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Contracting with the state – caveat!


Contracting with the state is not an easy feat and can have its fair share of challenges accompanied by legal consequences for all involved.
The global financial crisis has placed intense pressure on states to tackle major budget deficits and companies who provide goods and services to governments and state organs must be willing and able to contend with ever-changing procurement rules and regulations in this sphere.

Before dealing with the issues at hand, it is convenient to set out the relevant statutory matrix. Section 217(1) of the Constitution stipulates that when an organ of state in the national, provincial or local sphere of government, or any other institution in national legislation, contracts for goods or services, it must do so in accordance with a system which is fair, equitable, transparent, competitive and cost-effective.

Section 38(1)(a)(iii) of the Public Finance Management Act, No 1 of 1999 provides that an accounting officer for a department must ensure that the department has and maintains an appropriate procurement or provisioning system which is fair, equitable, transparent, competitive and cost-effective, thus echoing the provisions of s217(1) of the Constitution.

In a long line of decisions, the courts have found that contracts concluded in similar circumstances without compliance with prescribed competitive processes are invalid. It would seem that the rationale for nullifying these transactions is that they deprive the public of the benefit of an open and fair competitive process. Perhaps even more importantly, these statutory prescripts are aimed at ensuring accountability and good governance.

In the unanimous judgment of Marais JA in Eastern Cape Provincial Government v Contractprops 25 (Pty) Ltd 2001 (4) SA 142 (SCA), which involved the validity of two lease agreements of immovable property concluded without any reference to the provincial tender board and thus peremptory statutory prescripts, the court after outlining the applicable statutory tender requirements, said the following:

As to the mischief which the Act seeks to prevent, that too seems plain enough. It is to eliminate patronage or worse in the awarding of contracts, to provide members of the public with opportunities to tender to fulfil provincial needs, and to ensure the fair, impartial, and independent exercise of the power to award provincial contracts. If contracts were permitted to be concluded without any reference to the tender board without any resultant sanction of invalidity, the very mischief which the Act seeks to combat could be perpetuated.

Turquand rule

Some litigants have, (unsuccessfully) advanced the argument that persons contracting with a company or state and dealing in good faith may assume that acts within its constitution and powers have been properly and duly performed, and are not bound to enquire whether acts of internal management are regular. The gist of the argument is advanced under the rubric of the Turquand rule.

In the Contractprops case, the court said the following:

This is not a case in which ‘innocent’ third parties are involved. It is a case between the immediate parties to leases which one of them had no power in law to conclude and had been deprived of that power (if it ever had it) in the public interest. The fact that the respondent was misled into believing that the department had the power to conclude the agreement is regrettable and its indignation at the stance now taken by the department is understandable. Unfortunately for it, those considerations cannot alter the fact that leases were concluded which were ultra vires the powers of the department and they cannot be allowed to stand as if they were intra vires.

Similarly at paragraph 9, the court said:

As to the consequences of visiting such a transaction with invalidity, they will not always be harsh and the potential countervailing harshness of holding the province to a contract which burdens the taxpayer to an extent which could have been avoided if the tender board had not been ignored, cannot be disregarded. In short, the consequences of visiting invalidity upon non-compliance are not so uniformly and one-sidedly harsh that the legislature cannot be supposed to have intended invalidity to be the consequence. What is certain is that the consequence cannot vary from case to case. Such transactions are either all invalid or all valid. Their validity cannot depend upon whether or not harshness is discernible in the particular case.

Estoppel

In addition to the Turquand rule, some litigants have also attempted to rely on the doctrine of estoppel to enforce performance of these contracts (albeit unsuccessfully). The argument is often that the state represented to the counterparty, by conduct or otherwise, that it had complied with all statutory and internal processes including a competitive bid process. Relying on such representations, the counterparty altered its position to its prejudice and performed in terms of the agreement, so the argument goes.

In considering and rejecting of the respondent’s reliance on the doctrine of estoppel in the Contractprops case, the court said the following:

even if it be assumed in favour of the respondent that estoppel was pertinently raised in the papers (the matter came before the Court a quo by way of motion proceedings) and that all the necessary factual requirements for the doctrine to be applicable were canvassed, this is not a case in which it can be allowed to operate. It is settled law that a state of affairs prohibited by law in the public interest cannot be perpetuated by reliance upon the doctrine of estoppel.

This is such a case. It was not the tender board which conducted itself in a manner which led respondent to act to its detriment by concluding invalid leases of property specially purchased and altered at considerable expense to suit the requirements of the department. It was the department. If the leases are, in effect, ‘validated’ by allowing estoppel to operate, the tender board will have been deprived of the opportunity of exercising the powers conferred upon it in the interests of the taxpaying public at large. Here again the very mischief which the Act was enacted to prevent would be perpetuated.

Similarly, in City of Tshwane Metropolitan Municipality v RPM Bricks Proprietary Ltd 2008 (3) SA 1 (SCA), the court said the following:

Estoppel cannot, as I have already stated, be used in such a way as to give effect to what is not permitted or recognised by law. Invalidity must therefore follow uniformly as the consequence.

That consequence cannot vary from case to case. Such transactions are either all invalid or all valid. Their validity cannot depend upon whether or not harshness is discernible in a particular case.

What considerations should a party contracting with the state take into account?

By not embarking on a competitive bid process, particularly given the nature and scale of the services to be provided, including the cost implications in any case, the state is erring fundamentally.

By concluding the agreement without the approval of the employer and political principal and/or of the Cabinet or whatever the case may be, the state representative is acting ultra vires.

By concluding the agreement and incurring a liability for which there had been no appropriation, the state representative not only errs, but acts against mandatory statutory prescripts and against the constitutional principles of transparent and accountable governance.

For all these reasons, the agreement may be liable to be declared void ab initio.

CAVEAT!

Thabile Fuhrmann and Vincent Manko, Dispute Resolution practice and services, Cliffe Dekker Hofmeyr.

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