Part 6: Trusts and Other Non-profit Entities

Local Authority Governance of Subsidiary Entities.

The Local Government Act 1974 (the Act) gives local authorities wide discretion about how best to carry out a range of activities. Many authorities have set up stand-alone entities or other arm’s-length arrangements to undertake non-profit activities in an efficient and effective manner.

Local authorities have used this approach for a variety of functions, including regional marketing, economic development, the operation of leisure and recreational activities such as museums and libraries, and employment promotion. Entities set up for these purposes take a number of different forms – including incorporated societies, trusts, and special statutory bodies – and a variety of unincorporated forms, such as partnerships.

In this report we refer to these entities as “stand-alone entities.” The advantages of stand-alone entities are that they may:

  • be free to take a more commercial (although not profit-making) approach to the delivery of services or other activities than the local authority;
  • provide the opportunity for direct community involvement and participation in governance;
  • attract third-party funding more readily; and
  • have a quicker decision-making ability.

Stand-alone entities can play an important role in enabling the local authority to achieve outcomes for the community, and many of them depend heavily on ratepayer funding. Allowing a stand-alone entity to undertake community activities on behalf of a local authority (using ratepayer funds) may have the disadvantage of partly removing the activities from public scrutiny – despite a close relationship with the local authority.

A local authority itself must disclose general information about the activities of stand-alone entities. In particular, the following statutory provisions provide for the disclosure of information to the public about the intentions and performance of a range of stand-alone entities:

  • section 223D of the Act requires every local authority to prepare an annual plan in respect of every organisation under its control or in which the authority has a significant interest; and
  • section 223E requires a local authority to prepare an annual report that contains audited financial statements for companies or organisations under the authority’s control, or in which the authority has a significant interest.

However, local government legislation provides little specific guidance on how the stand-alone entities themselves should account for:

  • their use of ratepayer funds;
  • their stewardship of community assets; and
  • the performance of functions on behalf of the local authority.

In addition, stand-alone entities may be under no obligation to provide for public consultation detailed information about their planned activities, nor to report publicly on their performance.

We are not confident that existing provisions of the Act are adequate with regard to local authority reporting about the intentions and performance of stand-alone entities (as discussed in paragraph 605). In consequence, any public reporting on the activities of some stand-alone entities in which local authorities have an interest is likely to be limited.

This problem has been magnified by recent changes to the definition of a LATE in the Act. The Local Government Amendment Act 1999 removed from the definition those trading entities which are not companies and which do not exist for the intention or purpose of making a profit. This has meant that such entities are no longer required to comply with the accountability requirements – including the obligation to prepare and publish an SCI. The Act has no equivalent requirements for such entities if they are not LATEs.

In the absence of statutorily defined accountability arrangements, there may be a lack of clarity as to:

  • the purpose and objectives of a stand-alone entity;
  • what relationship it has with the local authority; and
  • the manner in which the entity will account to the local authority and the community for its performance.

A final important factor is the legal autonomy of trusts, which has a direct bearing on:

  • the independence with which the members of the trust’s governing body are required to act; and
  • the trust’s accountability relationship with the local authority.

Trustee law requires trustees to act independently in the interests of beneficiaries of the trust or, in a charitable trust, for charitable purposes. The requirement for independence is a potential constraint on the local authority’s ability to influence entity direction and hold the governing body to account.

How Did Local Authorities Address Key Issues?

We identified the following issues as being particularly relevant to an appropriate governance and accountability relationship between local authorities and stand-alone entities:

  • the roles of the entities and their relationships with the local authority;
  • the establishment of instruments for accountability;
  • the use of ratepayers’ funds;
  • openness and community involvement in decision-making;
  • an effective governing body; and
  • the role of councillors on governing bodies.

Entities’ Relationships with Local Authorities

The trusts and other stand-alone entities we reviewed had been set up for a variety of reasons, including:

  • as a product of specific legislation;
  • for tax efficiency;
  • for business efficiency; and
  • to create an arm’s-length relationship.

