Teckal iceberg could sink Shropshire Council’s private company ip&e

There are two arguments that Keith Barrow, leader of Shropshire Council puts forward to justify transferring ever more public services to ip&e, the council’s private company.

The first is that it will cut costs to the council.

The second is that it will make a profit for the council.

Neither stacks up in my view.

Cuts to costs could happen and have happened within the existing council structure. At present, staff in ip&e have the same terms and conditions as those in Shropshire Council. That could change, particularly on pensions. But if ip&e wants to attract highly qualified people in a tightening labour market, it may well have to pay above public sector rates. It will need healthy bank balances to fund that.

Dreams of making a profit are such a high risk that council finance officers won’t take account of them in the council’s future budget projections. I can’t see how this company can make enough money under Teckal rules to justify the risks involved.

One reason that these ambitions for profits are such high risk is that this business has spent three years getting up and running. The market is shifting rapidly as councils across the country are finding new ways of delivering services. ip&e is now running behind the market in private enterprise in public services. A second reason is that some are underperforming services being transferred, for example development control (planning applications). Surely, Shropshire Council will not allow the current delays in processing applications to continue when a contractor is delivering the service? That means ip&e will need to invest in skilled planning officers and that will be costly.

The main reason that this business carries risk of minimal profits is Teckal.[1]

Shropshire Council is handing contracts to ip&e without the usual competitive procurement required by UK and UE law. To do so, it must obey so called ‘Teckal’ rules. These rules exist to ensure that public sector contracts are awarded fairly.

The main messages from Teckal for ip&e are:

1) Shropshire Council must keep direct control of ip&e. It does so at present.

2) There can be no private sector financial involvement in ip&e. That means Shropshire Council can’t sell shares, for example, to Serco, Capita or G4L.

3) Most of the activities, and the most essential activities, that ip&e engages in must be for Shropshire Council. It can’t, for example, establish itself as a restaurant chain and serve up public services to the council on the side.

Teckal rules mean that no more than 20% of ip&e’s trade can be with other councils, organisations or companies.

It is not clear when Shropshire Council realised that ip&e is a Teckal company. It wasn’t mentioned when the Cabinet considered establishing ip&e in May 2012, but by February 2013 the council was taking steps to ensure that ip&e could not breach its Teckal status. Realising that Teckal was going to constrain the way the company works, it dreamed up a scheme to get around the rules.

In the summer of 2013, the cabinet decided to create a subsidiary trading company to “enable services to be provided to third parties, whilst protecting the Teckal status of ip&e Limited.” To cut costs, Trade Co. as it was called then, would share management with ip&e.

Trade Co was established as ip&e (Trading) Ltd in August 2013. ip&e (Trading) hasn’t traded to date but I am told by officers that:

The ip&e executive team and board will consider when they need to use ip&e trading limited to bid for new contracts via tendering process to ensure that ip&e limited trading status is not breached.

I’m not a lawyer but I’d be surprised if a council owned company set up specifically to circumvent Teckal procurement rules didn’t end up being subject to legal challenges.[2] There’s also an ethical argument against this arrangement. It’s the equivalent of tax avoidance – which is legal but hardly the high ground of morality for a public body.

So how much money can ip&e make as a Teckal company? According to cabinet papers, ip&e has a average annual turnover of £12.5 million (though Keith Barrow says its £15 million). It is due to make a profit of £108,000 in 2017/18, less than 1% of turnover.

Let’s assume it at some point ip&e has grown to a titanic turnover of £200 million. Under Teckal rules, it could do £40 million worth of trade within that £200 million. If the company is very successful, its pre-tax profits might be between £4 and £10 million. That’s a very useful sum. A 1% rise in council tax, for example, raises £1.2 million. But its only 2% to 5% of the company’s total turnover.

ip&e is like an iceberg. The visible bit that the council talks so much of is expected to make a profit. But most of the company (80%) will be unprofitable.

This unprofitable part of the company will still require managing every bit as much as the operations that make money. That’s a big risk factor for a business that aims to make a healthy return for its shareholder.

As cutbacks bite further, the risks will grow of the company struggling or failing to meet contractual commitments to its main client, Shropshire Council. As we have seen over the years with the privatisation of public utilities and services, the public are very intolerant of any failure of the private sector to deliver.

If any part of ip&e fails to deliver, Shropshire Council has set out its choices:

Available actions will depend on the nature of the underperformance which may be isolated and minor, persistent and minor or severe, and may include payment deductions, step-in by the Council and ultimately termination of the contract.

It’s absolutely right a contractor should be fined or have the contract cancelled if it fails to perform. But how keen will Shropshire Council be to deduct payments from a company it wholly owns and to which it has seconded staff, especially when it has an expectation of making money from it?

ip&e will need investment too. If its profits are routinely swept into Shropshire Council’s accounts, it will have to borrow to invest in its operations. It has a loan facility with the council of £500,000 but this is a one off to cover start-up costs which must be repaid within 30 months of drawing down. Any further loan from the council is likely to treated as State Aid and ruled illegal.

In my view, ip&e is an ill thought out model for a thriving business. It carries risks that are out of proportion to any likely financial gains.

Back in the heady summer of 2012, there was talk of transferring 1,700 staff and an expenditure of £36 million a year to ip&e in the first phase of ‘spin outs’. Three years later, ambitions have been halved and ip&e is only just getting up to steam. The June 2012 cabinet paper said:

If local people are to get the full benefit of these bold and creative changes quickly, it I essential that there is no delay in putting them into action.

That’s just what there has been – delay. Even now, most staff are seconded to ip&e not transferred.

That paper, by Kim Ryley, the former chief executive who departed the council at short notice a month later, also says:

With regard to decision on the formation of new vehicles to run current council services (whether in [ip&e] or not), it is essential that the council adopts a consistent and transparent process, as these could be open to legal challenge.

That really hasn’t happened. There is nothing transparent about ip&e and it is hard to find out what is actually happening from documents in the public domain (the business plan is secret).

On the face of it, ip&e looks an exciting adventure. In reality, it is a high risk gamble that has been dogged by delays and has only limited opportunities to make a profit. This carries huge risks for Shropshire Council which is relying too much on ip&e as a vehicle to cut costs and generate income.

ip&e can’t avoid being a Teckal company. With most of ip&e’s business set to be below the profit line, Teckal could be the iceberg that sinks ip&e.

Notes

[1]. Teckal is the name of an Italian company that made case law. It has become the code name for a suite of court judgements, EU regulations and general understanding on the degree to which publicly owned companies are allowed to act commercially. A briefing by Local Government Lawyer gives a good summary of the technicalities. Teckal was enshrined in the 2014 EU Public Sector Directive and incorporated into UK law from 26 February 2015 through the Public Contracts Regulations 2015. Before these regulations, it was understood that Teckal companies could only conduct 10% of their trade with external bides. The regulations increased this to 20%.

[2]. My understanding is that Shropshire Council has taken advice that this arrangement is legal but that does not mean that it is not venturing into aa legal minefield.