Clever ruses foiled again

Millions of pounds-worth of local authority finance deals, designed to circumvent government borrowing controls, may be unlawful, a recent court case revealed. The result could dislocate future capital budgets if existing contracts are not renewed.

Although it is now more than a month since the Court of Appeal reached judgment on the Credit Suisse versus Allerdale Council case, the wide- ranging implications of the decision are only now being recognised. Initially the case seemed to have a limited impact, the court having ruled that a council could not issue a financial guarantee through a wholly owned company for an activity that it was only empowered to undertake directly itself.

But council finance officers were told at last week's Chartered Institute of Public Finance and Accountancy conference that many other contracts could be affected. The most important aspect of the case is that the judges ruled that local authorities cannot get involved in clever schemes, in order to avoid government finance controls.

"The establishment of the company and the giving of the guarantee were part of an ingenious scheme designed to circumvent the no doubt irksome controls imposed by central government," said Lord Justice Neill, giving the judgment. "The council, however, could only do what it was empowered to do by statute. Neither the establishment of a company nor the giving of a guarantee fell within the express, or implied, powers of the council."

While the full implications of this will remain unclear for some time, it raises doubts over the validity of a wide range of contracts.

"If Allerdale is upheld in the House of Lords, or remains on the record as a Court of Appeal case, people will not be seeking to implement innovative schemes to get round controls, because the court has given notice that it will take action," says Ray Ambrose, a consultant on local government and public law at Nabarro Nathanson. "Any use of a company which is relying on Section 111 [which empowers councils to do anything to facilitate its functions] needs to be looked at in the light of the Allerdale judgment."

Councils' use of deferred purchase schemes, other than lease agreements, are particularly at risk. The schemes allowed councils to obtain assets in advance of the formal purchase of items.

The Department of the Environment has this week sent out a special notice to authorities advising that in the view of its legal counsel, the Allerdale judgment does not affect deferred purchase agreements. This is in advance of a meeting to be held on Friday of the Local Authority Powers Group, which has not met for four years, to discuss the problem.

Some district auditors are now looking at individual deferred purchase contracts, considering whether they were legally drawn up. And a number of local government legal specialists doubt whether the DoE is correct.

"The issue is not clear," says Martin Pilgrim, finance under-secretary of the Association of Metropolitan Authorities. "Each deferred purchase agreement would have to be taken on its own merits."

Martin Thomas, a litigation solicitor at Travers Smith Braithwaite, who spoke on the problem at the Cipfa conference, agrees. "The structure of transaction varies, they are all different," he says. "What it underlines is the fact that any kind of transaction with a local authority has the potential to be undermined by the courts as ultra vires [outside its powers], even when nobody could possibly be aware of that.

"The Allerdale case has brought this to the front of people's minds. The banking community will shy away from the sector, because they don't like ultra vires," adds Mr Thomas.

It is the loss of existing contracts that could cause the biggest problem for authorities. In some cases, deferred purchase contracts have been used for items that have no re-sale value, such as taps and boilers. If the contracts were unlawful it is unclear what should happen at the end of the agreement regarding ownership of the items, what payment should be made, and how payment can be made if it forces a council above its capital spending limits.

Because councils' legal advice said the contracts were valid, there will be no surcharge action against councillors. But the Allerdale judgment undermines the Government's Private Finance Initiative by making banks more cautious. Similar problems might arise with NHS trusts, which are also controlled by ultra vires considerations.

But the Allerdale case can be viewed positively. Ambrose, whose firm Nabarro Nathanson is giving a presentation on the implications of the judgment this evening, says: "Local government directors of finance will now know where they are, and there will be an element of certainty. So it may be a good thing."