Appendix 1: Examples of council-controlled organisations

Governance and accountability of council-controlled organisations.

The following examples describe matters that we consider might help local authorities who have CCOs or who are thinking of setting them up. The examples are referred to where relevant in the text of the report.

The first example is about Christchurch City Council's holding company, Christchurch City Holdings Limited (CCHL), and its monitoring of the Council's CCOs.

The City Care Limited example is about one of the Christchurch CCOs. It is included as an example of a local authority having a contracting relationship with a CCO in addition to the shareholder-subsidiary relationship.

The third example is about Dunedin City Council's group of CCTOs and the review of the group's governance structure.

The fourth example is a discussion of Queenstown Lakes District Council and Queenstown Airport Corporation Limited about the Airport company's issue of a minority shareholding to Auckland International Airport Limited without formally consulting its parent local authority. This example illustrates the need for trust between a Council and its subsidiary, and the significance of the subsidiary's constitution.

The fifth example is about Tauranga City Council working with the directors of its primary CCO to determine a new governance model for all of its CCOs.

Example 1: Christchurch City Holdings Limited and group

We reviewed Christchurch City Council's wholly owned subsidiary CCHL and its group of subsidiaries because they have been in place for more than 20 years and appear to operate successfully.

We spoke to chairs and chief executives of several of the subsidiary companies, to the then Mayor, and to the chief executive of CCHL.

The Council set up CCHL in 1993 as a holding company for the Council's commercial investments. It was designed as a "confidential, independent, non-political buffer between the Council and the companies it owned". The holding company structure was adopted to ensure a commercial approach to managing the investments.⁵⁵

CCHL's main purpose is to invest in, and promote the establishment of, significant infrastructure assets in a commercially viable manner. Its statement of intent for 2014/15 notes that "CCHL is mindful of the significant investment by the Council in its operations, and of the need to preserve and grow shareholder value

and the level of dividends to the Council". It has no role in the operations of the subsidiaries.

A board of eight directors governs CCHL, which currently employs three staff.

Group structure

The Council has interests in a range of subsidiaries. CCHL holds the majority of shares in, and monitors seven of, these subsidiaries:

Orion New Zealand Limited – an electricity distribution network covering 8000 square kilometres in central Canterbury. The Council has an 89.3% shareholding through CCHL. Orion owns the electrical contracting business Connetics Limited.
Christchurch International Airport Limited – which owns and operates Christchurch International Airport. CCHL has a 75% shareholding and the Crown holds the remaining 25%.
Enable Services Limited (trading as Enable Networks) – a CCTO wholly owned by CCHL that delivers high-speed fibre optic networks to Christchurch.
Lyttelton Port Company Limited – Christchurch's deep-water port, now wholly owned by CCHL.
Eco Central Limited – which oversees the processing of refuse and recycling collections throughout Canterbury. CCHL wholly owns this CCTO.
Red Bus Limited – a CCTO wholly owned by CCHL that provides public passenger transport and freight services in Canterbury.
City Care Limited – a CCTO wholly owned by CCHL that constructs and maintains infrastructure and property assets. It operates throughout New Zealand.

The Council has designated its shareholdings in CCHL and five of the seven CCTO subsidiaries as "strategic assets" in its significance policy. City Care Limited and Red Bus Limited are no longer designated as strategic assets.

When CCHL was set up, it had assets worth $170 million. As at 30 June 2014, the group was reported as owning assets with a combined value of $3.2 billion. Its 2014 group profit before tax was $454 million.⁵⁶ Its subsidiaries are reported to have generated average returns, including capital growth, of more than 14% each year since 1995. CCHL has paid $1.1 billion in capital and dividend payments to the Council since 1995.

Appointment of directors

As required by the Act, the Council has adopted a policy for the appointment and remuneration of directors of its subsidiaries.⁵⁷

Christchurch City Holdings Limited

The Council appoints the directors of CCHL. The CCHL board comprises four Council directors and four independent directors.

After each Council election, the Council forms a Council Appointments Committee to recommend to the Council candidates for non-Council director positions on the CCHL board when vacancies arise.

The Committee usually comprises the CCHL chair, a councillor, a recently retired councillor, and an experienced external director, none of whom are seeking appointment to the board.

The Committee first determines the skills, knowledge, and experience that the directors need for the board to be effective. The policy notes that, because of the confidential and sensitive nature of much of the business coming before the board, "it is critical to the success of this board that it has a composition which is capable of maintaining the confidence of both the Council and the subsidiary companies". The intention is that Council directors and non-Council directors are all appointed on merit.

The Council also appoints the Chair of the CCHL board, on the nomination of the Council Appointments Committee. A CCHL Chair Succession Planning Policy provides for the Council Appointments Committee to ensure smooth transition between CCHL chairs.

CCHL's subsidiaries

CCHL manages appointments to the boards of CCHL subsidiaries, in keeping with the Council's policy for appointing directors. If there are minority shareholders, CCHL consults them on appointments as necessary. As with appointments to CCHL's own board, the focus is on ensuring that each board has an appropriate balance of relevant skills and expertise, and that appointments are made on merit. The policy emphasises the need for directors to understand "the wider interests of the publicly accountable shareholder".

