by Christopher St John Smith
This piece of legislation has been awaited with
some interest by those financiers who wish to fund projects under
the private finance initiative, which involve local authorities.
The Act became law on 27 November and the main sections of the Act,
namely Sections 2 to 9, came into force on 30 December.
Although the terms of Section 1 of the Act have
tended to attract less comment from the banking community than the
certification provisions, and the protection accorded by them,
sub-sections (1) and (2) provide a useful clarification and
reminder of the purposes and limitations of this piece of
legislation. Sub-section (1) provides that every statutory
provision that confers or imposes a function on a local authority
also confers power on that authority to enter into a contract with
another party for the provision of assets or services to that local
authority for the purpose of enabling the relevant local authority
to discharge such function. Accordingly where, for example, a
statutory provision imposes a waste disposal function on a local
authority this provision now makes it clear that this confers on
the local authority power to enter into a contract with some other
party for the provision of, dust carts or incineration equipment or
a package of waste collection or disposal equipment and collection
and disposal services. This express extension of council powers
applies to the discharge of all of its functions including
education, recreation, public health and even local tax
collection.
Sub-section (2) then goes on to make it clear that
where a local authority enters into a contract for the provision of
assets or services of the type previously described and, in
connection with the relevant provision contract, a financier makes
a loan, or some other form of finance, available to enable a party
(other than the relevant local authority) to finance these
arrangements then the local authority can enter into direct
contractual arrangements with the financier. A common example of
this would be some form of direct agreement giving the financier
step-in rights if its borrower should fail to perform adequately
under the provision contract. In the view of certain local
authorities (and their legal advisors) these sections were not
necessary since they believe that existing legislation made it
sufficiently clear when local authorities had the requisite power
to enter into transactions of this nature. However many within the
banking community have not been so sanguine about this issue,
especially since the Allerdale and the Waltham Forest judgments in
the Court of Appeal. Whatever the merits of the local authorities
views on their existing powers, the clarification provided by this
Act on this point is helpful. It should however be noted that the
terms of Section 1 also effectively describe the type of contract
that is protected by the certification and other provisions set out
in the rest of the Act. This Act does not therefore apply to all
contracts that the parties may enter into with local authorities,
but only to contracts for the provision of assets or services that
fit within the express terms of the Act as described above and
which operate, or are intended to operate, for a period of least 5
years.
Accordingly, this Act does not affect the powers of
local authorities to enter into any kind of arrangement other than
one expressly referred to in the Act.
In addition, this does not alter the legal regime
relating to the power of local authorities to borrow or enter into
guarantees or any other type of financial support. It does not
alter the position with regards to their basic power to enter into
leasing arrangements or any limitations on that power. All of these
arrangements are the subject of existing legislative arrangements
that are not altered or superseded by this Act. In addition, whilst
the terms of the Act are helpful in clarifying the capacity of
local authorities to enter into certain types of contractual
arrangements that are associated with the private finance
initiative, the Act does not avoid the need for careful
consideration of a local authority's statutory power to enter into
a transaction. That will still need to be considered in order to
ensure that a relevant contract does fall within the scheme of this
Act and that it will obtain the full benefit of the Act.
Sections 2, 3 and 4 of the Act then go on to set
out the terms of a certification procedure for provision contracts
of the type already described. Where a contract is certified in
accordance with the terms of the Act, then the Act raises a
presumption that the contract is within the powers of the local
authority and that the local authority properly exercised its power
in entering into such contract. In order to obtain the benefit of
this presumption, the certification requirements prescribed in
Section 3 of the Act must be satisfied within six weeks from the
day on which the local authority enters into the relevant contract.
The certification process is to be dealt with and controlled by the
relevant local authority and satisfaction of the requirements
should be easily achieved by that authority provided that it has
properly considered the terms of the transaction that it is
entering into.
As I have indicated, the certification procedure
raises a presumption regarding the local authority's power to enter
into a provision contract. It does not conclusively determine the
point. In Section 5 of the Act it is made clear that this
presumption does not prevent the local authority's power to enter
into the relevant contract from being challenged on an application
to the courts for judicial review of the local authority's conduct
or on an audit review. However, sub-section (3) of Section 5 does
now expressly provide that where it is determined that a local
authority did not have the relevant power to enter into a certified
contract, the court has a clear power to allow the contract to
remain in effect if it wishes to do so, having regard to the likely
consequences for the financial position of the local authority and
for the provision of services to the public by that authority. This
is a very useful provision, since in the Allerdale and Waltham
Forest decisions, the view was taken by the Court of Appeal that
the courts did not otherwise have any discretion as to whether to
keep a contract in effect if it was considered to be outside the
powers of the local authority. Some commentators have doubted this
absolute view of the effect of a lack of capacity and this
legislative provision
has now put this issue beyond doubt in the limited
circumstances where the courts are dealing with a certified
contract.
