Council makes recommendations for setting up companies in report on failed firm

Councillors tasked with investigating why Mid Devon District Council's wholly-owned subsidiary housing company failed have concluded that the two organisations had "fundamentally different" cultures.

The report, which was authored by a ‘working group’ consisting of four councillors and a council officer, made a series of recommendations for setting up special purpose vehicles (SPVs) based on lessons learnt from the failure.

The working group concluded that: “With hindsight, the challenge in bringing two organisations with fundamentally different cultures together required greater thought and consideration and that challenge ultimately proved too difficult to achieve in this instance.”

The failed company, 3 Rivers Development, was incorporated in April 2017 and was intended to create a new income stream for the council by building, renting and selling both residential and commercial properties.

By 2019, financial concerns were raised about the company, leading the council to commission advice from Anthony Collins Solicitors.

Feedback provided by the firm revealed governance issues and called for greater clarity in the shareholder agreement and loan agreements, the addition of security to those loan agreements, and changes to the articles of association.

The firm also highlighted potential conflicts of interest for board members whose terms of employment required them to act in the interests of the council. It also recommended that officers be relieved from these terms when, by virtue of being directors, they were legally obliged to act in the best interests of the company.

The advice recommended that one or more non-executive directors with specific skills in property development be appointed as part of a recovery plan.

A Grant Thornton report for 2021-22 later spoke of weaknesses and risks relating to the council's conduct in its role as the company's shareholder, including its governance and oversight of its arm's length body.

Grant Thornton’s report also highlighted a "breakdown of normal good relations" between key officer and member groups.

The working group's report corroborated this, finding "ample evidence" of a poor relationship from 2019 onwards between the company and councillors.

It said: "The aggressive critique which some members levied against the company and those who were striving to improve its financial performance, undoubtedly increased the reputational damage suffered by the company leading to difficulty in maintaining contractors, and resulted in a degree of professional trauma."

The working group noted that more effective governance of the SPV from the outset would have included:

• More effective shareholder agreement
• More flexible approval processes
• Greater appreciation of operational independence of the SPV.

It also suggested that avoiding perceived conflict of interests and greater buy-in and understanding from councillors of the ambitions and aims of the company would have helped.

The report set out 10 recommendations that it said could be considered by Cabinet or Full Council in the event that the local authority is considering setting up another SPV. These recommendations suggest:

1. When setting up any commercial SPV in future, ensuring the relevant skills and experience required at board level is indispensable. This should include at least two external directors with specialised skill sets unrelated to the council.
2. Setting up such a commercial SPV should not be undertaken unless members are fully in accordance not only with the objectives of the enterprise but with the necessary distance from commercial decisions required by the shareholder /lender role.
3. When setting up a commercial SPV, it should be treated as a commercially independent subsidiary company and seek independent banking/financial advice on the viability of the business plan.
4. A commercial company such as an SPV should be audited by an industry-specific independent commercial auditor as a condition of any loan. Cabinet should discuss the structure of any loan to agree minimum safeguards and security.
5. Public interest regeneration objectives for particular sites should be separately funded from non-commercial sources, for example by the offer of a grant to attract developers. Putting the work out to commercial tender is essential, even where a Council-owned company bids.
6. When investments are made by the council, seeking higher returns than are available by market lending is acceptable if the risk profile of those investments is aligned with the preferred risk profile of the Council.
7. Any future SPV which undertakes public sector work should have a Teckel and Non-Teckel structure.
8. Establishing trust between stakeholders, including elected members, delivery agents/companies, contractors and the public, is a precondition for successful delivery of development projects.
9. An agreed exit strategy and decision threshold for exiting from a SPV needs to be clear and in place from the beginning.
10. When discussing any future SPV, regard must always be had to the reputation of the council as well as the SPV.

The council eventually voted for a soft close of 3 Rivers Development in September 2023, after the firm was “handicapped” by a Government ruling that SPVs could not invest outside their area.

The change delivered a final blow to the company, which had committed effort and expenditure investigating potential projects outside its area.

Adam Carey