CCHL maintains an up-to-date list of candidates. When there is a vacancy on the board of one of the subsidiaries, the selection process is carried out by the CCHL Governance Committee. The Committee determines the skills, knowledge, and experience needed for the vacancy, in consultation with the chair of the relevant board. The Committee then reviews its database for potential candidates, and also engages a recruitment consultant to identify other possible candidates. It then establishes a long list of candidates.

It usually selects four candidates to interview. The Committee then recommends its preferred candidate to the full CCHL board. The board then makes a recommendation to the Council, which makes the final decision.

Elected members are not precluded from appointment, but they must go through the same appointments process as independent candidates. At the time of writing, no councillors were appointed to any of the CCHL subsidiaries' boards, although councillors are appointed to the boards of four other subsidiaries owned directly by the Council.

Monitoring and oversight

The formal monitoring process comprises:

completing and approving each CCTO's statement of intent;
half-yearly presentations by each CCTO to the CCHL board;
quarterly reports to CCHL by each CCTO; and
annual letters of expectation.

The CCHL board considers each subsidiary's draft statement of intent and recommends the final statement of intent to the Council. The Council separately reviews the statements of intent. Twice a year, the chair, chief executive, and chief financial officer of each subsidiary meet the CCHL board and report progress against the objectives in their statement of intent.

In addition, the subsidiaries report to CCHL each quarter. Reports to the CCHL board are confidential. We were told that the confidentiality enables frank discussions and that there has been little difficulty in maintaining appropriate confidentiality in recent years.

CCHL reports to the Council on the subsidiaries' statements of intent. It also provides the Council with a periodic report on the subsidiaries' performance. However, because of the need to keep commercial information confidential, it will also conduct workshops for elected members on subsidiaries' performance and issues of interest.

At the start of each Council term, CCHL runs an education programme for all councillors as part of the Council's induction programme. The education programme sets out the rules and expectations for how the subsidiaries and CCHL will engage with the Council. It provides clarity about roles and responsibilities. CCHL has a Board Charter that sets out the roles and responsibilities of the board, and the Council has guidelines for the conduct of directors of CCHL and its subsidiaries.

In addition, all directors (both councillors and independent directors) are given an induction session led by CCHL's chief executive. The chief executive provides them with various documents and explains the company processes to them. All directors are encouraged to become members of the Institute of Directors, and CCHL funds their attendance at appropriate governance-related courses.

CCHL has a Director Induction policy that requires a subsidiary board to hold an induction programme for new directors as soon as possible after their appointment. The chair of the subsidiary is responsible for meeting the obligation.

Underpinning the relationships between CCHL and its subsidiaries, and CCHL and the Council, is a clear "no surprises" policy – that is, the subsidiary must give the shareholder timely warning of major issues.

When we carried out our work in Christchurch for this report, Lyttelton Port Company Limited was listed on the New Zealand Stock Exchange. Because of its obligations as a listed company to treat all of its shareholders the same, it could not provide any information to CCHL that was not also publicly available. As a result, CCHL's monitoring regime for that company differed. In effect, the port company briefed the CCHL board only annually.

Remuneration of directors

CCHL determines the remuneration paid to directors of the CCTOs and must review it at least every three years. Fees for each board are set as an aggregate amount, leaving each board to determine the remuneration for individual directors.

In setting remuneration, CCHL is required to take account of:

the need to attract and retain appropriately qualified directors;
the remuneration paid to comparable companies in New Zealand;
the performance of the CCTO and any changes in the nature of its business; and
any other relevant factors.

The Council's policy requires that a Council director on a CCTO board is entitled to receive:

… normal directors' fees due to this policy being based on all appointments being based on merit and directors being appointed to act in the interests of the company and not as representatives. It is considered that all directors on any board should be treated equally in recognition of the responsibility taken on by all directors to act in the interest of the company they serve.

The Council sets fees for directors of CCHL after the Council elections, based on a recommendation from CCHL. Again, the policy provides that no distinction is to be made between non-Council directors and Council directors when assessing fees. However, since the 2013 election, the Council directors do not receive fees. Instead, CCHL donates an equivalent amount to charity.

The policy requires CCHL to arrange and pay for directors' liability insurance for, and to indemnify, each of its directors. The policy further notes that the Council supports the payment by CCTOs of directors' liability insurance and the indemnification of all directors.

Complaints

We asked those we interviewed how complaints about a CCTO were managed, particularly where the complaint was made to a councillor or to CCHL.

We were told that a complaint about the activities of a CCTO was usually directed to the CCTO. If an elected member received a complaint, or had a query of their own, the matter is handled through the chief executive of CCHL.

Our observations

The directors and chief executives of subsidiaries we spoke to largely supported the CCHL holding company model. They variously described CCHL as a "buffer" or "insulating layer" between the Council and the operations of the CCTOs.

