Local authority trading: how to stay out of the twilight zone

Local authorities have long had legal powers to trade in certain activities.

The increased need for financial self-reliance has propelled most local authorities to look at all sorts of trading activities in the hope of generating income.

Many services can be traded: commercial waste collection, parking, recreational and leisure services, consultancy, professional and technical services, some regulatory and licensing matters but not services that the council has a statutory duty to provide for free.

Most services can be sold at a modest profit to other public bodies.  However, for services where there is no specific power to charge (trade waste collection or municipal restaurants being examples of specific powers) then the council will need to rely on charging powers under s93 of the Local Government Act 2003 or if it wishes to add a profit margin then it will usually need to set up a company under the trading powers in section 95 or use its general power of competence for a commercial purpose under sections 1 and 4 of the Localism Act 2011.

Some local authority enterprises have enjoyed success, others have ignominiously failed and some live in a twilight zone where no one is sure whether they are successful or not because the true operational costs are buried within the overheads of their parent authority.

So what are the factors that influence success or failure?  What is going to happen to the undead enterprises living in the twilight zone- will they be reincarnated as thriving businesses or will anyone put a stake through their hearts?

Most local authorities run services so successfully that they are almost invisible to their consumers who take it utterly for granted that their needs will be met because the authorities have become so good at regulating demand and rationing resources.  However profitable businesses must not just have the humility to know why their customer chooses to buy or not from them, but also the confidence to know whether a customer is worth having.

The first step both legally and financially is to research and build a business case – this can be based on HM Treasury Green Book principles but also needs an injection of acumen to sniff out the over optimistic trading assumptions and how realistic it will be to effect a culture change so that the public service ethic becomes a passion to be the best at what you are selling.

From a legal as well as a financial viewpoint the business case needs to be rigorous in its forecast of overheads and identification of the true costs of running and supporting the business.

Otherwise, not only will the enterprise be condemned to live forever in the twilight zone but it becomes a sitting duck for a stake through the heart in the form of a state challenge (for which there is a 10 year limitation period), queries by auditors and members of the public in relation to the authority’s accounts not demonstrating a return on investment or to a political decision to wind up the business.  One should always remember that local authorities are the stewards of public funds and as such have a fiduciary duty under common law to ensure value for money, act in a business-like manner having regard to all relevant considerations (e.g. are we getting a return on our investment with this business) and disregard irrelevant considerations (I fancy setting this up because it will look good on my CV).

State aid arises whenever a public authority confers a benefit on an undertaking which has the effect or potential effect of distorting competition across the EU and if it is unlawful can result in clawback of the aid with mandatory interest and a fine on the local authority.

Employees will always be a key issue to address at the outset.  If a business has to carry the same overheads (salaries, benefits and pension contributions) as local government it is less likely to be able to be profitable in a crowded marketplace especially where the gig economy is beginning to prevail.  If the business is providing a premium service for which there is high demand then it can afford more generous remuneration.

However it is possible also to rationalise and modernise terms and conditions and remain a decent employer.  In fact members may have to accept that to get the right people to run the business they may need to be paid more than the Council’s Chief Executive!

Economic, technical or organisational reasons entailing changes in the workforce can justify changes to terms and conditions where TUPE applies but do ensure an employment law specialist reviews your business case so that it does justify the changes, and do not inadvertently evidence other potential claims. Thought also needs to go into whether there is the potential for equal pay claims relying on comparisons between employees of the authority and the trading business as “associated employers”, before or after changes are made.  Early consideration of pension risks and an actuarial valuation will also prevent drifting into the twilight zone.

Some local authority businesses take their main customer, their parent local authority for granted and neglect them in the thrill of the chase for new customers.  This demonstrates complete naïveté from a commercial and political viewpoint.  If the purpose of the enterprise is to generate income then you should cost up how much resources have to be used to chase and secure the new customer, whether the resources might not be better spent looking after your existing customers but most importantly whether the new customers will deliver the same or a higher profit margin.  As the saying goes, “turnover is vanity but profit is sanity”.

So a successful revenue-generating business will include motivated and appropriately remunerated people from top to bottom who are genuinely passionate about delivering a great product which outclasses their competitors, they will understand market forces, have undertaken rigorous analysis of their overheads and where profit can be achieved and a sound legal and financial foundation.

Helen Randall

Helen Randall is a partner at Trowers & Hamlins LLP.