At your disposal
Never has the pressure been greater for local authorities to dispose of under-performing assets. Anthony Young looks at issues a local authority may encounter on selling shares in a company or joint venture.
We tend to think of local authority assets in the forms of land and buildings, perhaps intellectual property, or the paintings in the Mansion House. In fact, considerable local authority assets are in the form of shares in companies, either ones wholly-owned by the authority or a proportion of the shares in joint venture companies. Anthony Young looks at issues which a local authority may encounter on the sale of such an asset.
Transactional
This section assumes the transaction would be a share sale, although most issues would arise equally on an asset sale. This is an area most familiar to the private sector but possibly the least familiar to the council. This is where advisers with expertise in both the public and private sectors can really add value to their public sector clients.
Making it easy for bidders
Local authorities are under a fiduciary duty to get the best possible price for assets acquired or developed with public funds. That normally means a competitive sale process. Prospective bidders want confidence that the authority will go through with the sale and that they will not be faced with unreasonable costs in preparing a bid on a remote chance of success. So it is important to have clear and open bidding process, approved by the authority, which ideally enables the authority to reduce to a short list of bidders who will be required to pull together a detailed bid.
Due diligence
Any buyer will want to undertake due diligence to gain a detailed understanding of all of the legal issues surrounding the asset, which may in turn impact on giving warranties and other contractual comfort. Particularly in a competitive disposal, there is advantage in the authority collecting all relevant information in a due diligence report covering legal, commercial and financial aspects of the company, which can then be provided to all prospective bidders. This will give bidders confidence in the local authority’s commitment to the sale, avoid all the bidders incurring their own costs in collecting basic information (which costs any bidder will have to reflect in their bid price) and enable bidders to identify issues of concern to them early, so speeding the transaction process up – dragged out timetables become very frustrating.
It may be that such information needs to be split into two tranches, with bidders being provided with assumptions upon which to make their bids, but more commercially sensitive information which verifies those assumptions being provided only when a final buyer is identified.
The authority will need to ensure that it has staff who are competent and confident to answer the sometimes very complex questions raised in the due diligence process. Much of this information will necessarily come from the company rather than the authority, so the relationship between the company and the authority is critical to ensuring that this information is readily available.
Transaction structuring
Simple disposal of all the authority’s shares will normally yield the best cash return, but the authority may wish to retain some of the shares to profit from future growth, or as “golden shares” to give it control over the disposal of essential assets such as the town centre bus station. On occasions, it may be better to sell the company’s assets and fold the company.
Pensions
Many staff in local authority-owned companies remained within the Local Government Pension Scheme, which means that the successful purchaser of the company may have to fund a substantial deficit in the LGPS fund to meet the final salary pensions for the company’s employees. Indeed, the need to meet such a deficit may even be the driver behind the sale. Once the company ceases to be wholly or substantially local authority owned, it may no longer be eligible for “admitted body” status without the approval of the Pensions Regulator. Where such approval is either refused or not sought, the bidder may need to arrange for the company to offer a "broadly comparable scheme".
Uncertainty about the cost of funding employees’ LGPS final salary pensions may mean that this is an area where bidders would not be satisfied by due diligence and reducing the purchase price to reflect this risk, but may seek an ongoing indemnity from the local authority. So pensions will always be subject to considerable negotiation, and may be one of those factors which take the disposal into the political arena.
Staff
The company’s own staff may be opposed to the disposal, preferring to remain in the local authority family. In the private sector it is common to incentivise key management (e.g. the executive directors of the company) to assist the process and award them a bonus if there is a successful sale. But this can be divisive where there is no facility to pay a similar performance bonus to those direct local authority employees who equally facilitate the sale, or indeed to local authority members or officers who act as directors of the company.
It is also important to recognise at the inception of the sale that local authority members and officers who serve as directors of the company may have developed strong loyalties to the company, so it may be difficult to change board members of the company where their replacement is governed by specific provisions in the Articles of Association of the company, or the Constitution of the authority, for example where the change of board directors of the company to be subject to a full Council vote. These issues need to be identified early to allow for proper transaction management and planning.
Transaction terms
The detailed terms of sale are outside the scope of this note but the authority must be realistic about the obligations it can impose on the buyer. While it may be politically desirable to promise that the buyer will make no redundancies or cuts to services or changes to livery, this is unlikely to fly with bidders. Equally a claw-back provision ensuring the buyer cannot quickly and profitably “flip” the company on to a new buyer 12 months later will be resisted or circumvented by a buyer. The authority as seller may want a clean break, but the buyer will almost certainly seek continuing warranties, indemnities and other contractual protection from the authority, especially where there are issues which cannot be resolved in advance of the completion of the sale.
Working with other advisers
It is unlikely that an authority will be able to take on the volume and complexity of work involved on its own. If the authority is to satisfy itself and its auditors that it is getting full value for its asset, it is likely to need expert advice during the sale process. The best advisers from the authority’s perspective will not only have the transactional skills and experience, but also bring a real understanding of the public sector and political context within which that transactional advice is given. Lack of experienced advice risks failing to address issues, causing delays late in the process, bidders to reduce their bids to cover unresolved risks, or even the withdrawal of bidders.
