This article considers the benefits of ‘spinning out’ council services that were previously provided in-house.
With the continuing pressure on local authority finances, many local authorities (LAs) are now looking more closely at the option of ‘spinning out’ services previously provided in-house, with a view to maximising economies of scale and developing new revenue streams.
A ‘spin-out’ in this context is the process by which a local authority-delivered service is split off from the local authority to become a separate stand-alone company.
Having recently advised on the setting up of two Hertfordshire County Council spin-out companies including a collaborative school company (jointly owned by the council and schools in Hertfordshire) I will highlight the advantages of a collaborative school company spin-out model, and the practical legal and commercial issues involved in the use of this model.
What is a school company?
A school company is described under the Education Act 2002, as a company set up to:
a) provide services or facilities for schools;
b) exercise relevant local education authority functions;
c) make, or facilitate the making of, arrangements under which facilities or services are provided for schools by other persons; or,
d) purchase services or facilities for schools.
Although the popular assumption is that a school company can only be set up by schools, in actual fact, under Section 5 of the School Companies Regulations 2002 as amended by the School Companies (Amendment) Regulations (the Regulations), the following categories of persons are eligible to set up a school company:
(i) the governing body of a maintained school;
(ii) a local authority in England;
(iii) the proprietor or governing body of an independent school which provides full-time education for five or more pupils of compulsory school age;
(iv) the proprietor of an alternative provision;
(v) a company which has as a significant proportion of its business the provision of education or educational or ancillary services or goods;
(vi) the governing body of a further or higher education institution (within the meaning of section 90(1) of the Further and Higher Education Act 1992) if it has legal personality;
(vii) the proprietor of a 16-to-19 academy; and/or
(viii) an individual who is not subject to any of the disqualifications set out in Schedule 1 to the Regulations.
Pursuant to the above, therefore, a local authority either acting alone or in collaboration with one or more of the other categories of persons set out in Section 5 of the Regulations can (subject to restrictions set out in Regulations), set up a school company to provide educational services or facilities to schools.
Local authorities, in any event, have powers under Section 95 of the 2003 Local Government Act to set up companies to trade in areas relating to any of their existing functions.
Advantages of a collaboratively owned school company spin-out model
1. This model facilitates greater collaboration between the local authority and schools, as it is based on partnering ethos.
2. As stakeholders in the company, schools have greater influence over how the business is run and the quality of services to be provided by the company. This is beneficial to schools as the ultimate end-users of the services.
3. As a stakeholder in the company, the local authority is more likely to be keen (subject to State Aid rules ) to provide incubation support to the company, for example by providing office space, infrastructure (for example IT platforms), and back office services.
4. The Teckal exemption  would apply (insofar as the ‘function’ and ‘control’ tests are met, and all the shareholders of the company are ‘contracting authorities’ ). The effect of this is that schools that are shareholders of the company, and indeed the local authority, as the case may be, can purchase services or facilities directly from the company without having to undertake a competitive tendering exercise.
Checklist of practical legal and commercial considerations
Choosing the company model
The first issue in considering setting up a school company is deciding which legal structure to use. The most popular legal structure for a school company is the company limited by guarantee. There is, however, nothing to preclude the use of other legal structures, such as a company limited by shares, trust, industrial and provident society etc.
Hertfordshire County Council, following consideration of a number of potential legal structures selected the limited liability company as the option that would best cater for the current and prospective economic and equitable interests of the Council and the schools as shareholders of the collaboratively owned school company because it offered:
- Flexibility to accommodate differential voting rights via the ability to allot different classes of shares prescribed within its Articles of Association;
- Opportunity to alter the membership structure, if necessary, via the sale and issuance of shares;
- Easy exit via sale of shares; and
- Ability to distribute profits (dividends) to shareholders based on their respective levels of investment.
Where the collaboratively owned school company is set up with an intention to make profit, the LA must produce a business plan  setting out the services to be provided by the company, the potential clients for the services, costs associated with delivery of the services, anticipated profit etc.
Memo and Articles of Association
The Memorandum and Articles of Association will need to be drafted. In doing this, governance arrangements – appointment of directors ( executive and non-executive), chairman of the board of directors, company secretary etc, how decisions will be made, class of shares, voting rights etc. will need to be considered and set out clearly in the Articles which constitute the company’s constitution.
Roles, responsibilities and rights of respective shareholders
It is usually desirable where there will be a number of shareholders, to have a shareholders agreement to set out the roles, responsibilities and rights of the respective shareholders.
However, where the number of shareholders is very high (as was the case with the Hertfordshire collaboratively owned school company where there were about 400 school shareholders), the practicalities of arranging execution of the agreement by all the shareholders will need to be considered.
In such cases, it might be better to include the provisions relating to the roles and responsibilities of the shareholders in the Articles of Association as this document is not required to be signed by all the shareholders. The only issue with this approach is that Articles of Association of a company are open to public inspection and therefore there would be no privacy in relation to shareholder arrangements if they are set out in the Articles.
It is always a good idea to check with Companies House that the proposed company name is available, prior to completing the incorporation documentation.
To incorporate the company, Company Registration Form INO1 will need to be completed and submitted along with Company Memorandum and Articles and the applicable fees, to Companies House.
The following will need to be considered:
- Where will the company’s start-up capital come from?
- Will the paid-up share capital be sufficient to pay staff salaries, office rent and other company expenditure during the initial bedding-in period?
- If not, will the LA provide financial support to the company? If so, this will need to be structured as a commercial arrangement (such as a loan on commercial terms) to avoid the application of State Aid rules.
The following will need to be considered:
- Where will the company operate the business from?
- Will the company operate from the LA’s premises? If so, a Lease, or Licence Agreement, as the case may be, will need to be drafted setting out the terms of the company’s occupation of the LA’s premises. Again such arrangements will need to be on a commercial basis to avoid the application of State Aid rules.
Transfer of Assets
The following will need to be considered:
Will any LA’s assets be transferred to the company? If so, a Transfer Agreement including a comprehensive list of the transferring assets will need to be drafted.
Transfer of Staff
Will LA staff be transferring to the company? If so:
- Consultation with staff in relation to TUPE transfer will need to be undertaken.
- Current workforce information will need to be collated for inclusion in the Transfer Agreement.
- LA would need to consider whether it would be willing to indemnify the company for any TUPE liabilities. If so, details of the agreed indemnities will need to be set out in the Transfer Agreement.
The following will need to be considered:
Will the school company join the Local Government Pension Scheme (LGPS) or set up a broadly comparable pension scheme?
If they choose LGPS:
- An Admission Agreement and Bond will need to be drafted.
- Lists of employees already in the LGPS and of those eligible to join the LGPS will need to be collated for inclusion in the Admission Agreement.
- Actuarial assessment of employer contribution rate payable by the company, and the risk of other pensions liabilities that will accrue to the Council in excess of the employer contributions payable will need to be undertaken.
- How any identified risk of pension deficit will be covered will need to be considered i.e. whether a bond or indemnity will be required to cover this risk.
If they opt for a broadly comparable scheme, GAD Certificate  will need to be obtained.
Back office services
Will back office services such as legal, IT, finance, HR/payroll services be provided to the company by the LA? If so, a contract setting out the terms upon which the council will provide the services to the company will need to be drafted.
Services to be traded by the company
Contracts for the provision of the services to the respective shareholders (schools/LAs) wishing to receive services from the company will need to be drafted.
The LA will need to notify existing service users in writing of the change of service provider from council to the company.
Novation of existing contracts
Any existing contractual arrangements for the supply of goods and/or services between the LA department previously engaged in the provision of the services and its suppliers will need to be novated to the company.
Designation of supervising authority
Every school company must designate a local authority as its supervising authority within the time specified under the Regulations.
The LA will probably need to provide indemnities to its officers who will be acting as directors of the company by way of an Indemnity Agreement between the LA and the respective officers.
Conflict of interest
Potential conflicts of interest that may arise, for example, from directors acting both as officer of the council/schools and director of the company, should be identified and ways of mitigating them considered.
Other practical issues
Other practical issues that will need to be addressed following company incorporation include putting up signage at the company’s registered office address, printing company stationery (this needs to state whether the company is an LA ‘controlled’ or ‘influenced’ company ), opening a bank account, arranging insurance, appointment of an Auditor etc.
The collaborative LA and school company model is one that can clearly be advantageous to both the LA and school shareholders. It is hoped that as the benefits of the pioneering co-operative school companies begin to materialise, other LAs will be encouraged to avail themselves of the opportunities presented by this unique spin-out model.
Antonia Asielue, principal solicitor, Commercial Law Team, Hertfordshire County Council Legal Services
 Which preclude a public body from providing financial or other form of assistance to selected undertakings, where this could potentially distort competition/affect trade between EU member states
 As established in ECJ case Teckal Srl v Comune di Viano and Azienda Gas-Acqua Consorziale (AGAC) di Reggio Emilia
 As defined in Regulation 3 of the Public Contracts Regulations 2006
 As required under section 95 of the 2003 Local Government Act
 Issued by the Government Actuary’s Department, confirming the scheme is comparable to the LGPS
 As defined in the Local Authorities (Companies) Order 1995