Game of loans…

Helen Randall is a partner in the public sector commercial team at law firm Trowers & Hamlins

Northumberland County Council was recently in the news for buying out Hexham hospital’s private finance initiative contract to the tune of £114m.

This makes sense for Hexham hospital which was procured under the Private Finance Initiative and which was costing the NHS Trust an amount it could no longer afford, and also for Northumberland who wanted to maintain healthcare provision in its area and who have borrowed the money from the Public Works Loan Board.

It will apparently be at least £3.5m cheaper for the hospital to be financed by the local authority than by private equity.

In today’s climate this sort of deal makes increasing sense where public bodies are struggling to afford the costs of privately financed infrastructure especially PFI or PPPs, and where local authorities have reserves or access to cheaper funding – particularly after recent concerns about  the value for money of PFI unitary charges once construction has completed and risk is “swapped out”.

We are now also seeing an increase in local authorities funding regeneration projects. They are investing in service spin-outs to local authority-owned or joint venture companies, social enterprises and mutuals. Local authorities are also involved in private sector rented housing vehicles outside the housing revenue account, establishing mortgage-lending schemes and municipal banks while the Local Government Association is pressing forward with its multi-authority bond.

Local government is in some cases becoming the funder of last resort and in others acting as a catalyst to grow local economies. However, local authorities should tread somewhat carefully when embarking on these sorts of deals to protect themselves against potential vulnerability to challenge under statute and common law as well as European law.

Local authorities have investment powers under section 12 of the Local Government Act 2003 which states “a local authority may invest – (a) for any purpose relevant to its functions under any enactment, or (b) for the purposes of the prudent management of its financial affairs”, provided when exercising the power they comply with current secretary of state guidance and stay within their prudential indicators.

However, investment funding cannot necessarily be used to finance a council leader’s latest pet project. As is well-known, under common law local authorities are creatures of statute and as such have powers to do only what statute provides (Attorney-General v Great Eastern Railway Co. (1880) 5 App Cas 473), have fiduciary duties of stewardship regarding public funds to secure value for money (Roberts v Hopwood (1925) AC 578) and have legal duties to act in a reasonable and business-like way (Prescott v Birmingham Corp (1955) Ch 210. (1954) 3 All ER 698).

Hexham is a public NHS hospital which serves the entire community hence state aid is unlikely to be an issue.

But in a joint venture context state aid is increasingly important given that widespread state aid and procurement compliance audits of local authority recipients of European funds are now being rolled out.

Simply put, state aid is a benefit or advantage given by the state, or through the state’s resources, to one or more selected economic operators which has the potential to distort competition in the single European market and affect trade between EU member states. State aid is by default unlawful unless it is specifically permitted under ‘State Aid law’. Authorities should therefore ensure they invest on the basis of the Market Economy Investor Principle, which basically means that the terms and conditions of authorities’ investments should be acceptable to a private investor operating under normal market economy. There are additionally a number of exemptions for state aid available including de minimis and new general block exemptions, which may be helpful depending on the precise nature of the proposed investment and market sector. In any event, the issue with state aid is that it is assessed in the hands of the recipient and if funds are clawed back the recipient might be put into an insolvency situation.

Once you are clear that your authority’s proposed loan is legally compliant you will want to consider its terms carefully. Is the investment going to be made as a pure loan or equity funding by way of share capital? How do you want to take security over the asset for the finance? What due diligence are you going to undertake regarding the assets you are financing to ensure you are not acquiring a white elephant? Do your elected members appreciate the difference between shareholding and dividend distribution policy? How will any local authority appointed directors avoid conflicts of interests and what will their mandates be?

All these issues can be addressed but as ever need sufficient planning, prior briefing and negotiation to secure the most profitable and successful outcome.