In setting up a trust or other stand-alone entity, local authorities have considerable freedom about how such an entity will operate and what relationship it will have with the local authority and the community. Purpose, structure, powers, funding and accountability should be carefully considered when the entity is created. In many cases, the local authority will have a strong interest in the long-term ownership and control of the assets being transferred to the new entity.

A local authority should be especially clear about the role and purpose of stand-alone entities with which it has a funding or partnership relationship. It should ensure that an entity’s objectives, activities or programmes undertaken on its behalf are consistent with the outcomes which it seeks.

The roles of the entities we examined were generally clearly defined. A variety of documents were used to define these roles, such as trust deeds, heads of agreement, annual plans and SCIs. In some cases, we identified potential to amalgamate these documents.

As part of annual planning, a local authority needs to make links between:

  • its funding plan;
  • its relationships with stand-alone entities receiving those funds; and
  • the planned programmes and activities of those entities.

The functions of each entity we reviewed were clearly related to outcomes sought by the local authorities.

Establishing Instruments for Accountability

Local authorities must put the statutory accountability arrangements in place when first setting up a stand-alone entity. The annual plans and reports of the local authority should tell the public about:

  • the authority’s relationship with each entity;
  • the nature of its investment;
  • the purpose and objectives sought from that investment; and
  • the performance of the entity in meeting those objectives.

All local authorities we reviewed had addressed the need to put in place appropriate instruments for holding stand-alone entities to account and for exerting influence over their direction and strategy. Accountability instruments included:

  • the requirement to justify requests for funding through the local authority’s annual planning process;
  • formal council approval of the business plan;
  • the use of protocols and other written understandings specifying the relationships between the parties; and
  • the inclusion of summarised plans, budgets, financial and non-financial performance results in the local authority’s own annual plan and report.

In some instances, local authorities had drawn up formal relationship documents defining the parties’ respective roles and responsibilities. These documents can serve a useful purpose as an agreed governance framework as well as a means of clarifying the accountability relationship.

The relationship documents that we saw typically covered:

  • the objectives and purposes of the stand-alone entity;
  • corporate behaviour;
  • financial management; and
  • the manner in which the entity and the local authority would work together.

We noted the importance of such documents, including relevant and (where possible) quantifiable indicators against which to assess the performance of the entity.

A stand-alone entity that is directly accountable to the local authority may itself be able to create subsidiaries or other structures. This could have the effect of limiting the local authority’s direct influence on strategic direction and the development of community programmes. In such circumstances, control or influence, as appropriate, should be preserved through the local authority’s accountability relationship with the parent body. This approach is outlined below.

One trust had set up subsidiary entities to carry out community activities as agreed with the local authority. The trust consulted the local authority on the broad nature of its planned programmes through its business plan. However, delivery of the community programmes themselves was the responsibility of the two subsidiary entities – another trust and a company.

That structure created a risk that the local authority would lose direct access to information about the planned implementation of the community programmes – including changes in programme mix, the target audiences, and proposed new initiatives. The local authority addressed this risk by seeking assurance about the expenditure plans and operations of the operating subsidiaries through the business plan of the parent trust. The two subsidiary entities were also reporting quarterly to the local authority on progress against their own individual business plans.

Being subject to regular audit is also an important aspect of accountability. The Public Audit Act, when enacted, will ensure that the Auditor-General is the auditor of all stand-alone entities of which local authorities have direct or indirect control.

Using Ratepayers’ Funds

The stand-alone entities we reviewed were all funded to some degree, directly or indirectly, by the local authority. However, the trust deeds we examined did not generally contain accountability requirements in respect of ratepayers’ funds, either to the public or the local authority. We looked for evidence that local authorities were using other means to obtain assurance about the use of funds.

Stand-alone entities will normally seek grant funding through the local authority’s annual planning process. This process provides for public consultation and comment on the activities to be publicly funded.

However, not all stand-alone entities we reviewed were funded explicitly by a mechanism disclosed in the annual plan. Where other funding mechanisms are used, there may not be the same opportunity for the views of the public to be heard; nor may the expenditure of such funds be open to public scrutiny.

