Governance - The silent killer of LA Companies?

Due to the continued reduction in central govt financial support, and the resulting need for Local Authorities to become more self-reliant and more commercial, there has been an increasing increase in the number of LA companies being established.

Setting up a company brings with it certain consequences which are not always clear at the initial planning stages and until recently, one of the things missing from the Local Authority toolbox for facilitating such new commercial entities was any kind of guidance at all for putting in place strong governance procedures.  

I am sure you have read in the news many stories of Local Authority owned companies that have failed, and more often than not, it is the lack of adequate governance arrangements that have caused it.  So, what lessons can be learned from those who have fallen before us?

Put simply, Local Authority Companies need to strike the right balance between their own need for operational freedom, whilst also acknowledging the need for shareholder accountability, and supporting the parent Local Authority’s goals and objectives. 

Whilst many Local Authority Companies are set up to do things which the Councils already do, such as Repairs and Maintenance, Cleaning Services, Processing of Benefits Claims etc. with the right in-house skillss to provide such services to a simple and not overly competitive market, there are others who seek to enter totally new markets,  Robin Hood Energy and Bristol Energy being two such examples. 

However, what all Local Authority Companies have in common, regardless of complexity and what must never be overlooked or taken for granted, is the fact that they all involve the expenditure of public money and the stewardship of public resources and as a result there are key governance considerations that many in the past have failed to adopt, which have contributed to the demise of many a well-meaning Local Authority Company, regardless of its simplicity.

One key area is the composition and structure of the Board and the role of the Shareholder.

Shareholder

Shareholders are the owners of Companies.   

Shareholders control Companies through the appointment and removal of Directors and may also exercise control in accordance with rights given to them either in the articles or a separate contract with the Company, known as the Shareholders’ Agreement.

A Shareholders’ Agreement sets out which matters are delegated to the Board of Directors and which are reserved for decision by shareholders.  

In practical terms it is more effective to delegate most of the day to day decisions to the Directors, either at Board level or through an Executive Managing Director (MD) or Chief Executive Officer (CEO). 

However, the Council may wish to have reserved matters for significant strategic decisions such as undertaking new business, diversifying the business, taking on new debt facilities, deviating from or changing the agreed business plan, substantial disposals and acquisitions, or entering into long term partnerships.  

Initially, it is normal for the Council to approve the business plan and the Board of Directors would then have the remit and discretion to implement it, subject to the reserve matters.

Having approved the business plan, the Council will need to decide how it then wishes to exercise its ongoing shareholder function.  Given the function should be about strategic control over company’s activities it is normal for this function to be exercised by the elected Members of the owning Local Authority.  

Depending on the level of the control retained under the shareholders agreement, this could be by:

• having all shareholder decisions going to Cabinet;
• having a sub-committee of Cabinet being established to undertake some or all decisions; or
• delegating specific decisions to certain elected Members/ Senior Officers.

Such decisions and protocols should all be included within the proposed Shareholders Agreement.

Directors

The Directors will be the individuals who control the day to day operation and management of the company, subject to the reserved matters.  

There is no legal requirement to have a Company Secretary or any other specific roles such as Finance Director / Treasurer or Chairperson, however, it makes sense to have more than one Director registered at Companies House so that the company can continue to trade normally if one Director were to resign, die or is simply be unavailable to act when needed, for example when signing off company documents and returns. 

One key consideration for a Council is whether the Directors should be elected Members or Council officers.  The relationship between the company and the Council also needs to be considered, to avoid any conflicts of interest.  For example, Director Members would have to excuse themselves from Council decisions if they are seen to be in conflict with their role as company Director.

In addition, if you choose to have elected Members on the Board of Directors, you should consider whether to include a cross-party mix, and be aware of the potential implications that changes in both individual elected Members of the Council and an overall change in political control that can occur each May.  One of the key long-term risks for a Council Company is that a political change of Administration could easily result in a shift in the purpose of the Company that could undermine the future commercial viability.

However, it should be acknowledged that a company operating in a competitive commercial market ideally needs Non-Executive Directors who understand the relevant environment and market, and whilst Councillors may take their roles seriously and seek to understand the commercial environment, there is no substitute for having direct experience in that or a similar environment.

More generally, it is actually not seen as good practice for Councillors to be on the Boards of Local Authority Companies, as there are a number of other mechanisms and methods of scrutiny that can be put in place to ensure that the Company meets the Council’s objectives. 

Whilst having the relevant Councillor/Portfolio holder on the Board (eg the Housing Portfolio Member on the Board of the Housing Company) may bring advantages in that they would normally understand more than other Members about the sector and help to ensure that the Council’s policy priorities were being pursued, the Company can end up becoming an extension of the Council itself.

Having Councillors on Company Boards can therefore lead to a failure to properly separate the two sets of interest – of the Company and of the Council. 

As a minimum, the Council needs to review the appropriateness of being reliant on Councillors sitting on the Boards of its Companies and ensure that Boards have an appropriate level of sector-specific and commercial knowledge and experience. There may be some Companies for which a higher proportion of Councillors can still achieve this, although such arrangements still present risks around potential conflicts of interest.

It is also worth noting, if considering the appointment of Statutory Officers (S151, Monitoring Officer etc) as Company Directors, whether their statutory day to day roles actually allows them to act in the interest of the company only, when required to make decisions as a Board member of the Company.  

Ideally, the Council should appoint just one of its Senior Officers as ‘Shareholder Representative’, with the intention that this individual focuses on ensuring that the Council’s best interests as shareholder are served and protected. 

The role of the Shareholder Representative should be formally defined and essentially be the focus of all communication between the Council and the Company, with specific regard to protecting the Council’s interests, identifying risks and raising any concerns with the Council’s Statutory Officers.  It is through this role that requests for financial assistance should be requested, but also this role that should demand quality and accurate financial information from the Company to the Council.

This one point of contact between the two entities should ensure that there is a clear distinction between Council and Company, and a clear mechanism to hold the Company to account.  

A summary of key governance consideration is listed below:

• The Council must understand the risks involved in the ownership of, and investment in, LA Companies. 
• The Council must understand the financial position of its Companies through the receipt of quality and accurate management information.
• The Company must have sufficient sector or general commercial expertise at Non-Executive Board level.
• Where it chooses to appoint Councillors to Board roles, the Council should ensure that they have the required knowledge and experience to challenge management.  This is of particular importance where the company is operating in a sector which may be outside of the normal experience of a Council.
• When appointing Board roles to individual Councillors, the Council should ensure that the scope for conflicts of interest is minimised, with a clear divide between those in such roles and those responsible for holding them to account or overseeing them.
• Where Councillors are used in such roles, the Council should ensure that Councillors are provided with sufficient and appropriate training which is updated regularly.
• The Council should appoint a designated Shareholder Representative, to act as the communication link between Council and the Company.
• There must be clarity in relation to roles within the governance structure.
• Governance arrangements must establish an appropriate and consistent balance between holding to account and allowing the Company freedom to operate.
• The Council should ensure that all elements of its governance structure, including the Shareholder role, are properly defined and that definitions are effectively communicated to the necessary individuals.
• A suitable sub committees should be put in place to add an additional level of scrutiny and accountability. This could be in the form of a Council Director led steering group, an officer shareholder Board or a governance subcommittee that reviews the company governance arrangements, to ensure that risks are appropriately flagged and managed, as well as putting in place robust risk and financial monitoring.