Part 6: Our conclusions on the sale process

Inquiry into the sale of Paraparaumu Aerodrome by the Ministry of Transport.

The Government’s policy objectives

Our terms of reference say that we will examine what the Government’s policy objectives were for the sale of Paraparaumu Aerodrome, as expressed in Cabinet minutes or Ministerial and any other relevant directives.

The decision to sell was first made by one Government, and was later confirmed and implemented by another. The overall policy framework which dictated the disposal was broadly the same under each administration. It was that:

  • Civil airports and aerodromes should be run as businesses.
  • Government departments should not be involved in running businesses.
  • State-owned businesses that were profitable should be corporatised and either operated as State enterprises or privatised.
  • State-owned businesses that were not commercially viable should be disposed of on the open market.

Paraparaumu Aerodrome was not considered a commercially viable operation in public ownership. Accordingly, Ministers directed that it should be sold, subject to the Crown meeting its obligations to Māori under the Treaty of Waitangi and to former landowners under the Public Works Act.

We have recorded our conclusions in respect of the Public Works Act and Treaty aspects in Part 4. In our opinion, the Ministry was influenced by 4 other policy considerations, which were endorsed by the Minister, when carrying out the sale:

  • The aerodrome should preferably be sold as a single asset. Although it appeared that some aerodrome land may have been surplus to the Ministry’s existing operational requirements, decisions on whether that land should be disposed of should be left to the new owners, taking account of their future intentions. However, a partial tender would be considered.
  • Disposal should be both quick and complete, with no ongoing or residual Crown obligations in respect of the aerodrome or any aerodrome land. This consideration was influenced in turn by–
    • the pending capital charge on departmental assets (which would not, in the case of the Paraparaumu assets, be capable of being funded from revenue); and
    • consideration of the Crown’s responsibilities under the Public Works Act to former owners of compulsorily acquired land.
  • The aerodrome should remain operational for as long as possible, in accordance with the wishes of users and the local community. But there should be no obligation on any new owner of the aerodrome to keep it operational. These considerations were influenced by–
    • the lack of commercial viability, as demonstrated in independent valuations of the aerodrome as a going concern;
    • the aerodrome’s significance in managing regional air traffic, and in aviation safety terms; and
    • the Ministry’s wish to not place the Government in a position where it would have to re-acquire the aerodrome should it prove commercially unviable under new ownership.
  • Proceeds from the sale should be maximised, subject to the sale process meeting the Government’s requirements.

Design of the process and sale conditions

Balancing the objectives

Paraparaumu was one of many assets which the Ministry was dealing with at the time. In comparison with other disposals – such as those of ports, major international airports, and other joint venture airports – it involved a relatively straightforward trade sale (i.e. a direct sale of a state-owned business).

The Ministry and its commercial adviser approached the sale on the same basis as other trade sales, which were designed primarily to maximise the return to the Crown.

However, the particular objectives in respect of the Paraparaumu sale required the standard approach to be modified. As well as maximising sale proceeds, the Ministry had to give effect to Ministers’ wish that the aerodrome remain operational for as long as commercially viable, subject to the wishes of local communities.

We do not agree with the commercial adviser’s assessment that the desirability of the aerodrome remaining operational was no more than a political response to community concerns and users’ wishes. In our view, the desirability of the aerodrome remaining operational was a government policy consideration, mandated by Ministers – albeit in response to community concerns about the future of the aerodrome.

We noted in Part 5 that the Ministry considered the competing interests to be, to some extent, mutually exclusive. The Ministry’s approach to balancing the various objectives set out above involved:

  • introducing the criterion of “aerodrome user”, as a basis of eligibility to tender;
  • the Ministry satisfying itself that tenderers had both the commitment and capability to continue to operate the aerodrome; and
  • using EY’s commercial expertise to undertake a robust financial analysis of those factors.

Once those hurdles had been satisfied, price maximisation became the final determinant. These were, in effect, the evaluation criteria.

Other possible approaches

There were 2 other possible approaches. The one the Ministry considered involved the use of conditions or caveats requiring a purchaser to continue operations. There are indications from the papers that such conditions were considered unacceptable in the Government’s overall policy on asset sales. This emerges in particular from the policy debate which took place in 1993, when the AHL proposal was abandoned. (As mentioned earlier, that proposal involved operating Paraparaumu and other aerodromes as separate airport companies under a holding company established as a State enterprise – see paragraph 2.23.)

