Procurement: PPN 01/22 - Contracts with suppliers from Russia and Belarus

On 28 March 2022, the Cabinet Office published Procurement Policy Note “PPN 01/22- Contracts with suppliers from Russia and Belarus” (the PPN). 

The explicit aim of the PPN is to encourage public sector contracting bodies, where lawfully possible, to break contractual ties with Russian or Belarusian based entities in order to effect economic sanctions following the recent Russian military invasion of Ukraine. The PPN is aimed at both ‘In-Scope’ bodies (such as Central Government Departments, their Executive Agencies, and Non-Departmental Public Bodies) who are required to implement the guidance with immediate effect, and other public sector contracting authorities who should consider its application.

It must be noted that the PPN is not currently applicable to public bodies for whom Section 17 of the Local Government Act 1988 applies. This is due to their obligation to exercise their functions without reference to non-commercial matters such as the location or country of origin of a supplier. The Department for Levelling Up, Housing and Communities is currently considering amendment of this section via secondary legislation to provide an exception.

The PPN should be applied by In-Scope Organisations with immediate effect to both above and below threshold contracts, where it is “relevant and proportionate” to do so.

What immediate action must In-Scope organisations take?

In-Scope organisations must:

• Review their contract portfolio and identify any contracts where the prime[1] contractor is a Russian or Belarusian supplier. The focus should be on major contracts and those which could have the most impact and influence on the Russian or Belarusian regimes.

Such a supplier is defined in the PPN as:

1. an entity constituted or organised under the law of Russia or Belarus; or
2. an entity registered in the UK or with substantive business operations in the UK, or another country but controlled by an entity based in Russia or Belarus (e.g. a parent company or by ‘Persons of Significant Control’)

Whilst the PPN does not set out what “control” means for these purposes, the PPN FAQ document refers to  the usual corporate test for control as set out in Part 1 of Schedule 1A to the Companies Act 2006.  Accordingly, if the situation falls within part b) of the definition, the public sector contractor will be required to undertake in-depth due diligence checks (for example via Companies House or directly with the supplier[2]) to determine whether the extent of significant control hits the relevant 25% thresholds for shares or voting rights, or whether there are any rights to appoint or remove the majority of the entity’s board of directors.

• Following identification of a relevant contract, the contracting authority must consider terminating that contract (following a legally compliant process, i.e. as per the terms of the contract).
• Only terminate if an alternative supplier can be sourced in line with value for money, affordability and with minimal disruption to public services.

How should decisions to terminate be taken?

Decisions to terminate should be taken on a case by case basis.  HM Treasury consent must first be obtained for any transactions which are novel, contentious or capable of causing repercussions elsewhere. 

Contracting authorities should conduct a risk assessment in the context of effecting contract termination. Factors such as timescales, cost and complexity of switching suppliers, substitution of suppliers without terminating the contract (e.g. via novation, or similar methods), early termination payments and penalties, and the potential knock-on effects on other non-terminable contracts must be considered.  

The PPN provides example methodologies for assessing potential impact. The first considers business criticality regarding a contract termination’s impact on UK services and any potential threat to life or public wellbeing. The second considers any financial implications stemming from termination payments and penalties, and whether these would be prohibitive or counter-productive.

Of particular note is the fact that the PPN stresses the importance of detailed record keeping to cover the reasoning behind any decisions made, and to provide an audit trail for future scrutiny. Accordingly, it is clear that the application of the PPN may cause a risk of litigation, and that the Cabinet Office wishes public authorities to pre-emptively establish their defences to future challenges from sanctioned suppliers.

Implications

At present, it is believed the main force of the PPN will apply to public bodies linked to the energy industry; particularly those dependent on oil and gas supply. However, this is likely to also apply heavily to bodies making use of secondary products such as plastics or other hydrocarbon derivatives. Accordingly, the effect of the PPN will likely be widespread as supply chain analysis grows to identify industries reliant on Russian or Belarusian extraction or processing of fossil fuels.

Due to the nature of the industries involved, and the stated intention of the PPN being to implement economic sanctions, this may create difficult choices for public sector entities when deciding whether or not to terminate contracts. The PPN FAQ[3] provides the example of a new fixed three year energy contract with a confirmed price set below the current market price level. In this instance, termination would actually benefit the supplier in the long run as they may obtain both a contractual compensation for early termination, as well as the opportunity to sell their product to a new customer at a higher market price. Accordingly, where the best option would actually be to continue with an existing contract, public bodies need to be prepared to respond to criticism with a structured and persuasive rationale; particularly where such incidents may be subject to media scrutiny.

As a means of avoiding litigation risk, there has been consideration of councils and government entities requesting that the government implement a blanket ban on trading with certain Russian-controlled energy entities that are now based in the UK. This would aim to enable the exercise of force majeure clauses in certain contracts[4]. However, can this be regarded as a true force majeure incident where the situation has been encouraged by the public body itself? Again, this may open up further grounds for litigation, and should be considered.

If you would like to discuss this topic in more detail, please contact Emily Heard, Partner, or Rupert Simpson, Trainee Solicitor.

[1]               Although the PPN notes that contracting authorities may want to consider whether there are Russian/Belarusian subcontractors being relied upon to deliver the contract as part of the supply chain, providing a proportionate, risk-based approach is taken.  There is however no requirement to ask prime contractors to consider terminating subcontracts with Russian/Belarusian sub-contractors at this stage or to undertake full supply chain mapping.

[2]               As the PPN notes, this information should normally have been captured as part of the selection stage.

[3]               Procurement Policy Note 01/22 - Frequently Asked Questions (FAQs) (publishing.service.gov.uk)

[4]               Gazprom: UK customers face challenges to break ties - Capital Monitor