Running local authority trading companies

When it comes to local authority trading companies, who should be involved? Members, officers, others? Rob Hann reports.

Prompted partly by austerity and the need to find new ways of working and/or new income streams, there has been a proliferation of local authority trading companies in recent years. Indeed, the legislation which empowers commercial activity by local authorities 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’).

Setting up a company ring-fences risk (so far as that is legally possible) from the other many and varied statutory responsibilities which councils undertake. The birth 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 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 (and other) responsibilities.

Companies bring with them entirely different and sometimes potentially conflicting governance requirements from the regime which governs local government. Will officers or members have experience of acting as directors of companies and will they be able to manage these different rules and requirements whilst still undertaking their primary duties and responsibilities? Such individuals will have to balance two roles at least, namely – that of representative elected member or employee of the shareholder authority on the one hand and that of company director of a council owned/controlled company on the other. Conflicts of interest between the relevant duties owed to each body are to be expected and must be carefully managed to prevent problems arising for individuals concerned and the bodies they represent. Practical training from suitably qualified and experienced individuals who may themselves have already grappled with some of these issues, is essential before taking up these new roles.

Guidance published by the Cabinet Office in January 2016 (“Guidance for Directors of Companies Fully or Partly Owned by the Public Sector”) is also helpful (although a little light on detail). It also isn’t specific to local government. It is nonetheless essential reading, along with its sister publication “the Code of Conduct for Board Members of Public Bodies” also published by the Cabinet Office in 2011.

This sets out the seven key principles of public life as follows:

• Selflessness – you must take decisions solely in the public interest and must not act so as to secure material or financial benefit for self, family and friends;
• Integrity – don’t place yourself under any financial or other obligation to outside individuals or organisations which might or might be perceived to influence you in the performance of your public duties;
• Objectivity – In carrying out public business, including awarding contracts and recommending individuals for rewards and benefits you should make choices on merit;
• Accountability – You are accountable for your actions and decisions to the public and must submit yourself to whatever scrutiny is appropriate to your office;
• Openness – you should be as open as possible about the decisions and actions you take. You should give reasons for decisions and restrict information only when the wider public interest clearly demands;
• Honesty – You have a duty to declare any private interests relating to your public duties and take steps to resolve any conflicts arising in a way that protects the public interest;
• Leadership – you should promote and support these principles by leadership and example.

Company director duties are codified in the Companies Act 2006. In carrying out their functions, directors (whether formally appointed, de facto, or "shadow directors") owe a series of duties to the company. There are presently seven key duties set out in sections 171 to 177, which codify common law and equitable principles.

• Duty to act within powers
• Duty to promote the success of the company
• Duty to exercise independent judgment
• Duty to exercise reasonable care, skill and diligence
• Duty to avoid conflicts of interest
• Duty not to accept benefits from third parties
• Duty to declare interest in proposed transaction or arrangement

These duties may not be limited, waived or contracted out of, but companies may buy insurance to cover directors for costs in the event of breach. The Companies Act 2006 sets out certain types of transaction where a conflict of interest is likely to arise that includes substantial property transactions, directors’ loans, payment for loss of office and directors’ service contracts for more than two years. In general, should these circumstances be met, the transaction will need to be approved by an ordinary resolution of the shareholders. Directors will owe a number of other duties under company law, including ensuring that the company complies with filing requirements and other legal duties. In addition to company law, directors will also owe duties under specific legislation. For example, directors will owe specific duties in relation to insolvency, health and safety, environmental, anti-bribery, competition, and pension issues.

The vast majority of people who are directors of companies carry out their roles without any problems. But what can be difficult in a local government context, is to determine who is best placed to occupy the role of director of a council owned trading company and who is best placed to make independent and impartial decisions and ask questions about its activities and performance once in operation?

There are no hard and fast rules here. The law does not prohibit or restrict appointments of officers or members to such positions - nor should it. Some councillors might come from a business background or run their own businesses and be completely familiar and comfortable with the requirements that apply. Officers too may feel able to balance both their duties as employee to the authority and their duties when acting as a director of a council owned company.

