT system, i.e. replace the existing supplier. In cases where the contracting authority is unable to alleviate the lock-in effect through other means, such as acquiring software rights, it may be necessary to initiate a competitive procurement process for a new IT system.

Simply relying on the sole-supplier exception, the contracting authority cannot directly award contracts for the operation, maintenance and further development of IT systems to existing suppliers.

Takeaways

While the Advocate General’s opinions are not legally binding on the European Court of Justice’s decision, they do indicate a likely outcome of the European Court of Justice’s decision. Experience shows that the EU Court of Justice often aligns with the Advocate General’s position.

If this is in fact the case in the present case, it may at first glance appear that the decision could have an impact on the scope for entering into long-term IT contracts.

Based on our understanding, lock-in effects have been recognized in Norwegian practice as a valid basis for direct procurement, where switching costs and other risk elements also are taken into account. However, in our view, the Advocate General’s statements in practice mean that there may be a narrower scope for the lock-in effect to justify a procurement without prior publication.

Once the lock-in effect has occurred, it often becomes unrealistic for contracting authorities to acquire the rights to the software. This may be due to the high costs associated with acquiring such (usage) rights to the software or (as a general rule) due to the opposition of the supplier. In today’s market, large volumes of services are delivered as standardized cloud services, making it generally impossible to acquire software rights. When the Advocate General does not recognise switching costs as a “legitimate” lock-in, it seems that a larger proportion of IT contracts need to undergo open procurement than what we perceive is currently being practised regarding large and complex systems.

Nevertheless, we believe that it can be argued that the proposed decision must be interpreted within the context of the specific circumstances of the case, which makes it unique.

The original contract was entered into as early as 1992, and it pertained to a long-term system in the field of taxation that required frequent changes. Paragraph 18 of the proposal explicitly states that the contracting authority could have foreseen  the need for ongoing maintenance services, even after the expiry of the warranty period for the system. Therefore, the need for maintenance services, which was the subject of the new procurement in 2016, could have been addressed through options or a parallel maintenance contract within the original contract. Additionally, approximately twelve years had passed from 2004 to 2016, during which the EU directives were in force in the Czech Republic. Over such a long timeframe, it is easier to imagine that measures could have been taken to prevent lock-in effects that would lead to an even longer extension of the contract.

If the court’s decision aligns with the Advocate General’s proposal, it will require contracting authorities to provide greater clarity regarding the entire life cycle of an IT system in their contract(s). They will also need to actively manage and mitigate lock-in effects throughout the contract period. The possibility of awarding new contracts to existing suppliers could conceivably become somewhat more limited, at least when it comes to needs that the contracting authority could and should have foreseen.

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