Costs
Authorities which have not undertaken corporate transactions may be staggered by the level of costs that can arise - on a transaction realising c.£15m, it would not be unusual for advisers’ costs to exceed £1m. These costs can be mitigated by breaking a project down into stages. It may be possible to agree a cap to adviser costs at each stage, or persuade advisers to take some of the costs at risk, with lower fee levels if the sale fails but an uplift for a successful project. But for every pound that the authority may save by the management of their advisers, for every £100 that good advisers may generate in the final sale price, the authority can waste it all and more by failing to support the transaction process, by inability to take timely decisions and to provide necessary information.
Coordination
There is a real task in managing the team of advisers and ensuring that they focus on issues which matter to the completion of the transaction. This means defining what each adviser is to do, and ensuring that they deliver to time and to budget. An authority will want to appoint a strong project lead, or otherwise nominate one of their advisers to act as the transactional lead. It is not a job for a shrinking violet! The authority’s nominated adviser must be assertive and clearly identify and stick to the authority’s objectives in the transaction process.
Regulatory environment
The fact that the seller is a local authority has a significant impact on the nature of the transaction.
Consultation and decision-making
Consultation with service users, interested parties and disadvantaged groups affected by the proposed decision must occur before the substantive decision is taken, and must be taken fully into account in taking that substantive decision. This can be extremely difficult where the proposed transaction is controversial and requires political support and champions from the day of its inception. It requires clear programming of consultation on the outline proposals and on the detailed scheme, and great care to ensure that the formal decision-making does not run ahead of itself.
Members’ interests, directors and conflicts
The power of the authority to appoint members and officers as directors of the company may be important to retaining control of the company and securing its cooperation in the sale process. But where authority members or officers are directors of the company, there will be an inevitable conflict of interest between their loyalty to the company and their duties to the authority. Where key members are directors, it may be sensible to replace them on the company’s board at the start of the transaction, so that they can participate fully within the authority without running into prejudicial interests under the Code of Conduct. Officer directors may be under similar restraints under s.117 of the Local Government Act 1972 and their contracts of employment. Equally, long-service member and officer directors can build up a loyalty to the company, and may be opposed to the disposal. These issues must be anticipated, as they can cause havoc if they arise unexpectedly at a critical stage in the transaction.
Opposition
Many a disposal will be highly politically sensitive. As a result, every decision of the authority will be put under the spotlight. This is where an adviser with local authority expertise will earn his corn. Most of the authority’s decisions will be “executive decisions”, and opponents of the disposal can use the call-in and review powers of Scrutiny Committees at particularly sensitive stages in the transaction to rally opposition, to press for impromptu commitments on aspects of the transaction, to extract sensitive information and to delay implementation of decisions. In this, they may be supported by external allies who may deluge the authority with petitions and arouse local and even national media attention. It is not uncommon for particular interest groups to favour one bidder, and seek to undermine other bids or deter other bidders.
Opponents will use any means to de-rail the transaction, so irregularities in the appointment or management of advisers, or apparent conflicts of interest, may be just as damaging to the progress of the transaction as the basic financial deal. Careful programming and strict compliance with the authority’s internal contract, procurement and decision-making procedures is critical and, as such transactions can take a couple of years to complete, such programming must pay particular attention to the dates of local and national elections.
Confidentiality
There will always be a risk of information leaking during the sale process. The authority is entitled to withhold information relating to the commercial affairs of any individual, including the authority itself, and to exclude press and public from meetings when such information is under discussion. Members are precluded by the Code of Conduct, and officers are precluded by their contracts of employment, from disclosing confidential information, but standards or disciplinary proceedings after the event cannot remedy the damage caused by an unauthorised disclosure, and such disclosures on some transactions have caused bidders to withdraw.
This risk can be reduced through relatively simple steps such as having a code name for the project and strictly limiting the number of persons involved in the project. Similarly, it may be appropriate to restrict the commercially sensitive data which is made available to bidders in the early stages. Authorities will need clear communication protocols to define who can respond to enquiries.
Freedom of information and judicial review
Bidders and opponents are increasingly using freedom of information legislation, rights of access to council reports and background papers, even rights of access at audit to gain a competitive advantage and embarrass their competitors or to de-rail such transactions. Even judicial review is now seen as a legitimate delaying tactic and means of extracting sensitive information. So it is vital to keep the public and interested parties informed even if they are opposed to the proposed transaction, and to ensure consultation is properly done at a formative stage and is meaningful for the community. Within the authority, members and particularly affected ward members need to be kept informed to give them the ability to respond to constituent and press enquiries.
Conclusion
Local authorities are under pressure to dispose of under-performing assets. Major asset disposals are complex transactions. No-one can guarantee that they will proceed smoothly from inception to completion. But realism as to what is achievable and careful project planning can make the process less painful and secure a better return for the authority.
Anthony Young is a corporate partner at Bevan Brittan. He can be contacted on 0870 194 1261 or via This email address is being protected from spambots. You need JavaScript enabled to view it.
