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Piggy bank iStock 000009466746XSmall 146x219What do councils need to consider when lending? Jon Coane and Gurbinder Sangha look at the key issues.

The Government’s programme of funding reform and devolution for local government gathered more pace with this year’s Autumn Statement and Spending Review. For councils, it means the prospect of more resources in some respects and less so in other ways. There lies an opportunity for councils to be more innovative in generating income to subsidise areas that suffer from funding cuts. Lending money to commercial entities (including housing associations) can generate revenue from interest payments and arrangement fees. This article looks at some of the concerns which councils have when they consider lending.

Why should councils consider lending?

The benefits of on-lending include:

  • Making better use of councils reserves and/or borrowing from the Public Works Loan Board to on-lend in order to generate income. In a recent article in Social Housing, it was reported that Warrington Borough Council have generated £1.6m in arrangement fees and around £0.5m per year from interest paid from the £200m+ loans it has made. It is understood that they borrowed from the Public Works Loan Board and on-lent and the income which they generated is reinvested to help people in social care. Although councils can, from April 2016, raise council tax by 2% to help fund social care, the feeling across the sector is this will only go part of the way to bridge the funding gap. By lending money, the income generated could help bridge the funding gap.
  • Helping with the housing shortage in their area. Over the years many councils have completed housing stock transfers and no longer manage housing. A solution to the housing shortage could be to lend money to housing associations that are often in a better position to develop housing in a quicker time-scale. By providing a loan to housing associations it enables councils to generate income, fees as well as more council tax and the New Homes Bonus whilst also helping to deliver the one million new homes target set by Government. From a risk perspective, it is important to note that to date no housing association has defaulted on repaying a loan, which makes the proposition of lending to housing associations more attractive.
  • Regenerating areas that have suffered from not enough investment. If councils funded or match funded regeneration projects, this could unlock a number of projects which have struggled to get off the ground.
  • Delivering economic growth. By lending to the third sector or commercial entities it could help to drive growth and the number of jobs within the area. If the loan was used by the entity borrowing it to expand, it could also provide additional revenues for councils, if as announced by the Government in the 2015 Spending Review, they are to retain business rates.

Do councils have the power to lend?

Councils often ask: “do we have the power do lend and if so, do we have to create a separate trading vehicle?” The answer is yes, councils do have the power to lend and no, they do not have to set up a separate trading vehicle. The investment and related powers in summary are:

1. A council has a specific power to invest under Section 12 of the Local Government Act 2003.

2. A council has a specific power to make a loan under Section 24 of the Local Government Act 1988 (housing loans only).

3. A council has a general power to borrow under Section 1 of the Local Government Act 2003. Therefore a council could borrow from the Public Works Loan Board and make an investment under Section 12 of the Local Government Act 2003 or a loan under Section 24 of the Local Government Act 1988.

4. A council also has a general power to borrow and to make loans under the General Power of Competence in Section 1 of the Localism Act 2011. This power is not to be relied upon as a specific power to lend or invest but rather to supplement Section 12 of the Local Government Act 2003 or Section 24 of the Local Government Act 1988 when investing or lending.

Do councils have to be authorised by the FCA?

Another question often asked is: “If we lend, will we need to go through a lengthy and costly process of getting FCA authorisation?” The answer is no, councils do not necessarily need to get FCA authorisation when they lend. There are a number of potential exemptions for councils to rely upon under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 which avoids the requirement for FCA authorisation. The details of the loan help to determine whether there is an exemption and if so which one can be relied upon.

Will councils be caught by state aid if they lend?

State aid makes councils very cautious and rightly so. Fortunately for councils there are a number of approaches and potential exemptions which they can rely upon when lending. The potential exemptions include the General Block Exemption Regulation (the “GBER”) and De Minimis. If a council provides a loan on market terms, it should not be State aid because the council is acting in line with the Market Economy Investor Principle (the “MEIP”). When making such Ioans, councils will need, amongst other things, to carry out prior due diligence to demonstrate that the loan is a prudent use of the council’s resources and such that any other lender (i.e banks) would have a provided a loan on those terms.

How can councils protect their investment or loan?

In the worst case scenario that the borrower defaults on the loan, how can councils be protected? The most prudent way is to require the loan to be secured against the borrower’s assets and/or guarantee from a linked party. The different types of securities include a fixed charge over equipment, legal mortgage over real property, legal assignment over debts, a floating charge over the whole business, a personal or corporate guarantee or construction specific security. The type of security will depend on what assets the borrower has and the value of those assets and whether the borrower has given security over the same asset to another party. Getting the right security is important. Essentially, the more valuable security the council can get, the better the chance of the council getting its money back if the borrower goes insolvent before repaying the loan in full. In addition, where the council wants to rely on MEIP to avoid State aid they need to ensure that a bank would accept the same form of security.

It is crucial you have the correct legal advice to ensure you lend in a way that protects you and from lawyers who understand the lending market.

Jon Coane is a Partner and Gurbinder Sangha is a Solicitor at Anthony Collins Solicitors. Jon can be contacted on 0121 214 3680 or This email address is being protected from spambots. You need JavaScript enabled to view it., while Gurbinder can be reached on 0121 214 3625 or This email address is being protected from spambots. You need JavaScript enabled to view it..