A parable about settlements – or rather, the lack thereof…

The proposal to introduce a provision in the Public Finance Act providing for the possibility for public finance sector entities to enter into a settlement agreement has been widely commented on in recent days.

There is a very lively discussion around this proposal, and I recommend following it directly on the RCL website. Without wishing to go into detail, in principle I have to support the very idea of settlements by public sector entities. Unfortunately, to say that this form of settlement of disputes is rare would be a euphemism. In general, both the State Treasury and state legal entities, but also local governments, defend themselves with arms and legs against concluding settlements. A significant psychological barrier for officials deciding these cases is the sword of Damocles hanging over their heads in the form of liability for breach of public finance discipline. If we add to this the issue of decision-makers’ lack of personal identification with the interests of the client (i.e. the represented entity) and thus seeking to spare the client the additional costs and time associated with a potentially fruitless process, it is not surprising that settlements with public entities are currently so rare.

The provision of Article 54a is intended to apply to both in-court and out-of-court settlements. In this context, it is worth remembering that the condition for the effectiveness of a court settlement is its approval by the court, which is impossible in cases where the settlement is contrary to the law, principles of social co-existence or aims to circumvent the law. Court approval of a court settlement therefore takes the form of a decision in which the court should rule on the above criteria. However, an out-of-court settlement can also be assessed by the court when it is reached in the course of proceedings and results, inter alia, in the withdrawal of the claim.

After this brief introduction, I would like to discuss one of the settlements that the public entity managed to conclude with a private entity, namely the settlement between the Lux Veritatis Foundation (the „Foundation”) and the National Fund for Environmental Protection and Water Management (the „Fund”). A few months ago, a discussion swept through the media regarding the legitimacy of the settlement in this case and the typically political motivation behind it. However, as it turns out, the interests of the Fund were clearly in favour of a settlement in this case. The Foundation’s claim was more than justified, at least at the stage of the case at which the settlement was reached, as clearly demonstrated by the decision of the Regional Court in Warsaw discontinuing proceedings in the case in connection with the out-of-court settlement. I do not wish to summarise here the exceptionally voluminous grounds for the order, but nevertheless, in my view, this is one of the more important cases involving disputes over due public funds, so I will at least briefly outline the substance of the dispute.

The devil is in the detail
First of all, it needs to be emphasised that the court dispute initiated by the Foundation lasted for almost seven years and concerned the payment of compensation of just under PLN 28 million. The dispute arose on the basis of a grant agreement, which the Fund undertook to provide for the implementation of a project involving geothermal drilling, with the Fund agreeing to provide, under the terms of the agreement, a grant of more than PLN 12 million. The subsidy (which was still granted in 2007) was not finally granted, because, in the opinion of the new management of the Fund, the beneficiary breached the timetable for the investment and, in addition, did not provide adequate explanations concerning the project. It should be added, however, that the agreement with regard to, inter alia, the amount of the subsidy and the material and financial schedule was annexed, and as a result of signing this annex, the amount of the subsidy was increased to 27 million PLN (and the intensity of support to over 90 per cent of the costs), and the project schedule was extended. The annex was concluded under the condition precedent of providing the Fund with documents to demonstrate the right of perpetual usufruct to the land and the right of ownership to the building, which were to be the subject of security for the Fund’s claims (instead of the blank promissory note hitherto in force). These documents were to be provided by 31 January 2008, and by that date the Foundation provided a copy of the land and mortgage register of the property, which showed that a mortgage had been registered in favour of the Fund on the right of perpetual usufruct and ownership of the buildings. Subsequently, in May 2008, the Fund informed the Foundation that it considered the annex to be invalid due to the invalidity of the condition precedent stipulated in the annex on the grounds that the Foundation did not have the legal title to the buildings located on the property on which the mortgage was to be established and, in addition, the Foundation had not submitted the owner’s consent to the establishment of the security (despite the fact that the security had been established, as confirmed by the entry in the Land and Mortgage Register). Consequently, he concluded that the Foundation was improperly implementing the contract and terminated it citing, inter alia, the non-compliance of the project implementation with the original schedule.

Contractual disloyalty – in the eighth circle of hell
The Court, pursuant to Article 203 of the CPC, assessed the claimant’s statement of withdrawal of the claim contained in the settlement agreement, whereby, as it noted, when assessing whether the settlement agreement meets the prerequisites for its approval (or, as in this case, for discontinuance of the proceedings), one cannot abstract from the assessment of the evidence conducted in the given proceedings. Accordingly, in the order discontinuing the proceedings, it conducted an extensive analysis of the state of the case, finding, inter alia, that the termination of the grant agreement by the Fund was unlawful and that the claims that the entire annex was invalid due to the invalidity of the condition were unfounded. In doing so, the court found that the Foundation’s fulfilment of the impossible condition could not result in negative consequences for the Foundation, as there had been a provision of security in favour of the Fund. Therefore, in the court’s view, the other provisions of the annex, including the amended material and financial schedule, remained valid, in accordance with Article 58 § 3 of the Civil Code.

