I think this may be the only time I am in, at least partial, agreement with Warp and we should have the integrity to say when 'our side' gets it wrong or appears to have got it wrong.
On the evidence at hand, this looks pretty ****.
It may well be that there are good reasons, some of which have been surmised, but the reason actually given is pretty poor, as far as it goes.
I suspect there is more to it eg we are only allowed to renew contracts so many times before there is pressure (eventually a hard ruling) to go out to market to ensure fair play / haven't got too cosy a relationship with a contractor / company and I suspect there is something similar at play here. Likely an edict that as contracts come up for renewal they must be re-tendered because there may be new recruitment policies in place that weren't there originally and they want to be able to say every post goes through 'fair and open' competition etc. If the immediate contract manager is happy with this person then the reasons given may be him trying to say 'Sorry mate, not my fault and nothing to do with the quality of the work' but it was clumsily done.
So, as I say, it may not be as bad as it appears, may even be perfectly reasonable in terms of the organisation's wider policies, but, on the face of it, looks pretty bad.