Options for local government trading

Partnership iStock 000006695073XSmall 146x219Interest in the opportunities presented by local government trading has never been higher. Rob Hann examines the various delivery models and the challenges they bring.

One of the recurring themes at this year’s (always excellent) Weekend School in Exeter was the extent to which local authorities are now exploring trading initiatives of one kind or another. In the legal services environment the setting up of so called alternative business structures (‘ABS’) to supply legal services to a wider range of clients (or customers as they are apparently referred to under ABS jargon) is gathering momentum. Both Buckinghameshire Law Plus and HB Public Law (Harrow and Barnet) have recently successfully navigated the seemingly byzantine hurdles to ABS licence status.

As austerity continues to impact, heads of service across the wide local authority spectrum are seeking to set up trading companies for a wide variety of purposes, with a view to reducing costs through efficiencies and increasing income from trading with the world at large or with other councils (so called Teckal trading). At the Weekend School law firm Bevan Brittan led a very entertaining session entitled ‘Local Authority Dragon’s Apprentice’ where three entirely different ideas were pitched to the audience who were then asked to vote for their most likely to succeed trading venture. It was a bit of fun of course. If only real life was so simple?

Local authority officers and members are faced with a bewildering array of options when considering the establishment of a trading enterprise. The vast majority begin with the idea that in order to trade, there is a need to set up a wholly owned trading company. Undoubtedly, where a best value authority wishes to act for a ‘commercial purpose’ in order to generate profits from function related activity (using Section 95 2003 Act) or non-function related activity (using Section 4 Localism Act 2011), acting through a company is a requirement under the relevant legislation. But ‘commercial purpose’ is not defined by the legislation. In some circumstances ‘profit’ may not be the prime motivation for engaging with others through a trading enterprise. Where two or more local authorities are concerned, reducing costs or working more cost effectively and efficiently is more often the prime objective.

Setting up a fledgling new business can be a very risky enterprise at the best of times. Setting up a company also brings with it many new duties and obligations contained in the Companies Act 2006 (or other relevant legislation dependent on the vehicle chosen) which may be unfamiliar to those who work in the public sector. The formation of an entity, operationally distinct from the council, to concentrate on a particular type of activity or business might not therefore be the first option to explore. There are many considerations to weigh in the balance.

Where a local authority to local authority arrangement is contemplated, before expending monies on company or trust formation, the parties must consider carefully whether it is absolutely necessary to set up a trading company and whether it is easier and more beneficial to contract directly with another local authority/public body direct rather than establish a separate entity. Under a direct contractual arrangement all parties retain their individual identity and status. Each public sector stakeholder would be responsible in its own right for compliance with legal requirements on, for example, procurement, state aid and with legislative duties or propriety and governance rules, etc. Direct contractual arrangements have the advantage of being very flexible and less formal than arrangements established through a company, being governed by the consent and decision-making arrangements in the contract.

So what alternatives exist to setting up a wholly LA owned company for trading? The answer is ‘it depends on what the authority intends to do’ and whether it does indeed intend to ‘trade’ within the context of the 2003 or 2011 Acts. Some ideas are set out below for consideration:

Powers and procurement issues

It is worth remembering local authorities have been joining forces in one way or another to drive efficient working practices for many years using tried and tested legislation such as Section 101 Local Government Act 1972 (delegation of functions) and/or entering into agreements under the Local Authorities (Goods and Services) Act 1970. These important statutory provisions can help to provide a test bed or incubation facility whereby new ideas for service delivery on a more business-like basis can be tested without need of setting up a new company. The function would remain ‘in house’ but with demarcations creating distinct lines of operations and processes between the local authority and its business unit as if it were a separate legal entity. For example, the unit could have its own branding as well as a separate costs centre code for invoicing purposes.

This would give the individuals running the unit (and the council itself), valuable opportunity to test demand and to confirm if there is strong business opportunity for a commercialised service or product. Analysis should be undertaken by researching customers, products and competition. This will result in a better understanding of the competitive position, the chance to spot opportunities, risks being reduced, and, better decision making If the incubation period is successful, consideration might then be given to transferring the business unit to a company where it will be able to trade more widely and expand its customer base in the way envisaged by the 2003 and 2011 legislation.

The new Public Contracts Regulations 2015 implementing the new Procurement Directive contain at Regulation 12(7) - on the face of it - some helpful provisions which appear to assist public bodies where they wish to co-operate for common objectives in the public interest. These new provisions apply (enabling co-operation exempt from procurement) provided all of the following conditions are met:

  • the contract has the “aim of ensuring that public services they have to perform are provided with a view to achieving objectives they have in common” ;
  • the “implementation of that co-operation is governed solely by considerations relating to the public interest” ; and
  • the contracting authorities “perform on the open market less than 20% of the activities concerned by the co-operation”.

