Lawyers to the projects industry
projects
bulletin
Summer 2003
contents
Not for profit organisations
1
The way forward for projects?
What is meant by
not for profit organisations?
2
Why use NFPs?
2
Companies limited
by guarantee
5
Limited companies
5
Industrial and
provident societies
6
Foundation hospitals
6
Community interest
companies
7
Not for profit organisations
The way forward for projects?
At present there is a good deal of
interest in "not for profit
organisations" being used in PFI
projects. They are seen as potentially
offering improvements to traditional
PFI structures.
If you would like further
information on this area, or on
projects more generally, please
contact the projects team at
Nicholson Graham & Jones.
Details are set out at the end
of this bulletin.
www.ngj.co.uk
Nicholson Graham & Jones specialises
in projects work - it is one of our core
practice areas. We have devised a
number of innovative solutions for PFI
and PPP projects and we are familiar
with the key issues concerning not for
profit organisations. The purposes of
this memorandum are to set out:
what is meant by not for profit
organisations (because it is often
not entirely clear what is meant by
the term);
some of the advantages and
disadvantages of not for profit
organisations; and
some examples of not for profit
organisations. This is against a
background of the government
encouraging some diversity in the
models being used.
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What is meant by
not for profit organisations?
Not for profit organisations (or
"NFPs") are also known as "non-share
capital organisations", "public interest
companies", "not-for-dividend
companies" and "social enterprises".
They have been used in PFI projects in
a number of areas, particularly in
health-care services. Although there is
a resurgent interest in them in the
context of PFI, a number of them have
been available for many years in the
arena of public and community
services. For example, housing
associations, which are NFPs, are
numerous and have been used for
many years. NFPs have a number of
characteristics:
they are organisations which deliver
public services;
they are legally independent from
government;
they are not owned or controlled
by external private shareholders risk capital is not inherent in the
project vehicle. All surpluses are reinvested in the organisation rather
than being available for distribution
as dividends to shareholders; and
as well as investors, other
interested "stakeholders" (such as
service recipients) may have a say in
how they are run.
Therefore, NFPs are to be distinguished
from standard profit-driven UK
companies (as incorporated under the
Companies Act 1985). Such
companies are characterised by having
limited liability and by the fact that
they are operated in order to generate
profits for the benefit of their
shareholders. Risk capital is inherent
in these vehicles to the extent to
which the shareholders have made, or
are liable to make, capital
contributions for their shares. These
companies (and other limited liability
companies incorporated under
previous legislation) are, and long have
been, the standard legal vehicle with
separate legal identity which is used in
the UK economy (and accordingly they
are generally familiar). They have also
been used for the significant majority
of PFI and PPP work to date.
Why use NFPs?
subject to the right structure being
used, can bring advantageous offbalance sheet accounting treatment for
the procuring authority.
Secondly, however, NFPs are sometimes
viewed as a potentially more politically
acceptable model for the delivery of
public services than typical equitybacked PFI project vehicles. Where an
NFP is used, there is the advantage that
what are widely considered and
understood to be public services are
being shown to be delivered for their
own sake, rather than as a means of
making a profit. The argument, which
can be highly politically charged,
continues that any profits generated in
NFPs are not available to shareholders
and therefore NFPs are desirable.
The argument for NFPs may in fact be
strongest where procuring authorities
have experience of, or knowledge of, a
PFI project where the consortium has
generated substantial profits exceeding
those which had been expected when
the project was initially put in place.
Procuring authorities may, for example,
have found themselves unable to
adjust the unitary charges they pay
even though substantial and
unexpected profits are being made by
the consortium.
Advantages of NFPs
It is worth asking why is there now an
increased interest in using NFPs in the
context of public service delivery.
Firstly, NFPs may offer the same
advantages as standard limited
companies in delivering PFI projects.
For example, they may bring private
sector disciplines to public services and,
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However, whatever the form of the
vehicle delivering the services, the
general principle that pertains is that to
the extent that any private enterprise is
taking any risk in a project it will
negotiate strongly that it should be
paid for doing so. Actually, this may
be perfectly acceptable to the
Summer2003
procuring authority, provided that
profits are contained and politically
justifiable. The procuring authority
may therefore be thinking of using
NFPs not so much in a sweeping
rejection of the private sector making
profits but as a vehicle which fits in
with its aim of linking profits to good
services. This aim may be felt most
achievable with the project vehicle not
being inherently run for profit. In legal
terms, the specific rights of the
procuring authority in its contract with
the NFP are supplemented by the
general protection of the vehicle itself
not being run for the purposes of
generating a profit. Any distributable
profit which is unforeseen in
contractual arrangements (which can
last for 20 or 30 years in some cases) is
therefore not automatically available to
be paid to the consortium members.
Using NFPs is not the whole answer to
such political issues and issues of
getting genuine value for money. Care
will also be needed that services from
the sub-contractors are paid for at an
affordable rate which does not diverge
from the market rate over time.
Ultimately, service delivery is likely to be
the single most important test of the
political success of the project.