That separation allowed them to focus on commercial objectives. It reduced their concerns about their ability to keep commercial information confidential under political and public scrutiny. However, they were conscious that, as Council-owned entities, they needed to meet a higher standard of transparency than companies operating in the private sector.

They thought that the monitoring regime was effective in providing a degree of clarity about responsibilities and expectations. One chair described CCHL's monitoring as "reasonable and appropriate".

They all said that the appointments process worked well, that CCHL was always aware of the skills needed for the vacant positions, and that the sub-committee usually identified suitable candidates.

We noted several factors that might contribute to the apparent success of the CCHL model:

The roles of Council, CCHL, and the subsidiaries are clear. They are also clearly understood by the various participants.
There is a clear focus on skills and capability in appointments to boards.
There appeared to be mutual respect and confidence between CCHL and subsidiaries.
There is effective separation between political and operational matters, although this may mean that elected representatives have limited access to information about the businesses.

Example 2: City Care Limited – contracting with the parent council

Introduction

City Care Limited (City Care) is a CCTO wholly owned by Christchurch City Council through its holding company, CCHL. The Council has awarded several contracts to City Care. This has led to allegations that the Council is subsidising City Care and unfairly disadvantaging competitors.

We have included this example because it illustrates the potential conflict between a Council's interest as a shareholder and its interest in obtaining "value for money" for its ratepayers through a competitive purchase process, and treating other businesses in its district fairly.

City Care

The Council formed City Care in November 1999. City Care acquired the Works Operations Unit of the Council. Most, but not all, of the maintenance work previously done by the Council was awarded to City Care at that initial stage.

City Care's main activities are maintaining parks, gardens, sports fields, buildings and public facilities, roading networks, and water, wastewater, and storm water networks. Its clients include local and central government authorities and commercial businesses nationwide.

City Care employs about 1500 staff. It has offices in 16 locations around the country, including in Auckland, Hamilton, Tauranga, Wellington, and Christchurch. In early 2013, City Care launched its Building Construction division. It competes with other CCTOs and privately owned businesses for work throughout the country.

City Care is one of the five members of the Stronger Christchurch Infrastructure Rebuild Team (SCIRT), an alliance responsible for rebuilding damaged roading and water, storm water, and wastewater networks in Christchurch after the 2011 earthquakes.

One of City Care's primary objectives is to operate a successful business to generate a dividend stream for the Council. In 2013/14, City Care reported a profit of $12.9 million (compared with $2.8 million the previous year) and paid an annual dividend of $5.67 million ($6.28 million the previous year) to CCHL.

Christchurch City Council contracts awarded to City Care Limited

Since 1999, City Care has been awarded Council contracts for maintenance work on the Council's core assets. The Council and City Care entered into arrangements that secured favourable treatment for City Care for up to five years from formation. In 2003, the Council agreed to an extension of the term of some of its contracts in return for a reduction in the price paid to City Care.

The Council also agreed to cover a proportion of any redundancy costs that City Care might incur from a change in its circumstances. That obligation expired on 1 December 2009.

Contracts awarded between 2008 and 2010

In 2008, when some of the maintenance contracts had expired and others were due to expire within two years, the Council considered whether to enter into negotiations with City Care for three groups of maintenance contracts or to seek competitive tenders.

The Council took advice about whether it was able to enter into direct negotiations with City Care or whether it needed to carry out a contestable process. The advice was that, because City Care was (then) a strategic asset, the Council could take into account considerations such as the benefit of a strong, financially sound subsidiary and the effective and efficient use of Council resources.

Provided it followed the statutory decision-making process, the Council was able to negotiate new contracts with City Care. That process required the Council to consider the views and preferences of persons and organisations likely to be affected by, or to have an interest in, the decision – including contractors wishing to compete for the contracts.

Elected members considered the effect of City Care losing the contracts it held at that time not only on City Care but also on the wider Council group. In the end, councillors instructed the chief executive to begin negotiations with City Care while taking appropriate steps to ensure that any recommendation after the negotiation process was independently verified as being in keeping with sound business practice.

The Council agreed that its Audit and Risk Management Committee would appoint a panel to enter into negotiations with City Care. The panel was to follow our 2008 good practice guide, Procurement guidance for public entities.⁵⁸ Subject to the panel's approval, the chief executive was authorised to enter into the contracts after notifying the Council. The chief executive was required to report back to the Council if, in his view, the negotiated terms and conditions did not give the Council value for money. In that instance, the Council would start a competitive tender process.

After successful negotiations, City Care was awarded several facilities management and water and waste management contracts.

Contracts awarded between 2010 and 2012

During 2010/11, several Council urban parks contracts were due to expire.

The parks contract negotiation was in progress at the time of the September 2010 earthquake. As a result, the negotiation did not proceed. The Council asked City Care to continue the work under the previous contract.

