Expanded Possibilities for Applying the Lease Exemption in Extension Projects?

Legal Starting Points

According to the lease exemption in Chapter 3, Section 19 of the Public Procurement Act (LOU), acquisitions of or rights to property, including leases, are not covered by the scope of LOU. It is not uncommon for a lease agreement to also include elements of construction work if the premises need to be constructed or adapted before the contracting authority takes possession. The contract then includes both lease and construction work, thereby constituting a so-called mixed contract under LOU. A lease agreement may also include procurement-required services. In the delineation between the lease exemption and procurement obligation, the question of the primary purpose of the contract has thus become decisive.

The lease exemption typically covers the goods, services, and construction works that are normally part of the landlord's property management, including "customary tenant adaptations" carried out by a landlord. Practice from Swedish courts has historically mainly concerned situations where authorities have sought to apply the lease exemption for buildings not yet constructed and/or premises adapted for specific operations, such as the Administrative Court of Appeal in Stockholm's cases nos. 9369-21 and 9370-21, and the Administrative Court in Stockholm's case no. 35322-21. In these cases, the lease exemption has not been applicable, contributing to widespread caution in applying the exemption. Based on the aforementioned judgments, it can be concluded that courts have so far had a restrictive view on the possibility of applying the lease exemption concerning buildings not yet constructed.

Administrative Court of Appeal in Stockholm's Judgment of February 6, 2025, in Case No. 5645-24

Background

Nacka Municipality, which leased school premises, was in need of larger premises for its educational activities. The municipality's existing lease contract was therefore terminated for renegotiation. Subsequently, the municipality signed a new contract with the same landlord, without prior advertisement, regulating both the lease of the building the municipality had previously rented and the lease of an extension to be constructed directly adjacent to the building. The municipality argued in the case that the lease exemption was applicable and that no advertised procurement was therefore necessary.

The Swedish Competition Authority sought a procurement penalty of one million kronor based on an assessment that the new lease contract had not been preceded by advertisement and thus constituted an unlawful direct procurement. It is noted that the requested procurement penalty in the Administrative Court amounted to three million kronor, but the request was reduced in the Administrative Court of Appeal due to the uncertain legal situation.

Administrative Court's Assessment

The Administrative Court found that the contract included both lease of premises and construction work, thus constituting a mixed contract. The primary subject of the contract was therefore decisive for the question of whether the lease exemption was applicable.

The Administrative Court noted that the extension to be constructed under the contract constituted a building and therefore fell within the definition of a construction contract. The court also found that the municipality's requirements for the extension meant that the municipality exercised decisive influence over the type of building and its design.

The assessment of the primary subject of the contract was to be determined through an objective evaluation of the entire procurement covered by the contract, considering the main performances that predominated and were characteristic of the contract. The Administrative Court assessed that the purpose of the contract should be determined based on how the contract met the municipality's needs as a whole.

The Administrative Court emphasized that the extension only met approximately 20 percent of the municipality's needs and that the extension was not so distinctive that its realization could be seen as characteristic of the contract. Against this background, the Administrative Court considered the lease relationship to be the primary subject of the contract and that the element of construction work was of subordinate importance. The lease exemption was therefore applicable, and there was no basis for imposing a procurement penalty on the municipality.

Administrative Court of Appeal's Assessment

The Administrative Court of Appeal also considered, for the same reasons as the Administrative Court, that it was a mixed contract and that the primary subject, after an objective assessment of the entire procurement covered by the contract, was deemed to be the lease relationship. The element of construction work was considered to be of subordinate importance. The Administrative Court of Appeal therefore found that the lease exemption was applicable and that there was no reason to impose a procurement penalty on the municipality. The appeal was therefore dismissed. It is noted that the judgment of the Administrative Court of Appeal has been appealed to the Supreme Administrative Court, which has not yet decided on the issue of leave to appeal.

Analysis

Regarding what can be taken from the current judgment, the following can be particularly highlighted. Just as the Administrative Court noted in the case, there is a lack of practice concerning when only part of the lease object is to be adapted or constructed, making the current case particularly interesting.

In the reasoning regarding mixed, indivisible contracts and the assessment of the primary subject of such a contract when only part of the building is to be adapted or constructed, it is interesting that the Administrative Court in the judgment made the assessment based on the area (number of square meters) purely percentage-wise and not, for example, value or any other parameter.

It is also worth mentioning that despite the courts considering the lease exemption applicable, the courts still concluded that the extension to be constructed should be classified as a construction contract, which appears to be a relatively restrictive assessment in that matter.

The municipality argued, among other things, that the extension was initiated by the landlord, that the municipality had no further influence, and that the landlord reused drawings already prepared for another potential tenant. None of these circumstances seem to have been given any weight by the Administrative Court or the Administrative Court of Appeal, which is in line with previous practice. Our assessment is therefore that the judgment does not bring any direct change to the legal situation concerning the assessment of when an authority is considered to have exercised decisive influence.

Although the Administrative Court of Appeal agreed with the Administrative Court's assessment, there is a need for guiding judgments from higher instances regarding the conditions under which the lease exemption can be applied when new construction affects a smaller part of the premises to be leased. Given the ongoing uncertainty in the area, it would be desirable for the Supreme Administrative Court to grant leave to appeal in the case.

In this context, it should also be mentioned the Administrative Court in Malmö's judgment of October 4, 2024, in Case No. 5238-24, which also concerned the leasing of premises for educational activities. Kristianstad Municipality had previously leased premises for this purpose from a landlord and needed additional premises and certain adaptations of these. The municipality and the landlord therefore entered into an agreement for the reconstruction and leasing of additional premises in a new building to be constructed. The agreement stated that the agreed tenant adaptations were necessary for the municipality to utilize the premises for the intended purpose. Compensation for the tenant adaptation and the additional premises would be paid in the form of additional rent. The municipality subsequently procured a contractor under LOU to carry out tenant adaptations and construct the new building.

The Administrative Court found that it was a mixed contract and that the primary subject of the contract was construction work. In the current case, the court placed particular importance on the fact that a new building was to be constructed and the existing building was to be altered, including changes to the facade, floor plan, installation of sewage, heating, etc. Furthermore, the Administrative Court stated that the construction works were considered more extensive than a tenant can normally demand, that the extension corresponded to approximately 33 percent of the previously leased area, that the municipality had initiated the construction works and had decisive influence over the building and its design, and that the reconstruction and extension works had not yet been realized at the time of the agreement. The lease exemption was therefore not applicable, and the procurement obligation was not fulfilled by the municipality having separated the construction and procured it separately under LOU. The Administrative Court decided that the municipality should pay a procurement penalty of 1,500,000 kronor. The judgment was appealed to the Administrative Court of Appeal, which did not grant leave to appeal.

Our opinion is that this decision is also in line with previous practice in the area. It is difficult to determine whether the outcome of the case could have been different if it had been decided after the Administrative Court of Appeal in Stockholm's judgment. The judgments discussed above are particularly interesting as they concern constructions occurring within the framework of an ongoing lease relationship, an area where there is largely a lack of legal practice. It is also an area where contracting authorities may find it difficult to comply with LOU, as a landlord procurement is not always considered a suitable course of action.

In summary, it can be concluded that uncertainty continues to prevail regarding where the boundary between the lease exemption and procurement-required construction contracts lies. Based on the two judgments presented above, our assessment is that there may be room to argue that an extension can be covered by the lease exemption, provided that only a limited part of the authority's premises needs are met through the extension. However, an assessment needs to be made in each individual situation, and the lease exemption in extension projects should continue to be applied with some caution.