Stand-alone entities may, in special circumstances, seek local authority funding outside the annual planning process. In such cases, local authorities should ensure that the public is adequately informed and consulted before committing significant funds.

For commercial reasons, one local authority needed to respond quickly to a request to meet the capital costs of developing a significant trust-managed community facility. In reaching its decision, the local authority examined the trust’s proposal in detail and, with the trust, consulted the local community by distributing publicity material and seeking public submissions. This process was important to keep the community informed and involve them in the decision-making process.

Local authorities should consider setting specific requirements for the way in which stand-alone entities spend funds held for community use. One trust, for example, held significant trust funds generated from the sale of local authority assets.14 The trust’s use of those funds was controlled by provisions in its trust deed, which specified the manner in which capital and income could be used.

Formal, comprehensive service agreements are desirable and we are aware that some authorities are already using such agreements. Some entities reported to the local authority against well-defined service objectives and performance indicators.

However, in the local authorities we reviewed, few service agreements were in place between the authority and stand-alone entities – although one authority told us it was planning to put such agreements in place. In our view, service agreements are an important part of the accountability relationship between local authorities and entities delivering services.

Openness and Community Involvement in Decision-making

The relationship between stand-alone entities and the local community in which they carry out their activities is an important dimension of accountability. Local authorities and some other defined classes of public entity are subject to the information and disclosure provisions of the Local Government Official Information and Meetings Act 1987. Stand-alone entities are not subject to those same disclosure obligations. In consequence, their meetings are not generally open to the public, and the public may not have direct access to information about their activities.

Activities that are carried out in conjunction with, or on behalf of, the local authority are likely to have a direct community impact and will generate public interest. Access to information should be an important part of any accountability relationship and should be specified in service agreements or relationship documents – especially if the Local Government Official Information and Meetings Act does not apply.

In cases where the activities of stand-alone entities have a direct impact within the community, the entities may need to consult the community directly to:

  • develop and deliver programmes;
  • seek feedback on their activities; and
  • account publicly for their performance.

Such consultation was clearly occurring in some instances. Community or customer feedback was sometimes used as a measure of the entity’s success in meeting its performance objectives. In general, however, nonprofit entities were not required by the terms of their accountability documents to seek the views of their communities on their proposed activities, nor to account to the public for their performance.

In some circumstances (such as when considering the purchase, development or sale of community facilities), stand-alone entities should be encouraged to hold public meetings to seek the community’s views on specific plans and proposals or to report on their activities. Annual surveys of residents can be used to provide assurance to the local authority about the level of community satisfaction with the facilities or programmes managed by the stand-alone entity.

An Effective Governing Body

An effective governing body is vital for good stewardship and effective delivery of services for the community. The trust deed or other founding document provides a ready opportunity for a local authority to specify its power to appoint some or all members of the governing body of a stand-alone entity. This was a common approach, and allows the local authority to ensure that the direction of the stand-alone entity remains consistent with its own interests.

Nomination and selection processes for trustees or board members should provide assurance that:

  • local authorities have drawn as widely as possible on the pool of possible candidates across the community; and
  • appointments have been based on an objective process focused on obtaining the best possible mix of skills and experience.

Key elements of an effective selection and appointment process include:

  • a person specification and job description defining the skills, attributes and experience needed for the position;
  • a thorough process for seeking possible candidates; and
  • a transparent procedure for drawing up the shortlist and making the appointment.

We reviewed the processes followed to appoint trustees or other board members.

Two local authorities had, or were building up, databases of individuals with the skills, interest and commitment to serve on their boards. With this information, the local authorities will be able to draw on a pool of prospective appointees as the need arises.

The board of a stand-alone entity may (or in some cases must, as a requirement of the trust deed) draw on particular constituencies. A board with a constituency membership may not have the necessary professional skills and experience to discharge its governance responsibilities fully; nor to direct and oversee the operations of the entity in the most effective way. Using competency-based selection criteria can provide a desirable balance of skills and experience on the board, along with a membership mix which is representative of stakeholders.