Because of the Canterbury earthquakes, the roading maintenance contracts that were due to expire on 30 June 2011 were rolled over for another year. In June 2012, after direct negotiations, the Council entered into three contracts with City Care to maintain urban parks, road landscapes, and land drainage and waterways for a fixed term of two years.

The direct negotiations followed the process previously agreed by the Council.

Contracts since 2012

The Council has progressively put contracts to competitive tender. Since 2012, City Care has successfully competed in a tender to retain the roading maintenance work. The parks contract was also tendered, but City Care did not win the tender.

Public perception

There has at times been negative comment in the media about the Council awarding contracts to City Care without going through a competitive tender process. Industry members have commented about the perceived absence of competition. We have also received queries about the Council's decision to negotiate new maintenance contracts directly with City Care.

Our observations

A local authority is not obliged to tender its contracts. It is open to the Council to determine its own procurement policy, having regard to the principles that govern the use of all public funds. These principles are contained in Procurement guidance for public entities, and we expect public entities to consider these principles when relevant.

One of the principles is about ensuring value for money. Although open tendering can be the best way of demonstrating value for money, it is not the only way. The Council has the discretion to determine how it can obtain and demonstrate value for money.

If its subsidiary is a potential supplier, the Council is likely to also want to support its subsidiary and to take account of the effect of the subsidiary failing to prosper on the wider Council group.

In the contracts referred to above, the Council decided that the effect on the Council and group would be too great if City Care were not successful in a competitive tender process. The Council made a strategic decision to negotiate directly with its subsidiary. However, the overriding objective was a contract price that provided value for money to the ratepayer, while ensuring the ongoing viability of its subsidiary. If that outcome was not achievable through direct negotiations, the Council determined that it would then tender the contracts.

However, this came at the cost of a perception that the Council was unfairly favouring its subsidiary and stifling healthy competition.

The Council appears to have paid due regard to our recommendations about procurement in making its decision. In weighing up the advantages and disadvantages, the Council should always have the best interests of the ratepayer at the forefront of its decision-making. In this instance, the Council decided that the advantages in entering into direct negotiations rather than tendering the contracts outweighed the disadvantages of negative publicity about the lack of competition and the perceived effect on the industry.

Example 3: Dunedin City Council

Dunedin City Holdings Limited

Dunedin City Council (the Council) has a long-established CCO group structure. It formed its first CCOs in the early 1990s and its holding company in 1992.

The Dunedin City group comprises:⁵⁹

Dunedin City Holdings Limited, a holding company that owns and/or monitors the other companies in the group;
a treasury company that manages borrowing by the Council and the CCOs;
three CCTOs owned for investment purposes – that is, to make a profit rather than to deliver Council-related services to the public – and subsidiaries and associated companies of those entities;
two companies involved in managing and operating the Council's major facilities;
the Taieri Gorge Railway, a tourism company;
Dunedin's airport (the Council has a 50% ownership share);
a property owning company (the Council has a 49% ownership share); and
three non-trading companies and one small trust.⁶⁰

The Council's long-term plan is clear about why the Council has CCTOs. It states:

Council-Owned Companies

Council-owned companies are an important component in the Council's financial strategy. While they are valuable assets in terms of their capital value, the income (income includes dividends, subvention payments and interest) they generate from their operations are used to keep down the levels of funding required from the city's ratepayers.⁶¹

The CCTOs generate cash for the Council through dividend payments to the holding company, which the holding company then pays to the Council. The holding company also pays market interest to the Council on a shareholder advance provided by the Council. These dividend and interest payments contribute to the Council's cash flow, and it uses the dividend payments to help fund Council activities.

Review of council-controlled trading organisations

From 2006, the Council sought higher dividends from the holding company. It considered that the after-tax profits and cash flows in the group as a whole could support higher dividends. The Council needed to fund several large infrastructure projects and wanted more funding from its holding company and subsidiaries. As the pressure for higher returns continued during the next few years, the holding company began borrowing to sustain the dividends.

The Council and holding company could not agree on the size and nature of the Council's funding problems or solutions, and there were perceived dysfunctional relationships within the group. By early 2011, tensions had come to a head and the Council commissioned a governance review by Warren Larsen (the Larsen review).⁶²

Governance arrangements lacked commercial tension

The Larsen review was critical of the governance arrangements in the Council group and recommended changes. The long-standing governance practice in the Council group was that the five directors of the Council's holding company were also directors of the CCTOs. This meant that the boards of the holding company and the CCTOs had largely the same directors for more than 10 years.

There were historical reasons for this arrangement, but the Larsen review found that it had led to a lack of commercial tension in the group. This was because the holding company was not fulfilling a strategic and performance monitoring role for the subsidiaries. There was a risk that too much collegiality could impede robust debate (between the board of the holding company and the boards of the subsidiaries, because they were largely the same).

Other long-standing practices included:

a councillor chaired the holding company and was also a director of the subsidiaries, but he did not see himself as a conduit for information back to the Council;
a senior Council officer was the secretary of the holding company and attended holding company board meetings; and
the Mayor and chief executive of the Council attended part of those board meetings.