NFPs may well be used in LIFT
structures, where several projects are
co-ordinated together and required to
meet standards set by a national coordinating body. LIFT is seen as
potentially offering a way of
implementing high standards in the
health and education fields.
Capital and Fiscal Issues
Familiarity
There are a number of other issues
affecting NFPs. The traditional model
allows equity participation in the
project and the equivalent of this may
be needed. The banks to a project
with substantial risks may be unwilling
to lend without there being any
equivalent to risk capital. Financial
support could then be called upon in
the event of the lenders' requirements
not being met. For example, in the
case of Network Rail, which is a wellknown NFP, the UK Government
entered into contingent funding
agreements to support the financial
structure proposed for its acquisition
of rail assets. In the model being put
forward by the Argyll & Bute council
for its school investment programme,
risk capital is being provided through
Partnerships UK, which is partly
government owned, in the form of
subordinated debt. Another method
of building up sufficient reserves in an
NFP is through the generation of a
surplus over a short term to meet
medium and long term risks.
A potential disadvantage of NFPs is
that it may take longer to establish
them within a bid because of a
general lack of familiarity with them
compared with limited companies. In
some cases, this may be a
discouragement to bidders. In general
terms, however, diversity is being
encouraged by central government,
with a number of different NFP
models being used. This may in fact
generate a lack of clarity in the area.
Governance
The governance structure of private
companies is well defined and
understood. In effect, day to day
governance is usually under the
supervision of the executive directors
and within the control of the board of
directors. The directors are limited by
decisions of the shareholders and
ultimately by the power of the
shareholders to remove them from
office. NFPs need to be structured to
have an effective form of governance
to replace this model.
The financing of NFPs will invoke fiscal
issues. NFPs will have a role in the
public good but will not benefit from
charitable status unless they meet its
stringent requirements. Tax
transparency is another key issue.
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NFPs are often partly driven by the
motive of allowing various interest
groups to have a role in the decisions
and actions of the project. It may be
attractive for interested parties such as
service users and staff to have a say in
how the NFP is run, especially where
people will genuinely take an active and
effective role over the long term. This
is, for example, a key feature of the
proposed foundation hospitals, as
discussed below. UK companies have
not usually been run on this basis and,
at heart, allow very little say to groups
which are not investors. English law
provides companies are run for the
benefit of their shareholders and
otherwise usually only creditors have
significant rights. It may therefore be
thought that it is appealing to use a
different type of vehicle to enfranchise
other groups.
However, it may be possible to continue
to use limited companies for not for
profit purposes with various
stakeholding groups having a say, such
as by using different classes of shares
and weighted voting rights. In any
case, whichever model is used, the
enfranchisement of stakeholder groups
needs to bear up when different groups
have contrasting views (such as
investors, staff and service recipients),
and will need to ensure that persons
with expertise have a sufficient role in
governance and strategy.
Some of the requirements for a
successful NFP will be similar to a
traditional equity-based PFI, such as a
day to day management with sufficient
experience and skills. The issue of
management reward is likely to be a
critical factor in securing the right
management. It is probable that NFPs
will need to pay comparable rates to
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the private sector in order to attract
management of the right calibre.
Under the Companies Act, private
limited companies are obliged to
produce annual audited accounts.
Ideally, NFPs also need to provide
information of at least equivalent
quality. In some NFPs, such as
foundation hospitals, it is likely that the
financial information will be
complicated and difficult to interpret.
Procuring NFPs
We note that NFPs are also sometimes
suggested as vehicles on the
procuring side. This can be an
innovative approach in the particular
circumstances where the service
delivery side can see sufficient credit
to support the project.
TYPES OF NFPs
NFPs can take a number of forms. Some of the main types are as follows, with
some of their characteristics summarised in the table below:
NFP
Costs of setting up
Flexibility
Familiarity
Companies
limited by
guarantee
Set up costs are low
Good degree of
flexibility except that
interests are not
transferable
Familiar
Limited
companies
Set up costs are low
Good degree of
flexibility
Familiar
Industrial and
provident
societies
Set up costs may be
higher
Limited flexibility
Unfamiliar
Foundation
hospitals
Set up costs will be high
Limited flexibility
Unfamiliar
Community
Interest
Companies
Set up costs may be
quite low, though
higher than for standard
limited companies
Good degree of
flexibility
Unfamiliar
Summer 2003
Companies
limited by
guarantee
Companies limited by guarantee can
be formed under the Companies Act
1985. They have often been used as
vehicles for non-profit enterprises.
Their constitutional documents may
prohibit dividends to members.
Where the objects of the company are
within the category of being "the
promotion of commerce, art, science,
education, religion, charity or any
profession and anything incidental or
conducive to any of those objects",
and restrictions on profits, dividends
and capital are included in the
company's constitution, it is possible
not to have the word "limited" in the
company name. This may be helpful in
the presentation of the relevant
project as not being a private venture
which is run for profit.
Limited companies
Legislation and regulation relating to
equity based corporate models are
well established. Although there are
several models for NFPs, none is as
well developed as the limited
company.
