Rob Hann provides some practical tips for local authorities setting up local authority companies.
When I wrote the first edition of “Local Authority Companies and Partnerships” (‘LACAP’) in the mid-1990’s (now about to publish issue 41), the setting up of companies by local authorities was all the rage. Unfortunately, local authority companies were, back then, viewed with suspicion by the then Conservative Government under John Major, as a means by which local government might seek to avoid controls on capital spending. The legislative regime also didn’t help given there were no express powers to set up companies (except for certain defined purposes such as airports, buses or waste management). What made me first put pen to paper on this subject though, was the seemingly ever-expanding case law surrounding the subject of LA companies, particularly regarding the vexed question of whether local authorities had powers to establish or participate in companies for various purposes.
In more recent times, there has been a renaissance in LA companies, with many local authorities now keen to explore other ways of delivering services through separate corporate vehicles of one kind or another. There are reckoned to be over 200 local authority companies set up across England to explore the potential for generating additional income from ‘trading’ with a view to profit. The power of general competence contained in the Localism Act 2011 provided local government with increased confidence to establish LA companies for a myriad of functions and purposes. Prompted partly by austerity and the need to find new income streams, legislation which empowers commercial activity by local authorities positively requires the establishment of a company as a pre-condition of trading for a commercial purpose (usually interpreted to mean ‘with a view to profit’).
The availability of rate relief and other fiscal advantages and/or the availability of additional income streams often drive such initiatives and will likely determine the choice of corporate vehicle (e.g. a charitable trust, a company limited by shares or guarantee, community interest company etc - but there are many other options). Many LA trading vehicles are wholly owned and controlled by a single authority and a significant number are set up as so called ‘Teckal’ companies taking advantage of exemptions in EU law permitting supplies of services to flow between a local authority and its wholly controlled subsidiary outside the usual requirements to submit such services to competitive tender. The Teckal exemption (assuming it is essential to the establishment of the company) needs to be fully understood and very carefully monitored and managed. That said, no-one knows yet what impact Brexit may have on the importance of the Teckal exemption to LA company structures, longer term.
But setting up a company brings certain consequences which are not always clear at the early business planning stages of a venture. If a Newco is to take over an existing in-house service, for example, this will instantly create new relationships, interests and objectives which will (usually) flow both ways - from the ‘parent’ local authority to Newco (e.g. in the form of support or back office services) and from Newco to the local authority (depending on what service is being supplied back to the parent authority). It is common for Teckal companies to be established to deliver a major service through a contract to the authority. The contract will typically contain key performance indicators or efficiency targets which the company will be expected to meet going forward. Sometimes there are payment by performance targets included. Such a contract will be the mainstay of the company’s business, at least in the early years, and there will be a need for both the authority and the company to have experienced contract managers in place to ensure the company delivers the outcomes expected under the contract. At the same time, the company will also be expected and encouraged to seek new sources of income or finance. Like all business start-ups, LA trading companies need time to get the basics right before (for example) seeking to expand their horizons or to trade on a wider basis.
In addition, there may be services flowing the other way i.e. from the authority to the company - such as payroll, ITC and other back office services, which may be crucial to help the company deliver both the contract and other (new) business. These services will need to be provided at market value or risk issues arising around state aid.
State aid compliance will need to be kept under review during the life of the vehicle. Loans and other financial assistance to the company from the authority should also be fully documented not just on incorporation but over the duration of the relationship between LA and company.
From newco’s angle, it will need to manage and monitor performance across all relevant support services provided by the parent authority and decide as it goes forward whether these services are (from its angle) value for money. That could lead to potential conflicts of interest and problems after the company has been trading for a couple of years. Does the company have freedom to go elsewhere for back-office and other services if these can be secured perhaps for less money? What impact, if any will that have on central service departments in the parent authority? What impact on staffing will it have? What may seem to be a more value for money way of operating for the company may seem very different to the local authority if these issues have not been thought through from both parties’ perspective.
Setting up a company is often regarded as a way of mitigating and ring-fencing risk (so far as that is legally possible) from the other many and varied statutory responsibilities which councils undertake. The creation of a new company brings with it the twin benefits of the veil of incorporation and the protection for investors of limited liability. These long-established principles of English company law should mean trading risk is confined to the trading company. In theory at least, there should be no additional call on the council shareholder’s other resources should the company run into financial difficulties. However, the devil is in the detail and councils need to be careful when establishing such entities and when determining who should be engaged to take on board director (and other) responsibilities. There will be significant political embarrassment and potential adverse publicity (at the very least) to consider if a LA owned vehicle gets into financial difficulties and/or the expected positive outcomes do not, in the event, materialize.
Establishing a company brings with it new and potentially unfamiliar governance requirements for those who are used to operating within the local government environment. This adds layers of complexity. Will officers or members have experience of acting as directors of companies and will they be able to manage the different rules and requirements whilst still undertaking their primary duties and responsibilities as employees or councillors? Conflicts of interest between the relevant duties owed to each body must be carefully managed (which is easier said than done) to prevent problems arising for individuals concerned and the bodies they represent.
In a follow up article, I will look at a new code of practice which has been published by Lawyers in Local Government to help manage some difficult governance issues commonly faced by local authorities when setting up and running companies.