Despite these arrangements, the Larsen review noted that:

a few people often held important information, which was not shared appropriately;
communication within the Council and with its investment companies needed to improve, with more formal reporting structures between the holding company and the subsidiary companies, and between the holding company and the Council;
part of the blame for communication problems lay with councillors because of their poor attendance at important meetings about holding company matters; and
councillors needed to show more trust and capability in handling confidential information.

The Council changed the governance arrangements after the Larsen review to provide that a director could not be on the board of both the holding company and a subsidiary in the group, and that councillors and staff members could not be on subsidiary boards. The Council appointed a new holding company board in October 2011 with no councillors on it. It also created a position of group chief financial officer.

Our observations

The Larsen review illustrates the importance of maintaining tension in a company group structure between the monitoring responsibilities of the shareholder and the accountability of the subsidiary. It illustrates the importance of:

good communication between CCOs and local authorities and between subsidiaries and their holding companies, and the risk of relying purely on informal arrangements;
local authorities being clear with their CCOs about their appetite for risk;
having different directors involved in the holding company and the subsidiaries so there is independent oversight and monitoring of the performance of the subsidiaries; and
independent review of CCO governance arrangements from time to time, particularly long-standing arrangements.

The Larsen review contains useful observations for other local authorities with CCOs, particularly those with group structures.

Example 4: Queenstown Lakes District Council – Queenstown Airport Corporation Limited

Introduction

This example is about a decision in 2010 by Queenstown Airport Corporation Limited (Queenstown Airport) to issue a minority shareholding in the company to Auckland International Airport Limited (Auckland Airport) without formally consulting its then 100% shareholder – the Queenstown Lakes District Council.

The decision was subject to legal challenge by a group of concerned ratepayers and Air New Zealand against Queenstown Airport, Auckland Airport, and the Council. The legal proceedings were discontinued before a substantive court hearing.

We include this example because it illustrates:

the importance of relationships and systems that support good communication between a local authority and its subsidiary;
the tension between accountability and the need to keep some commercial matters confidential; and
the need for the constitution of a wholly owned subsidiary of a local authority to be kept up to date and appropriate.

In preparing this example, we talked with the main participants from the Council and the Queenstown Airport board to learn their perspective on the transaction. We also considered some of the legal advice prepared for Queenstown Airport, and affidavits and other material prepared for the judicial review proceedings.

Share issue

On 7 July 2010, Queenstown Airport entered into an agreement with Auckland Airport to issue just under 25% of the shares in Queenstown Airport to Auckland Airport. The agreement established a "strategic alliance" between the two airport companies. The Queenstown Airport board did not seek formal approval from the Council before issuing the shares to Auckland Airport.

The Queenstown Airport board had been discussing a possible alliance with Auckland Airport since late 2009, including the possibility of raising capital by issuing shares to Auckland Airport. The negotiations were carried out under a confidentiality agreement between Queenstown Airport and Auckland Airport, in keeping with standard commercial practice.

The board considered two main options at a meeting in late June 2010. The options were:

asking the Council to decide on the best way for Queenstown Airport to raise capital; or
raising the capital by issuing shares to Auckland Airport.

The board noted that the first option would take longer and would not necessarily achieve the same value. Any requirement for the Council to formally engage in the process would have increased the time needed to complete the transaction. It would also have increased the risk of others with competing commercial interests becoming involved.

The board had independent commercial advice on the merits of the share issue proposal. It was satisfied that issuing shares to raise capital was in the best interests of the company and its shareholder.

Constitution

Under Queenstown Airport's constitution at that time, the board could issue shares in the company to new shareholders without first having to offer them to existing shareholders. The board had legal advice confirming that its constitution did not require it to seek the Council's approval to issue a minority shareholding to Auckland Airport. However, the legal advice said that it would be highly unusual for the board to proceed without notifying the Council.

The board did not want to issue more than a 25% shareholding without engaging the Council. Therefore, it agreed with Auckland Airport that:

Queenstown Airport would initially issue a 24.99% shareholding to Auckland Airport; and
the board of Queenstown Airport would have the option to issue a second tranche of shares to Auckland Airport, subject to formal engagement with, and approval from, the Council.⁶³

Communication between the board and the Council

The chair of the Queenstown Airport board had sounded out the then Mayor⁶⁴ on options to raise capital, including the proposal to issue shares to Auckland Airport, in March 2010 and again in April and May. The chair was not seeking the Council's approval of the transaction but attempting a "no surprises" approach. The board was concerned that information about the proposal might be leaked and prejudice the deal if the whole Council were told too early.

In mid-June, the Mayor asked the chair to brief more people within the local authority. At a meeting on 17 June 2010, the chair briefed the Mayor, the Deputy Mayor, the chief executive,⁶⁵ and the Council's financial controller. The chair required them to sign confidentiality agreements. The chair was not seeking agreement to the proposal but providing information about it and seeking reactions from those present. The financial controller was concerned about whether the proposal was lawful, and raised the issue of compliance with the statement of intent. His preference would have been to have a confidential Council workshop about the proposal, but the Airport board was concerned about confidentiality. The meeting agreed that all councillors should be briefed on the transaction shortly before it was announced.

