September 08
LOCAL AUTHORITY COMPANIES
Contents
Forms of Business Organisation
Introduction
Partnership
Companies
Decision making
Written resolutions
Taxation
Debts and liabilities
Publicity
Directors
Types of companies
Company limited by shares
Company limited by guarantee
Public Limited Company
Charitable Company / Charitable Incorporated Organisation
Community Interest Company
Local Authority Company
Industrial and Provident Societies
Companies created by the council
Source of power to create companies
The trading power
Public sector bodies
State aid
Is a company necessary or appropriate?
The financial considerations
Summary
Factors to consider
Why am I considering a Company?
Are there financial benefits to creating a Company?
What are the financial reporting requirements?
What type of Company should I consider?
Should we opt for a controlling interest or a minority interest?
Members and Officers appointed directors of companies
Personal liability
Indemnities
Insurance
Conflicts of interest
Recommendations
Who can give me more information?
Guide A: Directors’ duties and liabilities
Director’s Duties
1.Duty to act within powers
2.Duty to promote the success of the company
3.Duty to exercise independent judgement
4.Duty to exercise reasonable skill and care
5.Duty to avoid conflicts
6.Duty not to accept benefits from third parties
7.Duty to declare interest in proposed transaction
Other statutory duties
Liability of directors
Local authority company directors
Indemnities and insurance
Guide B: Indemnities for Members and Officers
Guide C: Definitions in relation to Group Accounts
LOCAL AUTHORITY COMPANIES
Forms of Business Organisation
Introduction
There are a number of forms of business organisations through which the council can choose to operate a business. In ascending order of complexity, the most common are :
A local authority is a statutory corporation so it could never choose to do business as a sole trader, which is a business operated by an individual who alone makes decisions, owns assets and is ultimately responsible for the business’s debts and liabilities.
Partnership
Whether a partnership exists depends on whether or not the definition contained in s.1 of the Partnership Act 1890 applies. It isa form of business where two or more individuals or companies agree, on the basis of a contract, to do business together with a view to making a profit. The agreement does not need to be in writing and unless otherwise agreed, decisions are made by simple majority (except for introduction of new partners), profits and losses are shared equally and assets are beneficially owned by them all. The most fundamental characteristic of a partnership is that all of the partners share responsibility for all of the partnership’s debts without limit. And if one or more cannot pay, then the remainder must cover for them.
Companies
A company is a distinct legal person separate and independent from the members who set it up and the directors who run it. The company owns and runs the business.
All types of companies are a variation of the plain vanilla private limited company. Although they may be subject to different and more regulated regimescharity companies (CCs), community interest companies (CICs), public limited companies (PLCs) and local authority companies (and there are others) are all “bells and whistles” companies that are allowed to do or are prohibited from doing certain things by virtue of their constitution.
Decision making
Decision making is shared between members and directors. Directors are empowered to make the day-to-day decisions at board meetings or by written resolution.At board meetings decisions are made by simple majority where each director may cast one vote. Directors can delegate their powers to make decisions to individuals (managing director), to one of their own (executive director) or to a committee (audit and remuneration committee).
Being the owners of the company members have some important decision making powers such as the power to remove director(s) and to change the company’s constitution. Decisions made by members are made by a prescribed majority depending on the decision in question either at general meetings or by written resolution. Dismissing a director requires a simple majority (ordinary resolution), whereas changing the company’s constitution requires a majority of 75% of those voting (special resolution).
Written resolutions
In the same way as directors make decisions by simple majority at board meetings and members by prescribed majority at general meetings, and except for the removal of a director or the auditor, directors and members can manage the proposal and passing of resolutions byelectronic means (email). For the moment only private limited companies can take decisions by written resolutions.
Taxation
A company will pay corporation tax on the profits of the business.
Debts and liabilities
The company is responsible for all the liabilitiesit incurs in the normal course of business. Even in the event of the company’s insolvency the principle of limited liability insulates officers and directors from third party claims whereas shareholders are only responsible for the price they paid for their shares. Only in extreme cases, such as where the director or shareholder has been guilty of fraud, will they incur personal liability.
Publicity
To counter-balance the advantage afforded by limited liability, companies are required to make public certain information relating to its finances, directors and members. PLCs are required to provide even more information about their business and finances because its shares are traded on The Stock Exchange. Local authority companies are required to state on the company’s stationery that it is a local authority company.
Directors
A company must have at least one director who is a natural person. Directors no longer require to register their actual address, and can apply to have a service address registered instead at Companies House, nor do they have to register details of other directorships held.