At the same time, the court emphasised that the Fund demonstrated exceptional contractual disloyalty towards the Foundation, claiming that it should have implemented the project in accordance with the original schedule, not the one that was amended by the annex. In addition, irrespective of this issue, the court pointed out that the parties allowed changes to the material and financial schedule, and therefore, the Foundation’s refusal to agree to the schedule change, which it motivated by the work schedule agreed with the drilling contractor and which was not supported by sufficient justification, constituted another expression of its contractual disloyalty and, in addition, in the court’s view, an abuse of its subjective right.

Consequently, the court found that the Fund’s termination of the contract, as it did not contain the facts justifying it, was contrary to the principles of social co-existence and established customs.

The court then moved on to the legal qualification of the facts, finding that the basis of the claimant’s claim was Article 471 of the Civil Code and, consequently, that the Fund was obliged to settle the damage resulting from the non-performance. On the other hand, very interesting considerations concerned the damage itself. Namely, in the court’s opinion, the subsidy applied for by the Foundation in the realities of the case constituted damage in the form of damnum emergens (i.e. loss), and in assessing whether the amount of the subsidy would have entered the Foundation’s assets, the court found that, despite the termination of the agreement, the project had been implemented, expenses had been incurred, and its main objective in the form of the environmental effect had been achieved, and thus if it had not been for the termination of the agreement, the subsidy would have entered the Foundation’s assets. Interestingly, the court found that the Fund’s allegations concerning the correctness of the further implementation of the project (after the termination of the agreement) were groundless, since it had, at its own request, excluded itself from further participation in its implementation. As a consequence of the above, the court found that the out-of-court settlement reached by the parties did not violate the law or the principles of social co-existence and discontinued the proceedings.

Other devils were at work here?
The Foundation’s case shows how much learning still lies ahead of all administrators of public funds in terms of their proper use, including the still very exotic for many officials concept of cooperation with beneficiaries in the implementation of projects. Incidentally, in one of the cases I handled, I even came across an official’s view that his institution does not establish project supervisors because they could „befriend the beneficiaries” (sic!).

This is because regardless of which entity benefits from public funds, the awarding authorities should treat all entities equally, including in terms of the standards of cooperation in the implementation of contracts. Therefore, the very fact that the Fund arbitrarily refused to extend the project schedule in a situation where – as its employees pointed out – the standard of cooperation with other beneficiaries was far-reaching favour in this respect, constitutes a flagrant breach of contractual loyalty. Of course, a definite pathology, assuming this to be true, would be if the termination of the contract with the Foundation was in fact politically motivated. For it is impossible to assume, leaving aside the question of whether the Foundation was entitled to receive a grant (since the Fund did not formulate allegations in this respect, this was not the subject of the proceedings before the court), that such behaviour was within the framework of any standards. Unfortunately, it is an open secret that this kind of behaviour regarding either the allocation or settlement of public funds is in force in the implementation of many contracts.

Three cents about state aid
Last but not least, when considering a systemic approach to settlements by public entities, the issue of state aid must be borne in mind. The European Commission’s Communication on State Aid notes that State aid may occur (in relation to tax authority settlements), inter alia, where, on the basis of such a settlement, the amount of taxes has been significantly reduced without clear justification or reduced in a manner disproportionate to the taxpayer’s benefit. Although the Communiqué refers explicitly only to tax settlements, also other settlements e.g. ending grant disputes with institutions may contain an element of state aid, which is why it is all the more important that the criteria for such settlements by public entities are transparent and that the conclusion of the settlement itself is preceded by a sound assessment on the part of the public institution.

To conclude – absolution from a settlement
As the example of the Foundation discussed above shows, there is always a good time for an administration to settle, which is worth bearing in mind not only in the situation of 'friendly’ partners. A proposal aimed at encouraging the public sector to settle can therefore be welcomed. At the same time, there is no doubt that, when considering such a settlement, a public entity, just like a private entity, should assess the risk of a possible loss. However, while in the case of a private entity such an assessment is supported by an obvious economic interest, for the public entity the potential economic benefit (e.g. saving of further costs) of a settlement is not so obvious. Undoubtedly, courts play an important role in „absolving” administrative bodies of a settlement agreement, as in the example discussed above. The publication of the extensive court decision in the Foundation case certainly contributed to extinguishing the discussion around the 'political’ motivation behind the conclusion of the settlement. Therefore, perhaps it would not be out of place to equip the courts with the competence to approve settlements (e.g. by appropriately expanding the provisions of the CCP concerning calls for settlement attempts) – based on analogous criteria as in the case of court settlements – entered into by the public sector – also in those cases where litigation has not yet been initiated, e.g. on the basis of material provided by the public entity indicating the (broadly defined) expediency of the public entity entering into a settlement. The imposition of an obligation on the public entity – at least in certain categories of cases – to always assess the advisability of a settlement before entering into litigation also remains to be considered.