The Treasury favoured disposal of the aerodromes on the open market. Although the Ministry at first concurred in a recommendation to Ministers to that effect, its officials became aware that Ministers would not support the recommendation if it would mean closure of the aerodromes. The notion of a sale to “user groups and/or other local groups” emerged at that point.

The use of conditions was considered and debated further in 1995, when the sale process was being designed. The position which emerged was that conditions would have skewed the balance, to an unacceptable degree, between the competing objectives of continuing operation and price maximisation. Ultimately, the Ministry’s reasoning was that:

  • continuing operation of the aerodrome could not be guaranteed, and should not be;
  • it would be unacceptable for the Ministry to dispose of the aerodrome with a condition that a purchaser may find it commercially impossible to meet, resulting in the Crown having to resume ownership or control of the aerodrome at a later date; and
  • sale to local interests gave the best chance of the aerodrome’s future being determined by the local community.

The other possible approach was to use a “weighted attributes” approach. This would have involved assigning points to attributes such as capability and intention to operate the aerodrome as a going concern – as well as the price tenderers were prepared to pay. The commercial adviser told us that he thought this approach would not have been appropriate, given that future operation of the aerodrome was not to be the subject of any contractual requirement. Moreover, the Information Memorandum said that there was no requirement to accept the highest price. The commercial adviser was in no doubt that the approach adopted was in accordance with best practice at the time, for a business of this type.

Ministry officials took a similar view. What was most important, one official told us, was to be able to assess each bid on its merits in terms of the Government’s sale objectives.

We accept that a weighted attributes approach would have been unusual for an asset sale at that time. But it would not necessarily have been inappropriate. The over-riding consideration was to have sound and defensible criteria for evaluating bids, having regard to the particular requirements of the sale. Guidelines issued by the International Organisation of Supreme Audit Institutions (INTOSAI) in 1988 (Guidelines on Best Practice for the Audit of Privatisations) say, in relation to trade sales, that –

Without robust criteria against which to evaluate bids received, the vendor will not be in a position to assess to what extent each bid meets the objectives for the sale: in the absence of a tender evaluation plan, which incorporates the priority to be ascribed to each criterion, it can be difficult to demonstrate the reasons for, and fairness of, the decision to select a particular bidder. But this can be difficult because in the typical case the objectives for the sale are likely to be in competition with each other and not all of them are likely to be measurable … Even if the vendor succeeds in applying a set of weighted criteria consistently, there is a danger that the appraisal will be too mechanistic … The same potential drawbacks apply to an extent if the vendor, instead of assigning weights to each criterion, chooses one major objective – a quantifiable one – and treats all other objectives as constraints that must be satisfied.

If anything, the intention not to impose any binding obligation to continue to operate the aerodrome made it more important to assess tenderers’ intentions alongside the price they were prepared to pay. This would have ensured that the competing policy objectives of operating intention and price maximisation were considered together.

Identification of risks

In our view, the choice of approach was best made by identifying the risks to achieving the Government’s policy objectives for the sale. It seems to us that a number of potential risks converged at the start of the sale process. They were:

  • The Ministry was made aware of concerns in the community about the possibility of a tender for the aerodrome being made with a focus on developing the aerodrome land, possibly at the expense of the long-term viability of the aerodrome as an operational facility.
  • At the same time, the valuation of the aerodrome had highlighted the difficulty the Ministry could have in settling on a value which created the right incentives for a purchaser to continue operating the aerodrome (as opposed to realising the higher value of the land for other uses), while at the same time maximising the return to the Crown.
  • As discussed in Part 3, the Ministry believed that it had consulted adequately with Māori interests, and that they had agreed that the aerodrome could be sold, but this agreement was subject to 2 important riders –
    • Māori were keen to see the aerodrome continue in operation as an aerodrome, as a public good asset. Their approach to the sale would have been quite different were the aerodrome likely to close. There were also indications that Māori interests would be interested in being involved in the running of the aerodrome, as an alternative to closure.
    • There was ongoing concern about “surplus” aerodrome land, and a clear indication that Māori would expect surplus land to be returned to former owners.

