Advisory note three: The importance of good governance, effective oversight and accountability of council-owned companies

16 January 2023

This advisory note formalises key messages from the CIPFA Practice oversight panel on the crucial importance of good governance during the establishment and subsequent operation of council-owned companies. The note reinforces the good practice principles that local government bodies in the UK should adopt, and uses the experience of others to identify examples of good practice. The panel expects all organisations to be aware of, and learn lessons from, recent examples of failure; this advisory note highlights both these messages. 

The advisory note applies to all local government bodies in the UK. 

Summary 

Good governance lies at the heart of an authority’s ability to achieve its objectives, manage its finances and maintain the trust of those that it serves. Good governance also encourages more robust decision making, greater scrutiny of decisions and better planning for the future. It is therefore essential that a company is established in accordance with the principles of good governance, has effective and efficient financial management, and complies with relevant legislation. The establishing authority must also maintain appropriate arrangements for ensuring effective oversight and accountability for any alternative delivery mechanisms in which it has engaged. 

Background

There has been a large increase in council-owned companies over the past decade as legislation has changed. Many authorities have explored the use of this option as an alternative means of delivery that should not only improve the experience of users but could also potentially relieve some financial pressure. 

Council-owned companies have been established in a variety of sectors to deliver services to local authorities including leisure, waste, housing and energy. However, issues of governance and oversight has resulted in high-profile failures including Robin Hood Energy Ltd, Brick-by-Brick and Bristol Energy Ltd. Even where companies have not failed, they have in some cases attracted adverse comments via scrutiny; for example, Luton Airport where a local government finance review by Luton Borough Council in December 2021 recommended that “The authority, as the sole owner and lender to the airport needs to further strengthen its governance around the airport.”

Because of these concerns, a light has been shone on the risk attached to this type of activity. Firstly, there is a financial risk and councils who fail to manage their exposure to council-owned companies have been left having to find additional funding. For example, as per the Croydon Council medium term financial strategy, the failure of Brick by Brick means that, for the London Borough of Croydon, “the net shortfall will be written off over 40 years” . The reputation of the council will also be at risk as company failures are often subject to media scrutiny and if the failure is significant, the attention of central government. Finally, there is the loss of trust by the community who can experience service decline or removal because of the failure. Councillors and leaders will rightly be held accountable for the running of the services. 

The delivery of a service through a council-owned company does not remove the council’s obligations and the section 151 officer still has a statutory duty under section 151 of the Local Government Act 1972, to ensure that there are proper arrangements in place to administer the council's financial affairs. This encompasses much of the governance that surrounds these organisations and the section 151 officer working with both the monitoring officer and the chief executive should reassure both themselves and elected councillors that there is effective oversight. This includes many of the areas identified below in both the public articles of association and stakeholder agreement lists. 

The importance of governance extends to the use of holding companies. A holding company will have responsibility for managing a local authority’s interests in its subsidiary entities and will usually carry out the monitoring role on behalf of the local authority. The holding company’s primary responsibilities will be for the strategic direction of the local authority’s CCOs as a group and monitoring their operational performance, but again it is essential that the council has procedures in place for effective oversight. 

Evidencing effective oversight must be clear to both internal and external audit. Internal audit will be required to ensure that robust procedures are in place around monitoring and decision making, while the role of external audit also includes value for money judgements about the authority as a whole. The Local Audit and Accountability Act 2014 requires the auditor to be satisfied “that the authority has made proper arrangements for securing economy, efficiency and effectiveness in its use of resources.” 

Published findings such as Grant Thornton’s ‘Report in the public interest concerning the council’s financial position and related governance arrangements’ audit report in 2020, which said that the London Borough of Croydon suffered “collective corporate blindness” and did not understand its business venture, have helped identify several common concerns.  

Common causes of failure 

As part of advisory work carried out by CIPFA, a considerable amount of time has been spent working with organisations who have council-owned companies. There are several common causes of failure that occur regularly, including: 

  • no common understanding of what “being commercial” means
  • weak options appraisal, meaning that the rationale for creation is poor, plus optimism bias
  • lack of alignment with a local authority’s objectives meaning divergent thinking
  • not identifying/clarifying what the desired outcomes are for the company
  • lack of formal or inconsistent set-up procedures which can lead to poor decisions re structural model chosen
  • weak scrutiny and challenge, including ineffective company boards
  • no clear legal control framework – the legal documents supporting the setting up, governance and management of the company must be transparent 
  • poor market knowledge: buyer behaviour/competitors not understood
  • business plans not up-to-date or simply do not exist, so costs of delivery not transparent.

By recognising these causes of failure, those tasked with establishing and/or running a company should be able to put in place mechanisms and procedures to mitigate future problems. 

Good practice governance check list

A well drafted suite of documents that provides details on roles and responsibilities is a key starting place for strong governance. Below is an initial list on suggested contents for articles of association and a shareholder agreement. 

Public articles of association (if not contained in the articles it is important to confirm that these issues are covered elsewhere)

  • The purpose of the company
  • Authorised share capital
  • Voting rights
  • Rights of the shareholder(s)
  • Policies concerning declarations and conflicts of interest
  • Procedures at general meetings of the shareholder(s) and board meetings
  • Indemnities and insurance cover
  • Appointment of directors
  • Auditor access and appointment
  • The registered office
  • Rights to remove and appoint directors and provide for retirements where appropriate
  • Ensuring that board composition is kept under review

The shareholder agreement (if not in this document it is important to confirm covered elsewhere)

  • Business plans and the annual budget to be submitted for approval by the shareholder ( the council) once they have been approved by the company board 
  • The flow and frequency of information
  • Recording decisions made at board meetings
  • Regular reporting of company performance – reports should be submitted to the shareholder board once they have been approved by the company board the frequency of reporting, usually quarterly
  • Definitions and interpretations of roles 
  • Financing the company
  • Dividend
  • Subsidiaries
  • Management of the company
  • Stakeholder groups
  • Business plan compliance
  • Reporting and Accounting matters
  • Banking arrangements

Conclusion 

This advisory note recommends that authorities should adopt the high standards of the HM Treasury’s Better Business Cases and ensure that all decision making is subject to robust challenge and scrutiny. Those involved in the process either initially or during business as usual should be clear that while the council may not deliver services directly, it remains legally responsible for ensuring their delivery. 

Additional reading 

Other Practice oversight panel advisory notes can be found in the following locations: