projects bulletin Summer 2003 contents Not for profit - - PDF document

contents

What is meant by 2 not for profit organisations? Why use NFPs? 2 Limited companies 5 Foundation hospitals 6 Community interest 7 companies Industrial and 6 provident societies Not for profit organisations 1 The way forward for projects? Companies limited 5 by guarantee

Not for profit organisations The way forward for projects?

Summer 2003

Lawyers to the projects industry

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If you would like further information on this area, or on projects more generally, please contact the projects team at Nicholson Graham & Jones. Details are set out at the end

• f this bulletin.

At present there is a good deal of interest in "not for profit

• rganisations" being used in PFI
• projects. They are seen as potentially
• ffering improvements to traditional

PFI structures. Nicholson Graham & Jones specialises in projects work - it is one of our core practice areas. We have devised a number of innovative solutions for PFI and PPP projects and we are familiar with the key issues concerning not for profit organisations. The purposes of this memorandum are to set out:

what is meant by not for profit

• rganisations (because it is often

not entirely clear what is meant by the term);

some of the advantages and

disadvantages of not for profit

• rganisations; and

some examples of not for profit

• rganisations. This is against a

background of the government encouraging some diversity in the models being used.

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What is meant by not for profit organisations? Why use NFPs?

Not for profit organisations (or "NFPs") are also known as "non-share capital organisations", "public interest companies", "not-for-dividend companies" and "social enterprises". They have been used in PFI projects in a number of areas, particularly in health-care services. Although there is a resurgent interest in them in the context of PFI, a number of them have been available for many years in the arena of public and community

• services. For example, housing

associations, which are NFPs, are numerous and have been used for many years. NFPs have a number of characteristics:

they are organisations which deliver

public services;

they are legally independent from

government;

they are not owned or controlled

by external private shareholders - risk capital is not inherent in the project vehicle. All surpluses are re- invested in the organisation rather than being available for distribution as dividends to shareholders; and

as well as investors, other

interested "stakeholders" (such as service recipients) may have a say in how they are run. Therefore, NFPs are to be distinguished from standard profit-driven UK companies (as incorporated under the Companies Act 1985). Such companies are characterised by having limited liability and by the fact that they are operated in order to generate profits for the benefit of their

• shareholders. Risk capital is inherent

in these vehicles to the extent to which the shareholders have made, or are liable to make, capital contributions for their shares. These companies (and other limited liability companies incorporated under previous legislation) are, and long have been, the standard legal vehicle with separate legal identity which is used in the UK economy (and accordingly they are generally familiar). They have also been used for the significant majority

• f PFI and PPP work to date.

Advantages of NFPs

It is worth asking why is there now an increased interest in using NFPs in the context of public service delivery. Firstly, NFPs may offer the same advantages as standard limited companies in delivering PFI projects. For example, they may bring private sector disciplines to public services and, subject to the right structure being used, can bring advantageous off- balance sheet accounting treatment for the procuring authority. Secondly, however, NFPs are sometimes viewed as a potentially more politically acceptable model for the delivery of public services than typical equity- backed PFI project vehicles. Where an NFP is used, there is the advantage that what are widely considered and understood to be public services are being shown to be delivered for their

• wn sake, rather than as a means of

making a profit. The argument, which can be highly politically charged, continues that any profits generated in NFPs are not available to shareholders and therefore NFPs are desirable. The argument for NFPs may in fact be strongest where procuring authorities have experience of, or knowledge of, a PFI project where the consortium has generated substantial profits exceeding those which had been expected when the project was initially put in place. Procuring authorities may, for example, have found themselves unable to adjust the unitary charges they pay even though substantial and unexpected profits are being made by the consortium. However, whatever the form of the vehicle delivering the services, the general principle that pertains is that to the extent that any private enterprise is taking any risk in a project it will negotiate strongly that it should be paid for doing so. Actually, this may be perfectly acceptable to the

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procuring authority, provided that profits are contained and politically

• justifiable. The procuring authority

may therefore be thinking of using NFPs not so much in a sweeping rejection of the private sector making profits but as a vehicle which fits in with its aim of linking profits to good

• services. This aim may be felt most

achievable with the project vehicle not being inherently run for profit. In legal terms, the specific rights of the procuring authority in its contract with the NFP are supplemented by the general protection of the vehicle itself not being run for the purposes of generating a profit. Any distributable profit which is unforeseen in contractual arrangements (which can last for 20 or 30 years in some cases) is therefore not automatically available to be paid to the consortium members. Using NFPs is not the whole answer to such political issues and issues of getting genuine value for money. Care will also be needed that services from the sub-contractors are paid for at an affordable rate which does not diverge from the market rate over time. Ultimately, service delivery is likely to be the single most important test of the political success of the project. NFPs may well be used in LIFT structures, where several projects are co-ordinated together and required to meet standards set by a national co-

• rdinating body. LIFT is seen as

potentially offering a way of implementing high standards in the health and education fields.

Familiarity

A potential disadvantage of NFPs is that it may take longer to establish them within a bid because of a general lack of familiarity with them compared with limited companies. In some cases, this may be a discouragement to bidders. In general terms, however, diversity is being encouraged by central government, with a number of different NFP models being used. This may in fact generate a lack of clarity in the area.

Governance

The governance structure of private companies is well defined and

• understood. In effect, day to day

governance is usually under the supervision of the executive directors and within the control of the board of

• directors. The directors are limited by

decisions of the shareholders and ultimately by the power of the shareholders to remove them from

• ffice. NFPs need to be structured to

have an effective form of governance to replace this model.

Capital and Fiscal Issues

There are a number of other issues affecting NFPs. The traditional model allows equity participation in the project and the equivalent of this may be needed. The banks to a project with substantial risks may be unwilling to lend without there being any equivalent to risk capital. Financial support could then be called upon in the event of the lenders' requirements not being met. For example, in the case of Network Rail, which is a well- known NFP , the UK Government entered into contingent funding agreements to support the financial structure proposed for its acquisition

• f rail assets. In the model being put

forward by the Argyll & Bute council for its school investment programme, risk capital is being provided through Partnerships UK, which is partly government owned, in the form of subordinated debt. Another method

• f building up sufficient reserves in an

NFP is through the generation of a surplus over a short term to meet medium and long term risks. The financing of NFPs will invoke fiscal

• issues. NFPs will have a role in the

public good but will not benefit from charitable status unless they meet its stringent requirements. Tax transparency is another key issue.

NFP Costs of setting up Flexibility Familiarity Companies limited by guarantee Set up costs are low Good degree of flexibility except that interests are not transferable Familiar Limited companies Set up costs are low Good degree of flexibility Familiar Industrial and provident societies Set up costs may be higher Limited flexibility Unfamiliar Foundation hospitals Set up costs will be high Limited flexibility Unfamiliar Community Interest Companies Set up costs may be quite low, though higher than for standard limited companies Good degree of flexibility Unfamiliar

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Procuring NFPs

We note that NFPs are also sometimes suggested as vehicles on the procuring side. This can be an innovative approach in the particular circumstances where the service delivery side can see sufficient credit to support the project.

TYPES OF NFPs

NFPs are often partly driven by the motive of allowing various interest groups to have a role in the decisions and actions of the project. It may be attractive for interested parties such as service users and staff to have a say in how the NFP is run, especially where people will genuinely take an active and effective role over the long term. This is, for example, a key feature of the proposed foundation hospitals, as discussed below. UK companies have not usually been run on this basis and, at heart, allow very little say to groups which are not investors. English law provides companies are run for the benefit of their shareholders and

• therwise usually only creditors have

significant rights. It may therefore be thought that it is appealing to use a different type of vehicle to enfranchise

• ther groups.

However, it may be possible to continue to use limited companies for not for profit purposes with various stakeholding groups having a say, such as by using different classes of shares and weighted voting rights. In any case, whichever model is used, the enfranchisement of stakeholder groups needs to bear up when different groups have contrasting views (such as investors, staff and service recipients), and will need to ensure that persons with expertise have a sufficient role in governance and strategy. Some of the requirements for a successful NFP will be similar to a traditional equity-based PFI, such as a day to day management with sufficient experience and skills. The issue of management reward is likely to be a critical factor in securing the right

• management. It is probable that NFPs

will need to pay comparable rates to the private sector in order to attract management of the right calibre. Under the Companies Act, private limited companies are obliged to produce annual audited accounts. Ideally, NFPs also need to provide information of at least equivalent

• quality. In some NFPs, such as

foundation hospitals, it is likely that the financial information will be complicated and difficult to interpret. NFPs can take a number of forms. Some of the main types are as follows, with some of their characteristics summarised in the table below:

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Companies limited by guarantee can be formed under the Companies Act

• 1985. They have often been used as

vehicles for non-profit enterprises. Their constitutional documents may prohibit dividends to members. Where the objects of the company are within the category of being "the promotion of commerce, art, science, education, religion, charity or any profession and anything incidental or conducive to any of those objects", and restrictions on profits, dividends and capital are included in the company's constitution, it is possible not to have the word "limited" in the company name. This may be helpful in the presentation of the relevant project as not being a private venture which is run for profit. Companies limited by guarantee do not have any shares and so the interests of members are not

• transferable. This may be an

unattractive feature where relevant parties will wish to transfer their participations some time in the future (or at least have the ability to do so). The liability of the members is limited by the amount of their guarantees (which are specified amounts in the memorandum of association). Network Rail is an example of a company limited by guarantee in the public service arena.

Companies limited by guarantee Limited companies

Legislation and regulation relating to equity based corporate models are well established. Although there are several models for NFPs, none is as well developed as the limited company. It is possible to limit the activities of a company and make it a not for profit

• rganisation by so providing in its

constitutional documents (in particular, the memorandum of association). We consider that one of the most attractive types of NFPs in a number of situations is a private limited company. Difficulties that

• ther models may have, in terms of

risk capital, financial transparency and in having to implement a new workable system of corporate governance, are not experienced with the private limited company. A number of NFPs are limited

• companies. British Nuclear Fuels is

controlled by the Government and The National Air Traffic Service is partly owned by the airlines which use its services.

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Industrial and provident societies Foundation hospitals

IPSs are part of the mutual sector and are registered under the Industrial and Provident Societies Act 1965. Registration makes a society a body corporate with limited liability and the power to sue and be sued in its own

• name. The distinctive feature of an IPS

is that the society must fall within one

• f two classes. It must either:

be a bona fide co-operative society; or be carried on for the benefit of the community. There must be special reasons why the society should be registered as an industrial and provident society rather than as a company. A co-operative society is made up of members who pool their resources to work for the collective interests of the co-operative's own members. In contrast, members of societies established for the community benefit participate in an organisation where the benefits are provided to a wider class of beneficiaries than the members alone. Guidance issued by the Financial Services Authority indicates that registration as an IPS should confer a concrete advantage or benefit that would be lost or unobtainable if the

• rganisation were to register as a

company. The IPS model has been suggested as a model for securing community Foundation hospitals are perhaps the most generally discussed form of NFP at the moment. What they will be able to do is being debated within

• Government. It is currently proposed

by the Department of Health that 29 hospital trusts will, during spring 2004, subject to parliamentary approval, gain the freedoms of becoming foundation

• hospitals. They will be NFPs existing
• utside the direct control of the

Department of Health. It is currently proposed that only the most successful hospitals will be considered for foundation trust status. As with other NFPs, the political attraction of foundation hospitals is that they are a way of increasing the involvement of the private sector in managing and delivering public services without the perceived problems of private company involvement and the distribution of profits to shareholders. Foundation hospitals will be characterised by having greater autonomy from the Secretary of State for Health than NHS hospitals enjoy. In particular, they will be freer to borrow, to buy and sell assets, to generate surpluses for the hospital and to reach their own local pay agreements. Provided that the government is satisfied that enough risk and control assets while delivering public services based on them. Concern that the existing legislation (i.e. the 1965 Act) did not offer sufficient protection against demutualisation and distribution of assets led to the passing of the Industrial and Provident Societies Act 2002. It increases the voting requirements for a society which wishes to convert to a company and permits legislation applying to IPSs to be amended more easily to bring it into line with company legislation. Examples of IPSs include housing associations and ex-local authority leisure services at Greenwich and Bristol. has been transferred from the state, foundation hospitals will be free to use private finance to pay for capital projects (which would not then show up on the Government's balance sheets). There will also be increased local accountability through governance arrangements that give local stakeholders (patients, local community, staff and partner organisations) a say in the management of the hospital.

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The Department of Trade and Industry, the Treasury and the Home Office have proposed that a new corporate vehicle be made available for community and social enterprises, called a "Community Interest Company" ("CIC"). CICs would be regulated in a similar way to companies, including in terms of incorporation requirements, directors’ duties and reporting requirements. In addition, it is proposed that they would have to be acting for a public interest and there would be a special CIC regulator, who would check that the CICs are not for profit enterprises working for the public interest. CICs are not yet in place and will need new legislation.

Community Interest Companies Summary

Whilst traditional PFI structures will not be completely abandoned, NFPs are likely to be an important feature

• f the projects landscape for the

foreseeable future.

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Nicholson Graham & Jones 110 Cannon Street, London EC4N 6AR 020 7648 9000 The contents of this projects bulletin have been gathered from various

• sources. You should take advice before

acting on any material covered in this publication. Nicholson Graham & Jones is an ambitious medium sized City law firm with a distinctly contemporary

• utlook. Our strong track record of

growth and success is underpinned by

• riginal thinking and a thorough

understanding of business issues. We have developed an open, supportive culture where knowledge sharing and teamwork contribute to a lively, friendly atmosphere and help deliver better results. Nicholson Graham & Jones acts for a wide range of clients, many of whom have international interests. We are a member of GlobaLex, an international alliance of law firms, enabling us to advise on multi-jurisdictional transactions. Our Projects group advises private sector clients and public sector

• rganisations on all forms of PFI, PPP

and infrastructure projects. Christopher Causer christopher.causer@ngj.co.uk tel: 020 7360 8147 Carolanne Cunningham carolanne.cunningham@ngj.co.uk tel: 020 7360 8160 Stuart Borrie stuart.borrie@ngj.co.uk tel: 020 7360 8155

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