When good companies go bad: How local authorities should deal with companies they control or influence

Stephen Pearson, Freeths, Nottingham

Local authorities entering joint venture (JV) arrangements, either with other public authorities as part of shared service deals or with private sector partners who possess specialist skills, are becoming increasingly commonplace.

Like a marriage, the creation of a JV is often viewed by authorities through rose tinted glasses. There is an expectation that working together will be a happy and mutually beneficial experience, leading to the generation of commercial income, improved services or regeneration in a blighted low-value land area.

Those who bring JV proposals to the lawyer’s door are generally not lawyers and may not have in mind all the issues that need to be considered before a JV agreement is finalised.

The role of the lawyer is to take a long, hard look at the proposed relationship and consider every aspect of how it will work in practice. Some of the issues that need to be considered may be uncomfortable or contentious.

For example:

  • What commitments, in terms of management time and day-to-day support, will each partner make?
  • What will happen if members of the company seek to make the company act beyond the scope of its role?
  • What steps can be taken to ensure nominee directors do not ‘go rogue’ and act outside an authority’s policies?
  • What will happen if the service relationship between the company and local authority is not properly handled?
  • How can the relationship with the company be terminated?
  • What will happen to assets, employees etc if the company is wound-up?

A lawyer’s presence at the JV marriage is not a popular one, but the very mixed experiences of local authorities and JV entities means that a hard-headed approach needs to be taken.

There is a lack of detailed analysis concerning the rate of success and failure of local authority sponsored companies, with published information tending to focus on the arrangements that have gone badly wrong. Take for example the case of Southwest One, an outsourcing arrangement to deliver back-office services through a company set up between Somerset County Council, Taunton Borough Council, Avon and Somerset Police and IBM, which ended in legal proceedings when a dispute arose as to whether the arrangement was on target to deliver promised costs savings. In situations like this, the terms of the agreement between the parties are absolutely crucial.

Clients from both the public and private sector often say ‘we don’t need to talk about that’ because they believe that their relationship will be successful. In many cases it will be, but it is still important to have a robust agreement in place to cover those occasions where things do not go according to plan.

It is difficult to give generic advice to cover all scenarios, but it is possible to develop a checklist of legal and commercial questions that need to be asked. Below are suggestions for some of the things you need to consider:

  • What are the essential reserved matters which need to go into the members or shareholder agreement? At the very least, these need to allow for unanimous agreement on the nominee taking any steps outside of its core business, entering into transactions above a pre-ordained level, entering into major long-term financial commitments, and appointing members of staff above a stated seniority or pay level.
  • How are the directors, particularly those who come from a local authority environment, going to be trained to understand their formal duties under the Companies Act 2006 and how to act in the best interests of the company, while at the same time giving attention to their role as local authority members or officers, including when and how to make appropriate disclosures of their roles?
  • If the company is providing services to the local authority, how will a service agreement be put together so that it properly describes the service to be provided, the performance indicators that will be used and the mechanism for dealing with failures to provide the required level of service. In so far as this last point is concerned, it needs to be borne in mind that the people who are providing the service might well have worked for the local authority until a few months ago, and it may therefore be unrealistic to expect that they are going to transform themselves just because a different manager is overseeing them.
  • How will the JV arrangement be funded? Every organisation needs some cash flow to get it through its weekly obligations so that it can pay employees, rent and external professional services. If this is to be financed by loans, what are the terms of these loans going to be, both to satisfy your treasurer’s commercial objectives but also to avoid an unlawful state aid situation arising.
  • If the company is going to trade with your local authority, is this permissible in Teckal terms without a competition?
  • How is decision making going to be made on a regular basis? If there is a board, what will the business of that board be? If there is an equality of membership between local authorities or between a local authority and the private sector, how will a stalemate be dealt with? Will there be a casting vote by the chair, how will that chair be appointed, and does there need to be some additional dispute resolution mechanism for issues that cannot be resolved between representatives?
  • How can the company be persuaded to think strategically, rather than just respecting what its individual members are looking for? This is a combination of encouraging directors to think strategically, but it is also worth thinking about whether it is appropriate to appoint an external non-executive director who is not perceived as coming from one side or the other.
  • Is there a business plan for the organisation that is comparatively realistic over a period of say three or five years? It has been suggested that if an authority invests in an organisation without having at least some overall objectives and plan, they are not properly discharging their fiduciary duties.
  • If the JV arrangement does not go according to plan or if you just decide that you do not want to be involved in it any more, what is the exit plan? If it is a company, what will be the mechanism for buying out the other party’s shares or selling your shares to them? Can you trust the valuation methodology?
  • What about the workers? Will they be seconded or transferred out under TUPE? If the agreement comes to an end, will they be transferred back and will there be a space for them?
  • Will the company be required to join the Local Government Pension Scheme? Has the pricing for this been budgeted for? Will the actuaries recommend that a non-standard pension contribution is applied because of the age profile of your employees? If a guarantee is required, does this work in state aid terms?
  • Do you want to allow for other shareholders joining your venture and, if so, when and on what terms?
  • How is the company going to report back to the authority? For example, will it do an annual report? How will it go back for approvals in terms of things that are required to obtain shareholder consent?

Thinking about these issues at the outset will not guarantee the success of a joint venture, but it should help you to navigate any problems that may arise and give you the best chance possible of making your relationship work.

Stephen Pearson
Partner
Freeths LLP
0845 274 6900
stephen.pearson@freeths.co.uk