The statement of intent

The Council considered Queenstown Airport's draft statement of intent at a workshop in March 2010. The draft statement of intent did not mention raising capital or the proposed issue of shares. It said, "No capital injections from shareholders are expected in the current period."

In late June 2010, Queenstown Airport amended the draft Statement of Intent to say, "The company will consider the need for and source of capital subscriptions as may be required."

Councillors were given a copy of the final statement of intent, but the change was not pointed out to them. Those in the Council who had signed the confidentiality agreements considered that those agreements meant that they could not mention the change.

The transaction

The Queenstown Airport board resolved to issue the shares on 7 July 2010. Auckland Airport countersigned the agreement after financial markets closed on that day. Councillors were briefed on the transaction at 4pm that day. The time was chosen to ensure that there would be no leak before the matter could be made known to the market. On 8 July 2010, the transaction was announced and became public.

The legal challenge

Some councillors and some members of the Queenstown community were concerned about the share issue. The concerns included that the Council had not been consulted and that local people had not had the opportunity to express their views or to purchase shares in the airport.

A group of Queenstown people and business owners opposed to the sale and Air New Zealand began judicial review proceedings against the Council, Queenstown Airport, and Auckland Airport.⁶⁶ They considered that the Council had a duty under the Act to consult them on the matter.

Our observations

Communication between the Council and its subsidiary

Until early 2010, when the Council's chief executive left, there had been informal communication between the chief executives of Queenstown Airport and the Council, and between the Chair of Queenstown Airport and Mayor. The Mayor and chief executive also had a standing invitation to attend board meetings. The Council's new chief executive started in March 2010 and had not established a relationship or communication arrangements with Queenstown Airport during these events.

There were no protocols between the Council and Queenstown Airport for handling sensitive information. A protocol could have helped to guide communication about the proposal, although it would not have dealt with the concern about the risk of leaks by some councillors.

One of the board's objectives, as reflected in Queenstown Airport's statement of intent and noted in the Council's 2009 long-term plan, was to:

Ensure adequate communication exists between the Queenstown Airport and the community and its elected representatives by way of an ongoing public information service and the holding of regular open meetings with a liaison group comprising community group representatives, interested individuals, airport users, etc, while continuing existing reporting systems.

However, this broad objective did not suit a sensitive commercial negotiation where the board was subject to confidentiality requirements and did not trust all councillors to keep information confidential.

Statement of intent

Clause 1 of Schedule 8 of the Act says that the purpose of a statement of intent is to state the CCO's intentions for the year, to provide an opportunity for the shareholders to influence its direction, and to provide a basis for the accountability of the directors to the shareholders for the performance of the organisation.

The change to Queenstown Airport's statement of intent was made late and was not drawn to councillors' attention. The reference to raising capital was brief and vague given the board's actual intention at the time. It is questionable whether the statement of intent met the purpose requirements of the Act.

Confidentiality

The Mayor and others in the local authority were given information about the proposed transaction in confidence. That put them in a difficult position. The Mayor had to decide when to inform the rest of the Council about the proposed transaction. The chief executive and a senior staff member were also obliged to keep the proposal confidential. That meant that the chief executive was unable to meet her responsibility as the Council's main advisor.

The Queenstown Airport board members were also subject to confidentiality requirements, which made it difficult for the board to adhere to a "no surprises" policy and keep the Council fully informed. The confidentiality requirements were not consistent with accountability to a local authority shareholder and the wider community. Standard private sector confidentiality requirements may need to be adapted for a transaction with a publicly owned entity.

The constitution was out of date and had not been kept under regular review

Queenstown Airport was incorporated as a company in 1988. The constitution was written in 1996 when the company was re-registered under the Companies Act 1993.

Under section 45 of the Companies Act, if a board intends to issue new shares of equal rank to existing shares, the existing shareholders have a "pre-emptive right" to be offered the new shares unless the constitution of the company modifies or negates that requirement. Queenstown Airport's constitution removed the pre-emptive rights of existing shareholders and provided that the board could issue shares of any class at any time, to any person and in such numbers as the board thought fit.

Such a provision was unusual for a council-owned company. It was not consistent with the Act. Shares in an airport company are a "strategic asset" of the local authority under the Act, which means that a local authority cannot transfer ownership or control of the shares unless it consults on the proposal in its long-term plan or by amending its long-term plan.

The Council had not considered whether the constitution was adequate to protect its interests in the airport company nor had it made appropriate changes in response to the Act.⁶⁷

Example 5: Tauranga City Council – creating a new governance model for council-controlled organisations

Tauranga City Council has recently adopted a new model for the governance and oversight of its CCOs. This example describes and comments on the process the Council used in developing the model.