For further information about companies visit :
Types of companies
Company limited by shares
Almost every company formed with a view to make a profit is registered as a company limited by shares. A company limited by shares means the liability of its members (otherwise known as its shareholders) is limited to the amount of money they paid or promised they would pay in exchange for the shares registered in their name. It allows the owners to extract value from the company if it is profitable (via a dividend payment or increase in value of the shares), and by issuing shares it has an additional source of funding. A person becomes a shareholder either by having shares allotted to them directly by the company or by purchasing shares from other shareholders.
Company limited by guarantee
A company limited by guarantee is one where its members promise to contribute an amount of money towards the debts of the company in the event it is wound up. A company limited by guarantee cannot distribute its profits to members by way of dividend and if there is any money left after it is wound up it will normally be transferred to another similarly motivated organisation. Usually companies limited by guarantee are formed for not-for-profit purposes and are not appropriate if the idea is to trade with the private sector for profit. A company limited by guarantee can only be capitalised by incurring debt unlike a company limited by shares.
Public Limited Company
A public limited company (PLC) must describe itself as so (by inserting “plc” at the end of its name).The ownership structure and operation of a PLC is very similar to that of the private limited company. The differences arise mainly from the distinct regulatory regimes that can apply to PLC.The extra layer of legislative control is there principally because of the freedom PLCs have to offer their shares to the public at large, something a private limited company should not do. A more restrictive regime operates on PLCs whose shares are listed on The Stock Exchange. A lot of what is prescribed by these regimes is embedded in the constitution of PLCs.
Charitable Company / Charitable Incorporated Organisation
A charitable company is a private limited company or PLC that is constrained by its constitution to carry out activities that are exclusively charitable.The property and income of a CC must be applied solely for the stated charitable purposes. That means all profits or surpluses must be reinvested, directors cannot draw salaries unless specifically authorised to do so by the Charity Commission, and on the winding-up of the CC all the company’s assets must be applied to further the charity’s objects or be transferred to another CC which have similar objects. These controls exist because of the fiscal exemptions enjoyed by charities.
At the moment, CCsare regulated by company law and charity law,they must register with the Registrar of Companies (Companies House) and the Charity Commission and file statutory documents with both bodies. However, the Charities Act 2006 introduced a new legal form of incorporation which will bring corporate charities under one legal regime regulated by the Charity Commission only. The Charitable Incorporated Organisation will continue to benefit from limited liability like the CC but without the burden of dual regulation.
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Community Interest Company
A CIC has two distinguishing features. First, a CIC can only carry out activities (defined and entrenched in the constitution) that have the effect of “benefiting” the community, and second, a CIC must have an “asset lock”in its constitution. That means that all assets (including assets transferred by a founding member and the CIC’sprofits) must be used for the benefit of the community. The only way to remove the assets from the CIC is by a transfer at full market value or a transfer to another CIC. A CIC limited by shares can pay dividends to member CICs; to other members it can only pay up to the Dividend Cap (5% above the Bank of England’s base rate or 35% of the CIC’s distributable profits, whichever is less). Unlike private limited companies whereby the directors have the power to declare a dividend, with CICs, a dividend can only be declare by ordinary or special resolution of its members.
For further information please visit :
Local Authority Company
At the moment Part V of the Local Government and Housing Act 1989 defines what is a Local Authority Company (LAC). If a LAC is “regulated” the council must ensure that it applies propriety controls to the LAC, for example the company must advertise the fact that the company is a LAC on all company stationery. A regulated LAC is a company in which the council has either over a 50% controlling interest, or has at least a 20% interest plus a business relationship with the LAC accounting for over 50% of the company’s turnover or the LAC was located on council land leased or sold for less than best consideration.
When Part 12 of the Local Government and Public Involvement in Health Act 2007 comes into force it is expected that Part V of the 1989 Act will be repealed and a new set of definitions for a LAC will come into play. These new definitions are expected to cover a wider range of companies connected with the council.
Industrial and Provident Societies
Like limited liability companies, Industrial and Provident Societies (IPS) are corporate bodies with limited liability. Theyare registered under the Industrial and Provident Societies Act 1965 - 2002 (IPSA) and regulated by the Financial Services Authority. The defining feature of an IPS is that it must incorporate the principle of a bona fide co-operative: each member must and can only have one vote.
Companies created by the council
Source of power to create companies
Local government activity is controlled by the doctrine of ultra vires.As statutory corporations, local authority activity must be underpinned by a statutory power or duty. If a transaction is ultra vires it is deemed never to have taken place.
Local authorities have a variety of powers enabling them either to form, or acquire shares in, companies. Section 2 of the Local Government Act 2000 (LGA 2000) introduced a general power to enable local authorities to promote the economic, social and environmental wellbeing of their areas for the benefit of the area or persons residing or present in their jurisdiction (the wellbeing power). The wellbeing power authorises local authorities, amongst other things, to “co-operate with, or facilitate or co-ordinate the activities of, any person”.