However, conflicts of interest can and do arise. Pressures can be brought to bear both in terms of public duties and employment requirements, especially when things may not go as planned and perhaps additional funding or other support is needed to support a company through a difficult patch. Ironically, this is where it may be better for there to be some ‘distance’ between key council decision-makers and the company decision-makers, in terms of personnel. Conflicting interests should be declared on every occasion and the rules in the company’s articles or in relevant council codes of conduct, in terms of conduct in the event of conflict, should be scrupulously followed.

Information and its disclosure is typically the sort of thing that can cause problems. For example, it could be a breach of a director’s duty to the company to disclose confidential company information to their appointing council, even if it were relevant to something that the council was discussing. It would be equally wrong to disclose confidential information belonging to a council - to the company. The duty towards the company only applies when the individual is acting in their capacity as a director. When at council meetings or acting in a role as a local authority officer or elected member, he or she must act in the best interests of the council, subject to the above point about confidentiality. It is therefore very important that directors have a clear understanding of ‘which hat they are wearing’ at any time. Even then, difficulties in practice for both individuals concerned and the organisations they are involved with, should not be under-estimated.

The recruitment of a completely independent board is more unusual, although some authorities do recruit non-executive directors to bring experience and objectivity. This will help to develop the all-important commercial culture needed to make such ventures a success.

So here are some pointers that might help with the decision as to who does what:

• When setting up a company and appointing directors to the board, those establishing it must remember that the company is a separate legal entity, and directors will have duties to act in the best interests of the company. The directors must therefore be allowed actually to direct – i.e. decide for themselves, using their independent judgement, what is in the best interests of their company. Leading members, chief officers, monitoring officers, and solicitors employed by councils should also be particularly mindful of conflict and (in the latter case) specific professional conduct rules which also need to be considered.
• If directors are remunerated, local authority legislation contains some elephant traps for the unwary for both director/officers and director/members. These rules will need to be carefully navigated with the help of suitable legal advice and training.
• In circumstances where the interests of the company do not coincide with the interests of the parent authority, both the directors of the company, and the parent authority, could expose themselves to liability if they simply cause the company to do the parent authority’s bidding. The risk is increased if the company is facing financial difficulties and carries out a course of action that is designed to benefit the parent authority at the expense of the company’s creditors. Such liability could arise through (among other things) the parent authority being treated as a “shadow director” of the company. In effect, such interference could cost the parent authority the protection it would otherwise have had through using a limited liability trading company.
• It may be best to avoid any reference to the appointment being as a “nominee” director, because the term “nominee” tends to connote a person who is appointed solely to carry out a task (e.g. to hold and deal with property) for the benefit of another and who will act only in accordance with the other’s instructions. Reference to a “nominee director” could create the impression that the individual has surrendered all discretion to the appointor council, which might encourage, say, a liquidator or regulator to bring a claim against the individual for breach of duty and/or a claim against the appointor council. Instead, reference should be to a “nominated director”, “shareholder-appointed director” or something similar.

The case of R v Waltham Forest ex-parte Burgoine and Cooke still makes sobering reading 20 years on. It tells the story of how two well-meaning LA officers became embroiled in litigation after being appointed to the board of a local authority leisure trust which subsequently went into liquidation. As ever, the lessons of the past are worth heeding. My book Local Authority Companies and Partnerships (LACAP) traces the twists and turns of legislation and case law governing localauthority interests in companies over the past few decades.

Rob Hann is a solicitor, local government consultant and author of Local Authority Companies and Partnerships (‘LACAP’) local government’s essential guide to setting up and running LACAP’s and of the 2017 Guide to Local Authority Charging and Trading (LACAT). Several leading law firms also contribute chapters to LACAP on a variety of topics. If you need an independent review of your local authority company or partnership, please contact Rob by email or on 07768 906391).