Are you on form?

Principal consultant Peter Allanson shares some thoughts about legal models for public-purpose organisations

It was the Chicago based architect, Louis Sullivan, who coined the phrase “form follows function”, now often quoted in business contexts. Sullivan’s battle cry was taken to imply that decorative elements of buildings were superfluous, but perhaps a more helpful interpretation is to ask the question “Does it work?” – and this should be a key consideration when looking at legal models and forms in organisations that are in business for public benefit.

It is important to grasp some of the underlying principles, starting with legal personality. A legal entity with a legal personality is one that distinguishes between the entity itself and its owners – known as the corporate veil. So, the entity itself is autonomous and can behave, in corporate terms, as would a human and can enter contracts and enforce them, including suing and being sued. It can also own property and assets.

There is a principle of continuity in that the legal entity’s existence will continue regardless of changes of ownership. It may be reassuring to know that such an entity can find protection from personal liability for those involved in its operations. Ownership and management sit on the other side of the corporate veil.

UK organisational models

Within the UK there are various different types of organisation with legal personalities, including:

• Mutuals – co-operatives and community interest companies
• Corporations – both incorporated and unincorporated
• Companies – private and public limited liability companies, unincorporated companies, companies limited by guarantee, trusts and community interest companies
• Partnerships – 1890 partnerships where all partners are jointly and severally liable to their last penny and limited liability partnerships where their liability is capped
• Charities – in the form of companies limited by guarantee or incorporated organisations

This article is aimed at public bodies establishing subsidiaries so it is worth considering why they might wish to do this. There are about half a dozen reasons:

1. Trading activity that extends beyond their statutory remit
2. As a way of ring-fencing risk
3. To provide a joint venture platform
4. To commercialise innovation including products of research, intellectual property protection etc.
5. Tax efficiency and VAT recovery
6. Staff led enterprises to offer employee mutualisation.

There are numerous examples of all of these. There are, of course, restraints:

• They must fit within or be incidental to the statutory purpose for which the organisation was set up.
• They may need to pass the Treasury’s managing public money tests, meet public procurement law requirements*, as well as any public law duties and any rules set by the National Audit Office or other regulatory obligations.

What is essential is that it is clear to owners and managers why a subsidiary is necessary and that the form chosen is suitable for the intended purpose.

Examples include commercialising research undertaken by individuals but promoted by an organisation, establishing a stand-alone business either to provide services to the parent and others or as a crucible for eventual disposal, a structure to provide mutually needed services across more than one entity or to involve staff in the development and growth of a service or product in which they have an interest.

Layers to navigate

Inevitably there are likely to be several governance and regulatory layers to navigate. Firstly, in the entity itself where there will be a delicate balance that protects the interests of the parent while respecting its independence. Directors of companies, including charitable ones, are obliged to run the company for the benefit of its members – or, in the case of a charity, to fulfil its charitable objects. The company’s powers are set out in the articles of association, approved by the members, and the powers are given to the directors collectively.

It is also usual for directors to be allowed to delegate any or all of the powers to other individuals or a committee. But the directors collectively remain responsible and accountable for their performance. These form part of the seven duties contained within the Companies Act 2006:

1. To act within their powers
2. To promote the success of the company
3. To exercise independent judgement
4. To exercise reasonable skill, care and diligence
5. To avoid conflicts of interest
6. Not to accept benefits from third parties and
7. To declare interests in any proposed transaction or arrangement.

The reason for quoting these at length is to underline the seriousness of the independence of any legal model. There are similar lists for other types of entity, but each may have a set of responsibilities and requirements that may differ from those of their parent and in some rare instances may conflict with them. It is important to be aware of this possibility as it can lead to conflict.

A parent organisation may wish to nominate one or two directors, but they should not appoint the majority. The other directors should be properly independent and bring the skills, experience and attributes that will contribute to the success of the enterprise.

Regulating the relationship internally usually has three different parts:

• the articles of association
• an annual business plan, ideally emerging from a longer-term strategy
• a list of reserved matters which might be found in documents such as standing orders, a scheme of delegation, a scheme of reservation and delegation or a specific agreement.

These documents should be clear as to who owns them, who can amend them and what the approval arrangements are. Members can be reluctant to delegate powers, but it is usually sensible for them to do so to enable the entity to function and deliver what it has be set up to do. However, owners will expect to have a ‘nuclear option’ to remove the board or individuals, including the chair, under particular circumstances and following a resolution.

External agencies

In addition to local governance, external agencies will take an active interest – companies house requires certain information to be lodged with it and regular reports made. The same is true for charities registered with the charity commission. Co-operatives and community benefit societies are overseen by the financial conduct authority and community interest companies by a branch of Companies House dedicated to them. Universities and NHS trusts will chivvy the interest of the Office for Students, CQC and NHS England (for now) and the NAO, Audit Commission and various ombudsmen will supplement the work of the entities’ external auditors.

All of this will hopefully underline the fact that this is an area to be entered into carefully and advisedly – in other words with advice. Having subsidiaries dedicated to specific, ring-fenced activities can be a terrific strength. With specialist governance unique to them they can reduce the distraction that can take the parent away from mainstream activities and there are clearly social, scientific, commercial and stakeholder benefits form having an entity dedicated to a clear set of objectives and deliverables. But it is not a free lunch ticket – to return to Louis Sullivan – form, function and facility. Does it do the job better than the alternative?

Important: Please note this article is not advice – it is a description of possible options, and it is essential that any organisation contemplating establishing subsidiaries takes appropriate legal, financial and tax advice as necessary.

* Foot note: Local authorities often establish a corporate structure relying on what is known as the Teckal exemption which can help to reduce the need for lengthy and costly procurement processes. It is complex and has a number of rules that need to be applied – in other words, take advice. Note that the position has had further complexities added through the enactment of the Subsidy Control Act a new piece of post-Brexit legislation.