We asked Ministry officials what steps they took to identify those risks and to consider what, if any, mitigation strategies were called for. They told us that they did consider the risks, but did not see any need to change the Ministry’s approach – which was to dispose of the aerodrome in its entirety at the earliest opportunity to those who met the eligibility criteria. Officials had knowledge of each of the tenderers, and were satisfied not only that they met the eligibility criteria but also that they were both capable of and committed to continuing to operate the aerodrome.

The officials did not consider that it would be appropriate to second-guess a particular tenderer’s aspirations as regards the aerodrome. They preferred an approach that would allow them to consider each tender on its particular merits. Thus, the Information Memorandum did not exclude tenders being lodged by those with a commercial interest, provided they also had a “user” association with the aerodrome.

Our conclusion

We are satisfied that the approach the Ministry adopted provided an acceptable means of balancing the competing objectives. It was also, in our view, consistent with the overall policy framework for asset sales and the particular policy position of Ministers. However, we think that the alternative of a more formal assessment process (such as one using weighted attributes) should also have been considered as part of an assessment of the risks involved.

Valuation of aerodrome assets

The Ministry decided to sell the aerodrome as a going concern. Accordingly, it used the “going concern” element of the valuation prepared by EY as the benchmark for assessing tender prices.

In our view this was a reasonable approach, given that the Government’s policy objectives for the sale were not only to maximise sale proceeds, but also that the aerodrome should remain operational for as long as possible subject to commercial viability.

We commissioned an independent valuation to ascertain the reasonableness (in the context of valuation standards existing in 1995) of the EY valuation. The independent valuation examined 2 aspects of the original valuation:

  • the value of just over $700,000 given to the land identified as possibly surplus to operational requirements; and
  • the net realisable value valuation of the entire property of $3.5 million.

The independent valuation had an effective date of April 1995. It assessed the value of the “surplus” land at $735,000, and the net realisable value of the entire property (in other words, its value if sold for other uses) at $3.861 million.

It was impracticable, after the passage of time, to re-perform the other component of the going concern valuation (the net cashflow valuation of the core aerodrome assets). However, in our view, that aspect was not unreasonable. We are therefore satisfied that, overall, EY’s going concern valuation was reasonable.

The implementation of the sale process

Project governance arrangements

All of those involved had a common view that the sale process was a joint exercise, involving collaboration and reliance on each other’s expertise. We agree with the Ministry’s contention that a multi-disciplinary approach was necessary – given the need not only to conduct the sale on a commercial basis but also to ensure that the Government’s policy objectives were met. The project group appears to us to have been intended as an internal forum for this purpose and to enable the commercial adviser to report back to the Ministry on his conduct of the process.

But the meetings of the project group on 26 April 1995 and 3 May 1995 turned into key decision-making meetings, which had implications for the fairness of the process. To this extent, we consider the project governance arrangements to have been unclear. We expected to find a better-documented understanding of how key decisions were to be made in relation to the sale process, given that EY had been engaged expressly to manage the process and produce a recommendation for the Ministry.

Evaluation of tenders

We reviewed the commercial adviser’s handwritten notes of his financial analysis (see paragraph 5.47). We are satisfied that the tenders, including the financial projections of each tenderer, were analysed with the rigour that would be expected for an asset sale of this nature.

But there was no documented understanding of how the evaluation against the criteria would be conducted. We are concerned about 2 particular aspects.

First, the Information Memorandum made it clear that tenders were to be submitted on a particular basis, by a particular date. This gave a clear signal to tenderers that they were required to follow due process, and in our view it also created an expectation that the Ministry itself would also adhere to that process when considering tenders. Yet, we found no documented evidence of what that due process was to be.

This became a particular issue when one of the tenderers submitted a “relative bid”. The project group was clearly concerned about whether the bid conformed to the requirements of the Information Memorandum, and decided to seek legal advice. It received written advice that the bid did not conform. But subsequent discussions appeared to result in a softening of that advice.

Ministry officials maintained that the “relative” bid was excluded by the decision to go back to all tenderers inviting revised bids. The commercial adviser pointed to the following statement in the Information Memorandum to justify the decision to continue dealing with KAH –

The Crown and Ministry may at any time negotiate with one or more potential purchasers and enter into an agreement for the sale of the Aerodrome in any manner whatsoever without prior notice to any or all interested parties. Furthermore, the Crown and the Ministry also reserve the right to terminate, at any time, further participation in the investigation and proposal process by any party and to modify procedures without assigning any reason therefore [sic].