Hence, the power can be used to acquire shares in or form a company, provided the primary purpose of the measure is not to raise money. In exercising the power, regard must be had to the authority’s community strategy and to guidance by the Secretary of State. Paragraph 42 of his guidance states:
“The well-being power will...enable local authorities to form or participate in companies, trusts or charities, including joint venture companies, provided that they are satisfied that the formation of, or participation in, a particular company is likely to achieve the promotion or improvement of the economic, social or environmental well-being of the authority’s area. Such participation could give rise to dividend payments to the authority as a shareholder. In the Government’s view, such dividends would not amount to raising money for the purposes of section 3(2)...Indeed an authority may be acting contrary to its fiduciary duty to local taxpayers if it failed to ensure such a return on its investment.”
The trading power
Section 95 of the Local Government Act 2003 (LGA 2003) provides a first resort power to trade commercially in function related activities i.e. the council must have a statutory power (the wellbeing power would suffice) to undertake the activity for the purpose of profit. The trading power cannot be used where the council is under a duty to do something, nor where there is an existing power to trade commercially, like section 38 of the Local Government (Miscellaneous Provisions) Act 1976.
There are other limitations :
- only excellent good or fair (CPA categorisation)authorities can exercise the power to trade;
- the power may only be exercised through a company (not directly by the council); and
- only companies recognised by Part V of the 1989 Act can be formed to trade commercially.
Before the council can exercise the power to trade it must follow the procedures set out in the “Protocol relating to companies in which KCC has an interest” (the Protocol), which is currently in draft form awaiting Cabinet approval. However, it will apply retrospectively once it has been adopted by the council and annexed to the Constitution. Whether or not the Protocol is approved, the Local Government (Best Value Authorities) (Power to Trade) (England) Order 2004 (the 2004 Order) stipulates that local authorities shall prepare a Business Case, which must be approved, before they can form a company under the trading power.
The Guidance:
Public sector bodies
If the new company is classified as a public body it will be subject to human rights law, judicial review and EU law regulating state bodies.
The public/private classification is based on a “control” test. If a public authority owns more than 50%, has control over the appointment of directors, or, although a minority shareholder, manages to secure or has a right to exert a dominant influence it is likely to be classified as a public body. For more information on this area please consult the paper on financial considerations (Chapter II) and the Glossary at Guide C.
A public body may also be classified as a “contracting authority”, which would mean it would be obliged to follow the EU procurement regulations. A contracting authority is a corporation established for the purpose of “meeting needs in the general interest, not having an industrial or commercial character”, and financed wholly or mainly by the council, orsubject to management supervision by the council, or more than half of the board of directors or members of which, or, in the case of a group of individuals, more than half of those individuals, being appointed by the council.
A company set up under the trading power is a commercial entity and will not be a contracting authority for the purposes of the EC public procurement regime.
A wholly owned LAC is a public body for the purposes of the Freedom of Information Act 2000.
State aid
The European Commission has powers to monitor and sanction central government if “state aid” is provided to undertakings. An undertaking is a discrete unit that engages in economic activity, for example a company set up by the council under the trading power.
State aid is prohibited (Article 87 EC Treaty) unless approved by the Commission, which must be formally notified before the aid is granted. State aid is economic aid (in any form whatsoever, such as, grants, subsidies, consultancy support or other financial concessions) which may come from the government, the EU, KCC or any other local authority or public body.The Commission has the power to require the repayment of state aid which has been unlawfully granted.
To avoid granting state aid, an important requirement (regulation 2(3) of the 2004 Order) in the process of creating a company under the trading power is to put in place arrangements, which must be set out in the Business Case, detailing how the council will recoup the costs of “any accommodation, goods, services, staff or other thing it supplies” to the company.
Is a company necessary or appropriate?
The most common reason why an individual would consider operating a business through a company is because of the differences in tax treatment of the self-employed and of the incorporated business.Where tax is not critical, the protection from the risk of personal insolvency is always an influencing factor in deciding to trade as a limited company.
Where local authorities wish to exercise the power to trade they must set up and trade through a company.
There can be disadvantages to using a company as a vehicle to carry on a business. For example, KCC would no longer have direct control of the company's assets, the company might be liable to corporation tax or be unableto recover VAT on its expenditure. Equally there can be advantages: it is a separate legal entity which can shield KCC from possible risk in some cases.
This question cannot be answered in a vacuum. In each case Legal Services need to know what is proposed and why, and can then look at the appropriate structure.