Tauranga CCOs

Tauranga City Council has several CCOs. These include Bay Venues Limited, which oversees the council's aquatic and indoor sport and recreation facilities, Tauranga Art Gallery Trust, and Western Bay of Plenty Visitor and Tourism Trust. The Council also owns shares in Bay of Plenty Local Authority Shared Services and New Zealand Local Government Funding Agency Limited.

Organisational review

In January 2012, the Council commissioned a strategic review of its then CCO structure to ensure that the structure was compatible with the Council's outcomes and to determine the optimal operating structure for the CCOs.⁶⁸ The review was to consider the purpose and viability of each CCO, as well as the potential for cost savings or increased revenues. At that time, the CCOs included Tauranga City Aquatics Limited and Tauranga City Venues Limited, which were wholly owned by a holding company, Tauranga City Investments Limited.

The review came about because of a range of issues with the CCOs, and with Tauranga City Aquatics Limited and Tauranga City Venues Limited in particular. Those issues included lack of financial sustainability and poor relationships between the Council and the CCOs.

The review found that the CCOs were managed under four disparate regimes and that each had a separate relationship with the Council. As a consequence, the CCOs were not working together effectively.

The review identified a lack of clarity about the purpose of each CCO and uncertainty about expectations, roles, and responsibilities. It recommended that Tauranga City Venues Limited and Tauranga City Aquatics Limited be consolidated into a new entity, with a mix of public good and commercial drivers. The intention was to enable the new CCO to be more self-sufficient and less dependent on rates funding.

After the review, but largely as a result of direction from newly elected members and pressure from the two CCOs, the Council decided to restructure its subsidiaries. Bay Venues Limited (Bay Venues) was formed by the merger of Tauranga City Aquatics Limited and Tauranga City Venues Limited on 1 July 2013. Bay Venues was then amalgamated with the holding company, Tauranga City Investments Limited, on 1 July 2014.

Developing a new governance framework

After the new CCO was formed on 1 July 2014, Council staff ran a series of workshops and meetings with elected members (and, in several instances, Bay Venues directors). These workshops and meetings were held to discuss and agree a process for setting a governance framework for Bay Venues.

It was intended that the new framework would enable the Council to clarify its expectations of Bay Venues. Ultimately, the framework would apply to all of the Council's CCOs. The objective was to help the CCO boards to operate efficiently and to clarify their responsibilities.

As part of this process, councillors wanted to establish a greater rapport with the board of Bay Venues. Councillors recognised that the new governance model would be more effective if the two groups could work together on its development. They agreed that, where appropriate, Bay Venues directors would be invited to be a part of the development of the framework.

However, councillors wanted first to identify the important pillars of an ideal governance model. In a workshop, councillors and Bay Venues directors considered the experience of Auckland Council in managing its CCOs. They heard from two guest commentators, including an Auckland councillor, who spoke about their experience of the Auckland model.

The councillors and directors identified six main areas they wanted to clarify:

the role of the board;
the role of the Council;
governance principles;
organisational purpose;
funding principles; and
decision-making principles.

These six matters were then addressed as part of the development of the governance manual (discussed later in this example).

Councillors held a further workshop to determine the purpose of Bay Venues. They decided to assess each component of Bay Venues' business to determine whether it had more of a commercial focus or a community focus. Components with a commercial focus needed a clear definition of acceptable risk and to be properly empowered to function effectively. Community-focused components usually had more ratepayer subsidy, which meant that the Council should lead the setting of prices for the CCO's services.

This assessment enabled councillors and directors to identify the implications of each decision – such as setting user fees, monitoring progress, and ratepayer subsidy.

CCO Governance Manual

Informed by several workshops, meetings, and discussions, councillors agreed to set up a joint CCO working group, comprising four elected members and four Bay Venues board members, to develop a CCO Governance Manual. The Governance Manual was initially for Bay Venues but was intended to ultimately apply to all of the Council's CCOs. The Council wanted to develop a document that clearly outlined the Council's expectations of the board over the long term.

The completed document – now referred to as the Enduring Statement of Expectations⁶⁹ – outlines the Council's expectations of the Bay Venues board for matters that are unlikely to change from year to year.

The Enduring Statement of Expectations is designed to complement the annual letter of expectation. It identifies seven principles that the joint CCO working group agreed were needed for a strong governance relationship. These principles are:

Provide key services which deliver value to the customer/ratepayer.
Run the business in an efficient and effective manner.
Manage and invest in assets in a way that maintains and enhances them into the future.
Operate in an entrepreneurial manner (a manner which is results-focused, demonstrates proactive leadership and a preparedness to take sensible levels of risk relative to the nature of the entity).
Operate in a manner which does not fiscally disadvantage the Council.
Generate an ongoing decrease in the overall ratepayer contribution to Bay Venues.
Report to Council in a timely and transparent manner that ensures no surprises.

The Enduring Statement of Expectations clearly describes the purpose of Bay Venues and clarifies the respective roles of the Council and the CCO board. It also provides decision-making guidelines by allocating responsibility depending on the nature of the decision to be made.

