Power generation

A recent Court of Appeal ruling involving two local authorities in Norway has shown that vires issues remain an important consideration. And, says Rob Hann, even with the provisions of the Localism Bill authorities will still have to research carefully the powers they are going to rely on and exercise them carefully and rationally.

The recent Court of Appeal judgment (overturning a first instance decision) of Haugesund and Narvik Kommunes v Depfa and Wikborg Rein [2011] EWCA Civ 33 demonstrates local authority vires issues (in this instance, affecting two local authorities in Norway) remain a live issue for professional advisors involved in major transactions involving banks and local government.

On the facts, the Court of Appeal ruled that a law firm that gave negligent advice to a bank, did not have to reimburse the bank to the tune of £28m representing irrecoverable loans advanced by the bank to the local authorities concerned. Lord Justice Rix said it would be a harsh doctrine to force upon solicitors a general duty to advise on the creditworthiness of borrowers while advising on the validity of a transaction.

The ruling might be seen as good news for law firms advising lenders on complex financial transactions. However, the case has potential impact across the professional services market. Law firms, banks and other lending institutions, financial advisers and the insurance market will all be studying this judgment very carefully to consider where, in other similar circumstances, such risk should or will lie. Terms and conditions of engagement and the potential duty of care of lawyers and other professional advisers will be examined to determine where precisely such risk should sit when instructed by a bank to advise on legality, powers and enforceability of arrangements of similar transactions in future.

The instant case seems to hinge on the precise scope of the instructions received by the law firm from their client on what advice was required. Lord Justice Rix said: “Wikborg was asked to advise about a specific question, the validity of the proposed swaps contracts. It did not have a general retainer to report or notify problems about the proposed transactions. Depfa knew that it ultimately relied on the creditworthiness and good faith of the municipalities and on those qualities it made up its mind to lend the money and was wholly confident. It seems to me to be a harsh doctrine to visit a loss in fact due to creditworthiness on a solicitor as being within the scope of his duty to advise as to the validity of a transaction when that creditworthiness has been entirely within the province of the lender and outside the scope of the solicitors duty.”

Lord Justice Goss said: “Even if the contract was valid Depfa had been advised that it could not enforce a claim against the municipalities. So far as concerns the credit risk that was for Depfa – not its legal advisers.”

The reason why the bank took action against its lawyers was because it had no cause of action against the public authority lenders due to their lack of capacity to enter into such transactions. Depfa had alleged that its lawyers had failed to advise them that swaps contracts entered into with the two Norwegian local authorities fell outside those authorities’ powers and were unenforceable. The contracts were governed under English law. Depfa had advanced monies to the authorities which they then lost after their investments went badly wrong. The municipalities then claimed they lacked the capacity ever to have entered into the transactions with Depfa under laws which restricted their borrowing powers and refused to repay the ‘loans’.

These facts raise disturbing echoes of cases past which affected the English local government market in the 1980s and 1990s, such as Hazell v Hammersmith and Fulham LBC (1992) 2 AC1 (where a unanimous House of Lords eventually declared 592 interest rate swap transactions of a total value of over £6bn which had been arranged by Hammersmith and Fulham were unlawful, void and unenforceable – a judgment that had wide-ranging implications for the whole public sector) and Credit Suisse v Allerdale DC (1997) QB 306 (where a unanimous Court of Appeal ruled that Allerdale had no powers to enter into loan, guarantees and other transactions with Credit Suisse to build a leisure complex, swimming pool and time share apartments).

Over the years successive governments have sought to tackle the vires issues arising in the local government market through a variety of measures, most notably by introducing legislation which might – if applicable and if followed correctly – mitigate the effects of the ultra vires doctrine if and when transactions of this nature were subsequently to be struck down by the courts on capacity grounds. The Local Government (Contracts) Act 1997 clarified powers to enter into contracts, introduced a certification process and provided a means to quantifying liability as between the parties in the event of a subsequent ultra vires finding by the courts (known as relevant discharge terms). The Act undoubtedly helped to bring banks and other lending institutions back to the table to fund the PFI programme which was then rolled out by the Labour Government across all local authority sectors.

