Don’t let council-owned companies spin out of control

A small collection of failures has prompted many questions about council-owned companies. Helen Randall navigates the pitfalls and the safety mechanisms.

In the aftermath of the Liverpool, Croydon and Nottingham debacles, many local authorities are nervous about owning or creating companies and CIPFA is promising new guidance on council-owned spin-outs. This is unsurprising given some of the toe-curling commentary in the reports:

“The council has managed some of these initiatives …extremely poorly.” “They have pursued a policy of ‘commercialisation’…without much understanding of either the volatility or quality of these streams creating a risk issue in setting the budget.” “No-one within the Council was tasked with overseeing the contractual loan documents made with investment companies.”

There are many more.

Below are some of the flaws mentioned in the reports. Do they ring a bell? If so, it may not be too late to restructure the company and get it on the road to recovery before your authority becomes next week’s headline.

• Non-executive directors (NEDs) on the board who have insufficient industry experience;
• No or minimal training before directors are appointed, so they are unaware of the personal risks they are running;
• No consistent or detailed approach to cash flow forecasting, with the company funded on an “as and when needed” basis by the council;
• Infrequent board meetings. These should be six-weekly (or monthly during the pandemic);
• Company’s managers have no say in who is appointed to the board or on churn of board members;
• No watching brief by the council as shareholder to ensure its investment and policy objectives are being delivered by the company, just a reporting brief;
• Insufficient understanding of the company’s competitive environment or meaningful operational business risks beyond the company risk register;
• No formal contract between the council and the company;
• No competitive benchmarking of the fees the company charges the council (thus breaching Best Value legislation);
• Out of date business plan;
• Council’s funding to the company breached state aid/public subsidy control rules.

Duty

So, is it still a good idea to have a corporate vehicle and what lessons can be learnt from those reports? The answer depends what a council wants to do. Croydon’s companies, Brick by Brick and Croydon Park Hotel, were intended to produce commercial income but had not generated dividends or even repaid some council loans. Nottingham established Robin Hood Energy to avoid council redundancy costs and secure income from supplying cheaper tariff energy but it made losses. In both authorities’ cases, the companies appear not to have succeeded because of lack of understanding of the market at board level.

It is the personal legal duty of a company director to act in the best interests of the company with reasonable skill and care.

Moreover, company success will depend on whether elected members are willing to allow the company to be managed by directors with specific experience and detailed sector knowledge of the relevant business and understanding of prevailing trading conditions. As the Nottingham report noted:

“Being a brilliant ward councillor or an effective political leader are not necessarily the skills you need in assessing a business…. Being a company director needs specific skills and experiences, either in the industry itself or the wider business environment. … not many appointees were able to contribute and …too often, they were not on the board long enough to gain understanding.

“If the Council is to continue to be involved with a company structure in the future it needs to appraise the roles and skill sets required for specific companies and ensure they appoint the best match, even if this means the individual appointed is not a councillor”.

The council must allow sufficient resource and put in place administrative machinery for financial forecasting and holding the company to account. Otherwise, the council is in breach of its legal duty to obtain value for money. If you have not done this already it is never too late to start.

Resources

You should start by defining the key success measures for the company. Then scope the respective roles of: shareholder representative; council commissioner; and who will be running the company.

To prevent bias and conflict of interest, these roles should be kept distinct and no one should be twin-hatted. What are the skills, time, administrative and financial resources needed to perform each of these roles properly?

Document all of this in the company’s constitutional documents (articles of association and shareholder agreement), the business plan, the council’s scheme of delegation and the contract and funding agreements between the company and the council, and only then, decide which individuals should perform each role. You may also need to advertise to recruit externally.

It can be prudent for a council to have a company as long as it is run by directors who are appropriately skilled and experienced and the documents, administrative machinery and resources are there to enable the council to hold the company to account properly.

If these are lacking then the company will not have solid foundations and is less likely to survive. Although legally a shareholder’s liability for a company will usually be limited to the amount of its investment, in reality, few local authorities will wish to allow their company to fail so it is vital to define what factors mean success or failure at the outset.

It is possible to restructure existing companies to put them on a sounder footing. Alternatively, prudence may dictate repurposing, selling or closing a company if for example, market conditions are not as predicted.

However, a council has a legal fiduciary duty to make decisions with its business brains rather than its political brain. That way, it will avoid a Croydon, Nottingham or Liverpool scenario arising on its front doorstep.

Helen Randall is a partner at law firm Trowers & Hamlins LLP.