It is possible to limit the activities of a
company and make it a not for profit
organisation by so providing in its
constitutional documents (in
particular, the memorandum of
association). We consider that one of
the most attractive types of NFPs in a
number of situations is a private
limited company. Difficulties that
other models may have, in terms of
risk capital, financial transparency
and in having to implement a new
workable system of corporate
governance, are not experienced
with the private limited company.
A number of NFPs are limited
companies. British Nuclear Fuels is
controlled by the Government and
The National Air Traffic Service is
partly owned by the airlines which
use its services.
Companies limited by guarantee do
not have any shares and so the
interests of members are not
transferable. This may be an
unattractive feature where relevant
parties will wish to transfer their
participations some time in the future
(or at least have the ability to do so).
The liability of the members is limited
by the amount of their guarantees
(which are specified amounts in the
memorandum of association).
Network Rail is an example of a
company limited by guarantee in the
public service arena.
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Industrial and provident societies
IPSs are part of the mutual sector and
are registered under the Industrial and
Provident Societies Act 1965.
Registration makes a society a body
corporate with limited liability and the
power to sue and be sued in its own
name. The distinctive feature of an IPS
is that the society must fall within one
of two classes. It must either:
be a bona fide co-operative
society; or
be carried on for the benefit of the
community.
There must be special reasons why the
society should be registered as an
industrial and provident society rather
than as a company.
A co-operative society is made up of
members who pool their resources to
work for the collective interests of the
co-operative's own members. In
contrast, members of societies
established for the community benefit
participate in an organisation where
the benefits are provided to a wider
class of beneficiaries than the
members alone.
Guidance issued by the Financial
Services Authority indicates that
registration as an IPS should confer a
concrete advantage or benefit that
would be lost or unobtainable if the
organisation were to register as a
company.
The IPS model has been suggested as
a model for securing community
assets while delivering public services
based on them. Concern that the
existing legislation (i.e. the 1965 Act)
did not offer sufficient protection
against demutualisation and
distribution of assets led to the
passing of the Industrial and Provident
Societies Act 2002. It increases the
voting requirements for a society
which wishes to convert to a company
and permits legislation applying to
IPSs to be amended more easily to
bring it into line with company
legislation.
Examples of IPSs include housing
associations and ex-local authority
leisure services at Greenwich and
Bristol.
Foundation hospitals
Foundation hospitals are perhaps the
most generally discussed form of NFP at
the moment. What they will be able
to do is being debated within
Government. It is currently proposed
by the Department of Health that 29
hospital trusts will, during spring 2004,
subject to parliamentary approval, gain
the freedoms of becoming foundation
hospitals. They will be NFPs existing
outside the direct control of the
Department of Health. It is currently
proposed that only the most successful
hospitals will be considered for
foundation trust status.
As with other NFPs, the political
6
attraction of foundation hospitals is
that they are a way of increasing the
involvement of the private sector in
managing and delivering public services
without the perceived problems of
private company involvement and the
distribution of profits to shareholders.
Foundation hospitals will be
characterised by having greater
autonomy from the Secretary of State
for Health than NHS hospitals enjoy. In
particular, they will be freer to borrow,
to buy and sell assets, to generate
surpluses for the hospital and to reach
their own local pay agreements.
Provided that the government is
satisfied that enough risk and control
has been transferred from the state,
foundation hospitals will be free to use
private finance to pay for capital
projects (which would not then show
up on the Government's balance
sheets).
There will also be increased local
accountability through governance
arrangements that give local
stakeholders (patients, local community,
staff and partner organisations) a say in
the management of the hospital.
Summer 2003
Community Interest
Companies
The Department of Trade and Industry,
the Treasury and the Home Office have
proposed that a new corporate vehicle
be made available for community and
social enterprises, called a "Community
Interest Company" ("CIC").
CICs would be regulated in a similar
way to companies, including in terms of
incorporation requirements, directors’
duties and reporting requirements. In
addition, it is proposed that they would
have to be acting for a public interest
and there would be a special CIC
regulator, who would check that the
CICs are not for profit enterprises
working for the public interest. CICs are
not yet in place and will need new
legislation.
Summary
Whilst traditional PFI structures will
not be completely abandoned, NFPs
are likely to be an important feature
of the projects landscape for the
foreseeable future.
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Nicholson Graham & Jones is an
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Our Projects group advises private
sector clients and public sector
organisations on all forms of PFI, PPP
and infrastructure projects.
Nicholson Graham & Jones
110 Cannon Street, London EC4N 6AR
020 7648 9000
The contents of this projects bulletin
have been gathered from various
sources. You should take advice before
acting on any material covered in this
publication.
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For more information contact one of
the following partners:
Christopher Causer
christopher.causer@ngj.co.uk
tel: 020 7360 8147
Carolanne Cunningham
carolanne.cunningham@ngj.co.uk
tel: 020 7360 8160
Stuart Borrie
stuart.borrie@ngj.co.uk
tel: 020 7360 8155