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Good governance in a ‘commercial council’

First published in Local Government Lawyer Insight July 2017

Good governance in a ‘commercial council’

“Commercial Council” is a term heard increasingly in local government circles as Authorities struggle to meet the cost of delivering services. We are heading for a situation where central government funding will cease and there will be three sources of income; Council Tax, National-Non Domestic Rates (NNDR) and whatever could be made from their own activities.  The Local Government Finance Bill fell with the calling of the election, adding a degree of uncertainty as to the precise recipe for the future but one thing is fairly certain, budgets will be tight and Authorities will continue to explore commercialisation as a route to raise much needed finance.

The importance of good governance has long been recognised and fostered within local government. But the core purposes for which those principles have been fostered are the local government of an area and the delivery of public service functions in that area by a politically led organisation funded by tax payers’ money.  Commercial business activity presents different challenges and risks and potentially may require different management, skills and governance models.   And of course, there is the added tension of the interface between the two roles, public and commercial.

Some key risk areas include:

Financial failure:  whilst the aim of commercial activity is to make money, success is not guaranteed and there is a risk that a business makes a loss.  According to the ONS, the UK five-year survival rate for businesses born in 2010 and still active in 2015 was only 41.4%; in other words almost 60 % of business start-ups closed within five years.  Being a public sector owned business does not protect a business and public money invested in it from financial risk.  Looking back to one of the key local government vires cases of the 1990s, Credit Suisse v Allerdale BC [1996] 4 All ER 129,the nub of the case was that the joint venture company in which the Council had invested and provided a guarantee made a loss and the bank sought to call in that guarantee.

Reputation risk is another area where a Council involved in a business activity is vulnerable. It will, by it very nature, be far more in the spotlight in the media and politically.  Ethical, social and environmental issues may play differently.

Financial exposure – commercial activity will heighten the Council’s exposure to claims for losses and damages from contract breach and negligence.

The classic tool to mitigate financial risk in a business is to conduct it through a limited liability structure. Of course if the activity requires reliance on the Localism Act or the Local Government Act 2003 trading powers then that will be a requirement, though as drafted it does not permit the use of an LLP for this purpose.  If there is a choice then the relative merits of a corporate structure in term of limited liability may need to be weighed against potential liability to Corporation Tax.

But in addition to the limited liability a corporate structure can offer additional advantages to a Council in terms of governance. The board can focus solely on successfully delivering the business of the Company without being distracted by the public sector functions of the Council. Its board can comprise a mixture of officers, whether based in the company or the Council, and members.  It could also have external non-executive directors with private sector commercial experience; This would not of course be possible under normal local government structures but is common in the private sector where it is seen as creating  a different dynamic the business  and offering a different perspective on corporate governance, risk management and other areas.

The role of shareholder can, and probably should, be kept separate from that of the board. A decision will need to be taken as to who will exercise the role of shareholder.  Some Councils delegate the function to a committee of the Council or the Executive, in others it is delegated to one or more individual officers or members.  Separation will give a structure which can hold the board to account, set strategic frameworks, for example through business plan approval and keep the business under review in terms of ensuring it delivers what the Council needs and continues to justify the Council’s involvement and investment.

A company structure would also facilitate a joint venture, particularly where the partners are not other local authorities. Where a private sector partner is involved, careful consideration will need to be given to how the partnership is structured and how the partner is selected to ensure that it does not transgress state aid or public procurement rules.  Thought will need to be given to whether, as is common in private sector joint ventures, a shareholder agreement is required to protect the interest of the Council rather than relying solely on votes at boar and shareholder meetings.

For the Monitoring Officer, commercialisation raises a number of issues. Where the Council is not acting through a company structure (for example selling to the public sector under the Local Authorities (Goods and Services) Act 1970), the duties under Sections 5 and 5A of the Local Government and Housing Act 1989 will clearly be triggered in respect of those activities.  Whilst it may be arguable that they do not strictly apply to the actions of a local authority company, that is not a point the courts have really had to consider.  In any event authorities will want to avoid the reputational damage to them if a trading company it owns was found to be breaking the law.  So it will be important for the Monitoring Officer to be aware of rules which may impact on the activities of the company in its areas of business and to have satisfied themselves that they are complied with.  And it should not be forgotten that breach of such public law matters give a competitor an opportunity to legally challenge the business activity (see R v Yorkshire Purchasing Organisation ex parte British Educational Suppliers Ltd [1998] ELR 195).

The vires question which for many years fettered the ability of a Council to undertake commercial activities have largely, though not completely, been eased by the general power of competence under the  Localism Act 2011 and the charging and trading powers under the  Local Government Act 2003.  However there remain restrictions and requirements and the Monitoring Officer will need to be comfortable that they are complied with.

Another major consideration will be to ensure that State Aid Rules are not breached in financing or operating the business. Where a company is to provide services to the Council as well as in the market, the structure of the business will need to be kept under review to ensure that the “Teckal” exemption under Regulation 12 of the Public Contracts Regulations 2015 can be sustained.  Also, Part V of the Local Government and Housing Act 1989 may apply to the Company.  Freedom of Information applies not only to the Council but also to a local authority controlled company (see Section 6 of the FOIA).

But undertaking commercial activities brings into play legal and regulatory requirements beyond the standard local government and public sector regime. Competition law and the regulation of the CMA applies to public sector based bodies undertaking commercial activities just as they do to any business.  Consumer protection law may apply if selling to private consumers rather than businesses or institutions. The business area it engages in may be subject to external regulation whether in terms of health and safety consumer protection or industry specific regulations such as in energy market.  The requirements of the Bribery Act should also be borne in mind.

Operating as a business may require a different mix of skills than needed for statutory services. The business will be selling.  It may therefore along-side managing its own supply chain need to focus on marketing, client management, even tender writing.  For lawyers too there could well be a new range of issues to consider, apart from just regulatory matters.  A key area will be contractual terms and conditions and risk.  Although most Authorities will have suites of contracts used in procurement, they will have been designed to secure the position of the Council as purchaser.  Its risk and concerns may be very different when it is supplying.  Thought will need to be given to developing (or negotiating) terms that reflect the needs and risks of the business and its commercial model.  Another area that may be come more prominent is intellectual property.  For many businesses brand protection is fundamental and this will increasingly become so for Council businesses as they grow.

The move to commercialisation offers potentially exciting opportunities but it does also raise a new range of challenge and risk. It will be vital that legal teams are involved from the outset to ensure those issues can be covered off and contribute to success.

Business meeting