We found that there was potential to make appointment processes more systematic. Some appointments were based on an objective assessment of skills. In general, however, appointment processes were less objective, formal, transparent, and consistent than those followed for appointing directors to the boards of commercial trading enterprises. We recommend that, while having regard to the different mix of skills and experience required for non-profit entities, local authorities should use appointment processes similar to those followed for appointing directors of their commercial enterprises.

The Role of Councillors on Governing Bodies

Views differ in local government on the merits of appointing councillors to be directors or members on the governing bodies of commercial or non-profit entities. Of the four local authorities we reviewed, only one had a practice of appointing councillors to the boards of non-profit entities. We explored the benefits and disadvantages of councillor appointments.

Arguments in favour of appointing councillors to governing bodies of non-profit entities include:

  • aligning their activities with the outcomes sought by the local authority;
  • overcoming the difficulty of specifying desired outcomes in contractual terms;
  • lifting the profile of the entity in the community; and
  • reflecting the social and community focus of the entity’s activities.

Local authority representation can be seen as necessary:

  • to align the direction of the entity with the objectives and priorities of the local authority;
  • to secure local authority support for strategic initiatives; and
  • to co-ordinate and rationalise the activities of non-profit entities performing complementary functions.

Local authority representation can also be seen as a way to provide a mechanism for monitoring performance, to communicate with the local authority, and to be a voice for the interests of the community.

Councillor appointments may also have the following significant disadvantages:

  • Trustees and members of governing bodies are expected to give priority to the interests of the stand-alone entity, and they have certain legal and professional obligations.
  • Councillors face a potential conflict between their roles as trustees or board members and their interests as elected representatives.
  • Direct involvement of councillors in the internal governance of the entity may also inhibit the effective operation of an arm’s-length accountability relationship with the local authority. This may make it more difficult to hold the governing body to account for its performance. In particular, a strong councillor presence on the governing body has the potential to undermine the operating independence of the standalone entity.
  • Councillors are unlikely to have the time and resources to analyse and monitor the performance of the governing body objectively. In our view, this monitoring role is best assigned to local authority officers.
  • In their role as members of the governing body, councillors may become personally liable for the decisions of the body.

Conclusions and Recommendations

Establishing stand-alone entities to undertake community activities potentially removes such activities from public scrutiny. We found that local authorities had generally addressed accountability issues in an effective way through a variety of accountability instruments. A range of relationship documents specified the power of the local authority to comment on (and, if necessary, influence) business planning, and to receive regular reports on performance and other relevant information.

Local authorities should ensure that stand-alone entities are fully aware of a need to consult the community in carrying out their activities. While we found that this was often occurring, it had not generally been specified as a requirement of the entity in carrying out its activities.

We recommend that all local authorities develop formal agreements as a means of holding stand-alone entities to account for their delivery of services. Such agreements should be the basis for ongoing monitoring of performance, information collection, reporting, co-ordination, and consultation between the parties. Suggested elements of a service agreement are outlined in Appendix B on pages 114-115.

We identified the need for local authorities to adopt a more systematic approach to the appointment of trustees and members of the governing bodies of stand-alone entities. Explicit skill-based selection criteria should be used. Procedures should also be in place to review the performance of board members individually and of the board as a whole.

Local authorities should consider the benefits and advantages of councillor appointments. A balance is needed between maintaining a close working relationship and policy alignment, on the one hand, and an appropriate arm’s-length monitoring relationship, on the other.

We are aware that consideration is being given to undertaking a review of local government legislation. The current legislation does not adequately define the accountability relationships between trusts or other non-profit entities, and local authorities or the community. Should such a review take place, we recommend that consideration be given to addressing this shortcoming by putting in place clear accountability requirements which reflect an appropriate balance between the interests of the local authority on the one hand, and the autonomy of the stand-alone entity on the other.

14: Section 225c of the Act allows a local authority to transfer to a community trust proceeds from the sale of shares or equity securities in a port company, LATE or LATE subsidiary.

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