Section 6 of the Act then goes on to raise a
further presumption regarding the enforceability of what are termed
"relevant discharge terms" in a certified contract. This applies
even in circumstances where on an application for judicial review
or an audit review it has been determined that all of the other
provisions of a certified contract were outside the capacity of the
local authority. "Relevant discharge terms" are essentially terms
providing for compensation as between the parties in the form
either of compensatory damages or some adjustment of rights and
liabilities in respect of the assets or goods to which the
provision contract applied. An example of this might be to provide
for the payment of certain sums on any early termination of the
relevant contract combined with the local authority agreeing to
relinquish any further claims in respect of assets provided to it
under the terms of the contract. The Act provides that where a
local authority has agreed such terms in an identifiable form,
those terms (as opposed to any other terms within the contract)
shall have effect as if the local authority had power to agree them
and had properly exercised that power. However despite the strong
terms in which the presumption regarding the effectiveness of
relevant discharge terms is put in Section 6(4) of the Act it
appears from the terms of Section 7(3) that there still may be
circumstances in which a successful challenge may be made to the
capacity of a local authority to enter into such terms.
Section 7 sets out what happens if a court on an
application for judicial review or an audit review determines that
a certified contract should not have effect, due to lack of
capacity on the part of the local authority and if such a contract
does not contain any relevant discharge terms. Section 7(3)
effectively provides that such a contract may not have relevant
discharge terms if the court determines that any purported relevant
discharge terms do not have effect. Whilst it is not entirely clear
when such circumstances would arise some guidance on this was
provided in the discussion of this provision in the House of Lords.
Certain Law Lords indicated that the circumstances where both the
contract and purported relevant discharge terms would both be
struck down would be rare and extreme. The examples that they gave
included where there had been fraud or corruption used in order to
induce the parties to enter into the contract or where the terms of
the contract were "outrageous". Various attempts were made to
define the latter circumstance, including references to gross
unreasonableness, but the general consensus appeared to be that
"outrageous" conveyed the right sense. In any event where such a
contract is struck down in this fashion and there are no relevant
discharge terms, Section 7(2) provides that the other party to the
contract shall still be entitled to be paid by the local authority
such sums as he would have been entitled to if the contract had
been effective up until the time when the relevant court ruling was
made but had then been terminated by the local authority by a
repudiatory breach of the contract by the local authority. In
essence the normal contractual measure of damages will then apply
to compensate the aggrieved party to a contract. Although this is
not the complete "safe harbour" provision that some have sought,
this does represent a substantial improvement for any financier
dealing with a local authority in PFI and other types of project
finance structures. It could also be argued that the process of
setting up rebuttable presumptions that is followed in the Act is
nearer to the true protection afforded by the terms of Section
44(6) of the Local Government and Housing Act 1989 in connection
with local authority borrowing.
In all such cases, this serves to underline the
fact that although this legislation provides financiers with a
significantly greater degree of protection than was previously
available, it does not remove the need to proceed with caution when
dealing with local authorities and to check, independently, that
the financier is satisfied with the capacity of the relevant
authority. The difference is that if it subsequently proves that
the local authority did not have the relevant capacity, a bank that
is involved in such a transaction is likely to obtain a significant
level of compensation rather than being left without remedy. The
residual risk is that if the termination or compensation terms that
are set out in the contracts are not considered by the courts to be
a proper measure of contractual damage suffered by the bank, then
the court will impose its own terms. This may mean that whilst a
bank may recover its principal and some interest, default interest
may not be recoverable to the extent that it may be regarded as a
penalty. The same test may also be applied to other standard
provisions in loan documents.
This would appear to bring the legal risk
associated with contracts of this type more into line with the
usual corporate customer. However care still needs to be taken to
ensure that the provisions of this Act apply in any given set of
circumstances and that the local authority involved can and should
be entering into a transaction of the type envisaged.