The boundaries of the new procurement code (several years in the making) have yet to be tested by case law and (as ever these days) local authorities will have to consider potential procurement challenge risk if no competitive process is contemplated (see for example Piepenbrock Dienstleistungen GmbH and Co. KG-v- Kreis Düren (C386/11)) where cleaning of certain public buildings was not regarded as a public task in this sense). Identifying what statutory functions parties to such arrangements are seeking to perform through co-operation, is essential. There may be other procurement challenge risk mitigation measures which can be considered (e.g. the publication of a voluntary ex-ante transparency notice – VEAT notice under EU rules).

Trading through an existing enterprise

Trading through an existing trading enterprise i.e. participating in someone else’s existing trading company appears to be an option only very few authorities have considered to date.

If a business already undertakes the type of service the authority wishes to perform, one option might be to seek to invest directly in that existing undertaking. This may be less risky than starting a new business from scratch, although equally, there may be hidden liabilities in an existing business which would require extensive due diligence before any investment is made. In the original guidance on trading powers published in 2003 (and which still remains largely valid) DCLG expressly mentioned this option see paragraph 39 of the 2003 guidance on trading under section 95 LGA 2003 extracted below:

“…Although an authority may want to establish a company for the purpose of using it as a vehicle for function-related trading, it does not have to proceed in that way. It may equally trade through a company in which it has not been directly involved in setting up for this purpose. A local authority need not establish its own company, nor are the commercial purposes necessarily just those of the authority. It would be possible for a local authority to agree with an established commercial company to trade through it on a contractual basis to mutual benefit.”

A variation on the above theme might be to establish a new company to be formed with an existing trading partner. In this scenario the authority would not be taking all the risk (or reward) but would partner with an experienced operator through a company vehicle. This would then be a clean vehicle for tax (and other historic) liability purposes. The authority could consider what equity stake it takes (minority, deadlock, majority etc) depending on its appetite for risk and other factors. Procuring a partner through a competitive process would probably be a pre-requisite for this type of trading venture, although if the authority were simply motivated by extracting a financial return on its investment, procurement rules may not impinge (see Regulation 10(1)(e) PCR 2015).

Combined authorities and economic prosperity boards

The Public Contracts Regulations 2015 codify and slightly amend the Teckal test at Regulation 12. Regulation 12(1) sets out three cumulative conditions that must be fulfilled for an organisation to be ‘in-house’ and not subject to procurement. These are:

  • The contracting authority exercises over the legal person concerned a control which is similar to that which it exercises over its own departments;
  • More than 80% of the activities of the controlled legal person are carried out in the performance of tasks entrusted to it by the controlling contracting authority or by other legal persons controlled by that contracting authority; and
  • There is no direct private capital participation in the controlled legal person, with the exception of non-controlling and non-blocking forms of private capital participation required by national legislative provisions, in conformity with the Treaties, which do not exert a decisive influence on the controlled legal person.

Regulation 12(3) defines what is meant by ‘control’: the controlling contracting authority must exercise “a decisive influence over both strategic objectives and significant decisions” of the controlled subsidiary. Regulation 12(4) confirms that where contracting authorities jointly control an entity, a similar exemption applies, provided that the conditions in Regulation 12(4) are satisfied. Alternatively, the control could be evidenced where “the control is exercised by another legal person which is itself controlled in the same way by the contracting authority” (Reg 12(3)(b)). Whilst most local authorities seeking to take advantage of these new provisions might understandably consider setting up a jointly owned company, there may be another option which would be entirely within the public sector legislative framework.

Many clusters of local authorities in England are currently considering the establishment of either Combined Authorities (CA) or Economic Prosperity Boards (EPB) to promote economic development and growth related functions. Where such bodies are being created, one potential function these new legal entities might undertake could be the role of a Teckal-type trading vehicle on behalf of all the members of that CA/EPB. This could mean contracts between the CA/EPB and its members are free from procurement considerations (subject to compliance with regulation 12 and basic EU Treaty principles) and the need for compliance with the Companies Acts requirements and all other related complications are avoided.

At some future stage it may be necessary to hive off the activity from the CA/EPB into a company e.g. to ring fence risk and/or allow the new venture to trade more widely. However, in the short term, the new CA/EPB structure may provide another way of testing and incubating inter-authority arrangements.

Conclusion

Setting up a wholly owned company to undertake a new trading venture does seem to be gaining in popularity in local authority circles but other powers and possibilities, depending on a careful analysis of what the authority or authorities are intending to do, should be considered in the round. Companies have their place but may not always be the first, best or sole option when looking to save money or to better perform public functions or engage with other local authorities. Procurement challenge risk is an ever present complicating factor but is only one of several factors to consider when establishing any new trading enterprise, whether incorporated or not.

Rob Hann is Director - Legal Services at Local Partnerships LLP.

© April 2015

Rob is author of Local authority companies and partnerships and Local authority charging and trading powers, both published by LexisNexis

Local Partnerships run assurance reviews for new and operational local authority trading enterprises and have huge experience in this field. Contact Rob for more information on 07768 906391 or This email address is being protected from spambots. You need JavaScript enabled to view it..