James Hawkins and Scott Dorling consider the key issues that councils must consider when setting up local authority companies.
The last ten years has seen an exponential growth in the number and variety of local authority companies including new joint ventures being set up between public, private and third sector organisations.
With a fundamental shift away from outsourcing local authority services, the local authority/public sector wholly owned or Teckal services company is an increasingly popular model – both for services currently provided in-house and as an option for delivering services once an outsourced contract comes to an end.
The increasing focus on commercialisation has resulted in local authorities setting up trading companies to sell services to third parties or as vehicles to develop, manage or invest in revenue generating assets such as rented housing (affordable and market rent), commercial property as well as leisure and cultural facilities.
Joint venture vehicles are increasingly being used to deliver shared service arrangements between public sector partners and as vehicles to allow the public sector to participate in commercial ventures with private or third sector partners including major real estate and regeneration initiatives.
Any arrangement involving a local authority owning or making a significant investment in a company raises issues of good governance for the local authority directly and in relation to the internal operations of the company. The desire to implement a project and the practicalities of getting a company up and running has meant that in some instances, good governance has taken second place resulting in unmanaged risk and lower than expected returns.
Government is also looking more closely at local authority governance following calls by the Public Accounts Committee for the government to strengthen audit and governance of the “complex and fast-moving” environment that local authorities find themselves in. The Public Accounts Committee particularly focussed on shared services and local authorities taking on commercial risk whilst simultaneously dealing with a “significant” reduction in resources.
What is good governance?
A local authority may have a number of roles in relation to a company, for example as the shareholder (owner) of the company; funder and also commissioner of services. Accordingly, there is a potential tension between the different roles. This may be compounded where the local authority also nominates council members or senior staff as the directors of the company. Mechanisms for identifying and dealing with potential conflicts need to be in place.
Within the company itself, good governance includes ensuring there are directors with sufficient skills and experience to run the company, ensuring the scope of directors' authority is clear (including training on directors' legal duties), transparent decision making and compliance with governance documents including the company's articles of association, standing orders and schemes of delegation and financial and contract regulations.
Where there is a service contract between a council and its company, the parties need to implement appropriate contract management arrangements (usually set out in the services contract) which often include joint liaison committees to review service and operational issues including disputes, company performance and strategic developments both in the relationship between the parties and any proposed extension of the company's business.
Implementing good governance – local authorities
At the outset of any project, the local authority should confirm the basis allowing it to set up, fund and contract with a company and any limitations which apply to the arrangements. This will help to frame the ongoing relationship with the company and inform the approach to governance arrangements.
Articles of Association
This is the overarching constitution document for a company. It will set out the purpose of the company, powers, rights of shareholder(s) and procedures at general meetings of the shareholder(s) and board meetings. For a Teckal services company, the articles will also need to demonstrate local authority control over the company by confirming the local authority's rights to remove and appoint directors and provide for periodic retirements to ensure the composition of the board is kept under review.
The articles should be supplemented with a shareholder agreement - even where there is only one local authority shareholder/member. The shareholder agreement should set out matters which are reserved to the local authority including any rights to remove and appoint directors, restrict the company's rights to issue new shares or admit new members, limit the company's rights to borrow, provide regular information, approve any changes to the business plan (to be reviewed and updated annually) including proposals to expand trading with third parties and compliance with other requirements such as restrictions on political activity.
For Teckal services companies, the shareholder agreement will help demonstrate the required level of control over the company. For trading and investment companies, the shareholder agreement may need to evidence sufficient independence from the local authority to ensure the company is not treated as a public sector entity for accounting and procurement purposes.
The local authority will need to decide how it will exercise its rights as shareholder including which member or officer is authorised to exercise the local authority's rights at general meetings of the company. This could be a specific officer (e.g. head of paid service or monitoring officer) or a committee of members/officers. The terms of reference for any shareholder committee should be documented for clarity.
If the local authority is providing loan funding, this should be properly documented as a commercial loan incorporating similar provisions and covenants to a commercial bank loan. The covenants should be monitored by both the local authority and the company's finance director and any mechanisms for identifying and resolving breaches followed. It is likely that this role can be best monitored by the local authority's S151 officer.
Where the company is providing services to the shareholder local authority, it is advisable to establish a clear client / contractor split so it is clear who at the local authority is responsible for ensuring that the required services are delivered to the contract standard and that any mechanisms for dealing with poor performance and remediation are followed. This role is likely to be fulfilled by a retained local authority senior manager.
Local authorities should adopt a formal conflicts policy to address conflicts between the local authority and the company and between the different roles of the local authority. The policy should recognise that conflicts can be reduced if local authority members and officers with designated roles acting for the local authority are not also appointed to senior positions in the company.
Particularly during the set-up phase, local authorities may want to formally second staff to help the company work up the business plan and any contract and specifications and to deal with mobilisation. Care should be taken to make sure that seconded staff are not seen as also making decisions on behalf of the local authority particularly in matters relating to land and other assets to be acquired by the company and, for service companies, in relation to service specification, pricing and performance standards.
Implementing good governance - companies
Board of directors
The board should regularly undertake a skills audit to ensure that it has an appropriate balance of skills and experience appropriate for the type of company they are running. This is likely to include people that collectively have commercial, financial, business development, legal and HR experience. Those skills may either be demonstrated by people nominated by the local authority or by the company employing non-executive directors.
Directors' service contracts
The terms of each director's appointment including role, responsibility and any remuneration should be clearly documented including provisions for removal and retirement.
Directors should receive regular training on their legal roles and responsibilities, both as company directors and also in relation to companies generally – e.g. responsibilities under the Bribery Act 2010, Modern Slavery Act 2015, Data Protection and Health and Safety.
Internal governance documents
For public sector companies, high standards of internal governance should be expected. This can be documented in a number of internal governance documents including standing orders - setting out how decisions are to be made and at what level (board, designated directors or other members of staff). It is also prudent to adopt financial and contract regulations confirming how financial issues are to be dealt with including business planning, budget control, financial systems and financial monitoring and reporting. Contract regulations will help to ensure compliance with procurement law, transparency, probity and the need to drive value for money and other relevant objectives (such as social value) when letting contracts. We have prepared internal governance documents for a wide variety of our public sector company clients.
Where the company is providing services to the local authority, the success of the arrangements is likely to be increased if both parties regularly check they are complying with their obligations in the services contract (and any related funding agreement). This means that key staff delivering the contract need to understand the company's obligations and what it is required to deliver including performance standards. Any variations to the arrangements should be documented as required in the agreement (usually a change control notice) so there is a clear audit trail on how and when any changes have been agreed.
How we can help
We can help you address all of the issues highlighted above, both when setting up a local authority company or deciding to enter into a joint venture arrangement and also in relation to any periodic review of the local authority's and company's governance arrangements.
We understand that governance issues need to be handled sensitively, particularly as the parties will want to have a close on-going relationship with each other, but it is preferable to look at these areas when things are going well rather than following an adverse audit or as a result of the company facing financial difficulties.