The Enduring Statement of Expectations includes a set of relationship expectations, including communication protocols, branding expectations, financial reporting obligations, and consultation expectations. It provides clarity about funding, including the principles to be applied. It also establishes the Council's expectations for public meetings, director appointments, and performance review processes.

Letter of expectation

The same CCO working group then set about developing an annual letter of expectation for Bay Venues, to outline the Council's short-term goals for the CCO. The Council expected that the focus areas and deliverables identified in the letter of expectation would be reflected and incorporated into the CCO's next statement of intent.

The letter of expectation provides direction on issues that are important to the Council. It clarifies that the Council's role is to determine the outcomes that Bay Venues is expected to deliver, to set out the parameters Bay Venues will operate within, and to monitor Bay Venues' performance.

The letter of expectation provides specific performance measures that the Council will use to assess the performance of the CCO. The targets are derived from direction provided by elected members and from the Council's agreed strategic objectives, informed by several Council strategies and policies.

The letter of expectation was provided to Bay Venues in November 2014. The Council required that Bay Venues incorporate the focus areas and deliverables into its 2015/16 draft statement of intent, which Bay Venues provided to the Council for consideration by 1 March 2015.

The CCO Working Group reviewed the draft statement of intent before it was considered by the Council. The CCO Working Group agreed that applying the letter of expectation and the Enduring Statement of Expectations to the development of the draft statement of intent was a positive step.

Review of funding options

As part of the governance review, the Council also reviewed the financial structure of Bay Venues to determine whether it was the best way to deliver the Council's objectives. In particular, the Council considered whether the mix of commercial and community-focused assets in a CCO model is the most effective way to meet its needs.

After a series of workshops that involved both elected members and Bay Venues directors, a set of principles about the financial structure of Bay Venues was agreed. The principles are:

Asset ownership should be in the entity managing the service in relation to that venue.
An initial debt to equity ratio of 20:80 is appropriate.
The initial debt servicing grant should match the initial debt servicing cost.
Council should take up the interest rate risk on initial debt.
Unless specifically decided by Council, new capital projects should have debt servicing costs covered from additional revenue.
A business case will be required for all new capital projects (new capital excludes renewals).
Depreciation funding will be retained within Council.
Renewals will be funded by specific renewal grants.

Council staff prepared a draft report that the Bay Venues board considered. The report was then updated to include the directors' recommendations and presented to elected members for final consideration and approval. The financial restructuring was completed in June 2015.

Our observations

The Council appears to have gone through a careful process to determine the purpose and objectives of its CCOs and the Council's expectations of them. The process provided a forum for the main parties to reach a shared view on a comprehensive set of issues to do with the Council and its CCOs. It also enabled councillors and some board members of the major CCO to develop good working relationships.

The Council has documented the results of the work in two documents that set out its expectations of its CCOs.

A longer-term Enduring Statement of Expectations that clearly states a set of governing principles and procedures provides clarity of purpose and should contribute to a robust and effective relationship built on mutual trust and understanding.

An annual letter of expectation to inform the CCOs' development of their statements of intent is a valuable mechanism for ensuring clear objectives and strategic alignment with the Council.

In trying to establish a better working relationship with its CCOs, elected members and board members have been actively involved in preparing these two documents. This should ensure that the documents are regarded as authoritative and meaningful governance documents.

55 See "About CCHL" on Christchurch City Holdings Limited's website, www.cchl.co.nz.

56 Total comprehensive income for the year net of tax was $553 million.

57 See "Policy on Appointment and Remuneration of Directors", 27 October 2011. The Council first adopted a policy on appointments in 1997.

58 Available at oag.govt.nz/2008/procurement-guide.

59 Dunedin City Council, Long Term Plan 2015/16 - 2024/25, Volume 2, "Section 6 Council Controlled Organisations", pages 310-311.

60 These have been exempted from accountability requirements under section 7(3) of the Act.

61 Dunedin City Council, Long-Term Plan 2015/6-2024/25, Section 1: Major Issues and Strategies, page 41.

62 Larsen Consulting (2011), Governance Review of All Companies in Which Dunedin City Council and/or Dunedin City Holdings Limited has an equity interest of 50% or more.

63 Auckland Airport and Queenstown Airport cancelled the agreement about a second tranche of shares in March 2011.

64 References in this Example to the Mayor and chief executive are to the people who held those positions at the time of these events in 2010.

65 The Council had a new chief executive who had started in March 2010.

66 The group formed a company, Queenstown Community Strategic Assets Group Trustee Limited, to act as trustee for an incorporated society to be formed for the purpose of opposing the share issue.

67 The constitution has since been amended to restrict the board's power to issue new shares without shareholder approval.

68 Morrison Low (2012), Tauranga City Council: Review of CCOs and Allied Leisure Activities.

69 See Example 5 of Appendix 1 and the minutes of Tauranga City Council's meeting of 15 December 2014, "Enduring Statement of Expectations for Bay Venues Ltd" (available on the Council's website – www.tauranga.govt.nz).