More widely drafted ‘enabling powers’ of wellbeing were also brought into force under the Local Government Act 2003. Express powers to trade commercially for profit and to charge for discretionary services were also introduced.

Despite these measures, vires issues, whilst less common, still occasionally surface and reach the courts. The Brent case, up to the Court of Appeal stage, focused on both vires issues (use of wellbeing powers to establish a mutual insurance company) and EU procurement issues around the Teckal exemption. The scope of the dispute narrowed considerably by the time the case reached the Supreme Court due to the fact that the Parliament had by then given Royal Assent to the Local Democracy, Economic Development and Construction Act 2009 (“the 2009 Act”). Section 34 will, when in force, give power to local authorities to enter into mutual insurance arrangements. The change in the law largely superseded any question as to the statutory power of local authorities to enter into such arrangements but for the purposes of this article it demonstrates that it took another intervention from Parliament via primary legislation to expressly permit what these London boroughs already thought they had power to do under wellbeing powers.

The coalition government have now introduced the Localism Bill to Parliament in another attempt to provide a lasting solution to the vires concerns of third parties dealing with local authorities. A general power of competence is contained at Clause 1 of the Bill which has yet, of course, to traverse the Parliamentary scrutiny process before it becomes ‘law’. The new powers aim to give local authorities the ability to act in the same way as a natural person. At first blush these proposed powers do indeed seem to ‘do what it says on the tin’ i.e. enable local authorities to "do anything that individuals generally may do".

Clause 1(4) states that the power can be exercised "in any way whatever":

• anywhere in the UK or elsewhere;
• for a commercial purpose or otherwise with or without charge; and
• for or otherwise than for the benefit of the Authority, its area or persons resident or present.

The power does not need to be rooted in the particular area covered by the individual authority seeking to exercise the power or to the residents. However, the capacity to undertake actions will still be subject to challenge under normal public law principles around acting rationally and ‘Wednesbury’ reasonable.

Almost inevitably, the Bill, even at this early stage of its journey through the Parliamentary process, contains measures restricting its scope - such as:

• restrictions as to the exercise of a pre-commencement powers which will apply to the general power in so far as there is any overlap;
• limitations in powers in earlier legislation will apply;
• post commencement limitations will only apply where they are expressed to apply to the general power/all powers;
• commercial trading will only be permitted in function related activities where the Authority is not under a statutory duty to provide services (as with the s.95 Trading Power and must also be exercised through a company under s95); and
• not allowing authorities to do anything specified in an Order made by the Secretary of State under Clause 5(3)

Whether these new proposed powers (should they make it through the Parliamentary process) prove to be a complete answer to local government’s vires issues remains to be seen. The words in Clause 1 appear to be a valiant attempt to address capacity issues and goes further than ever before in that respect. The list of restrictions which follow Clause 1 however, signify that great care will still needs to be exercised by all concerned both to research limitations on powers contained in other legislation and to exercise the powers sensibly and rationally. The new powers should most definitely not be used as some sort of ‘comfort blanket’ or as an excuse not to investigate and ensure the proper use of powers by local authorities (and other public bodies) going forward.

As for lawyers involved in complex transactions involving banks and other lending institutions in the light of the Norwegian experience above – perhaps its time to re-check the firms PII cover and terms of engagement?

Rob Hann is Director of Legal Services at Local Partnerships (www.localpartnerships.org.uk). He is also author/editor of Local Authority Companies and Partnerships (see www.lacaponline.com).

Together with Edward Craft of Wedlake Bell and Stephen Matthew of Nabarro, Rob will be presenting a workshop at the Annual Weekend School for Lawyers in Exeter on 15 April 2011.

© Rob Hann