It is not for us to say what the Ministry’s legal obligations were at this point. We accept that the external legal advisers were kept appraised of the situation in writing, and did not demur. But, if the written legal advice had been followed, the tender would have been excluded and/or the process recommenced. Ministry officials maintained that this was, in effect, what happened. But no such decision was communicated in writing to the tenderers. In our view, it would have been good practice for the Ministry to have obtained further written legal advice, mandating its intended approach, before it allowed the non-conforming tenderer to make a revised bid.

Our second concern relates to the lack of any formally documented evaluation criteria. All tenderers clearly understood the importance of both commitment and capability, and all met those requirements. But the criteria, and the evaluation against them, ought to have been documented.

Consideration of revised bids

We are satisfied that the commercial adviser properly informed all tenderers of the need to take account of the value of surplus aerodrome land when submitting their revised bids. However, we do not think that a fair process was followed from that point.

We have no doubt that the commercial adviser gave tenderers until Friday 5 May 1995 to submit their revised bids. Yet the project group met on Wednesday 3 May and–

recommended that negotiations be undertaken with [KAH] with a view to finalising the sale and purchase agreement.

Good tendering processes begin with a strictly process-driven stage of appraising tenders, followed by a more open-ended stage involving negotiation of contract terms with a “preferred tenderer”. It is not clear to whom the project group’s “recommendation” was directed. But, in our view it was, in effect, a decision to move from the first to the second stage. The decision was premature and was inconsistent with good tendering practice. It created significant procedural unfairness. The project group did not know what the other bids would be at that point, and was not in a position to do any more than speculate about any condition(s) that KRAL would attach to its bid.

We do not think that the provision referred to in paragraph 6.33 justifies the departure from good practice.

The commercial adviser told us that he would have accepted any higher bid until the time a contract was signed. We presume that, had KRAL’s revised bid been higher than that of KAH, he would have asked for the project group meeting to be reconvened. In our view, it would have been essential to have done so – especially because the condition attached to the bid (that the Crown deliver separate titles to the land identified as surplus) had financial implications.

In the event, KRAL’s revised bid was less than that of KAH. It could therefore be said that there was no unfairness in the result. But that does not justify the deficiencies in the process.

Standard of documentation

The standard of documentation of some parts of the sale process was poor. We have already commented on the lack of documented governance arrangements, evaluation process, and evaluation criteria. We also expected the actual evaluation of the tenders to have been documented with reference to those criteria, but they were not.

Conflict of interest

In our opinion EY had a conflict between their role of acting as the Ministry’s commercial advisers for the sale and being named as KAH’s accountants in its tender. We do not think that the fact that EY had previously acted for a KAH partner on an unrelated matter necessarily created a conflict.

It is important that conflicts of interest be identified and disclosed, and that appropriate steps be taken to manage them. Some conflicts are so significant that they are not capable of being managed short of the conflicted party withdrawing from the assignment. Others can be managed by steps being taken to mitigate their effects – for example, additional disclosures or reassigning staff.

Although a conflict of interest existed, it was not in our opinion so significant as to have required the commercial adviser to withdraw from the sale assignment. We think the position would have been different had EY advised or assisted KAH in the preparation of its tender. In either of those cases, withdrawal from the sale assignment would have been the only option open to EY.

There is also, in our view, no risk that the commercial adviser’s work for the Ministry was in fact influenced by EY having been identified in KAH’s tender.

EY told us that in its view everyone acted in accordance with its internal policy on independence and conflicts of interest. The commercial adviser also told us that he acted in accordance with EY’s internal policy. He said the matter could have been dealt with by creating a “Chinese wall”, but he did not regard that as acceptable and instead took steps to ensure that there was complete separation from KAH.

The commercial adviser appears to have dealt acceptably with the conflict of interest when it came to his attention. However, it does not appear that EY disclosed the conflict to the Ministry, as its internal policy required. Disclosure would have alerted the Ministry to the conflict and enabled it to assess its implications.

The Ministry acknowledged to us that its officials overlooked the reference to EY in KAH’s tender, and that the oversight created a perception of a conflict of interest in the eyes of the unsuccessful tenderers.

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