Scott Dorling 20 October 2020

Institutional Blindness – there is a cure

In August 2020 Nottingham City Council's auditors, Grant Thornton, issued a report in the public interest under section 24 and Schedule 7 of the Local Audit and Accountability Act 2014. The report was issued because of the serious concerns about failures in the council's governance arrangement in relation to Robin Hood Energy Limited. Any local authority with interests in corporate vehicles (and there are few these days who don’t fall into that category) should read the report and take the opportunity to review the governance arrangements it has in place for its connected entities.

This article considers some of the key lessons that need to keep being learned and re-learned.

The council set up Robin Hood Energy in 2015 as a wholly owned not-for-profit subsidiary, in order to tackle fuel poverty in the City of Nottingham and be a realistic alternative to the ‘big 6’ energy suppliers. A key aim was to help people below the poverty line access to better deals. This is a hugely commendable objective and goes someway to explaining the losses that Robin Hood Energy made in its initial years of operation. The losses compounded, cumulating to £34.4m in 2019, which is what brought the attention of the auditors.

A key concern expressed in the public interest report is the council decision making process that led to the giving of significant additional loans to the company is 2018/19 and 2019/20. The report highlights the failure of governance. The additional loans were given despite the council's 'concerns about the quality of the financial information being produced by the company and the company's deteriorating financial performance and therefore its ability to make repayments'.

This is not only a failure of governance but it also goes to the heart of any council's fiduciary duty to its council tax and rate payers. Prudence is a fundamental aspect of any council's financial management and making loans with serious concerns as to the prospect of their repayment is indeed a matter of public interest.

The report catalogues the reasons for the company's failure. Whilst the sector in which the company operated was acknowledged to be 'highly complex, highly competitive and highly regulated', it is nonetheless surprising how much of the failure appears to be due to poor governance. These have been cogently summarised in the report as:

• insufficient appreciation within the council (as a corporate body) of the huge risks involved in ownership of, and investment in, the company;

• insufficient understanding within the council of the company’s financial position, partly due to delays in the provision of information by the company and the quality and accuracy of that information;

• insufficient sector (or general commercial) expertise at non-executive board level;

• a lack of clarity in relation to roles within the governance structure;

• the arrangements did not establish an appropriate and consistent balance between holding to account; and

• allowing the company freedom to manage, and this worsened as levels of trust decreased and the financial position deteriorated.

The most striking and eye catching statement of the report (hence my use in the title of this piece) of the report, highlights that the council's governance of the company was overshadowed by its determination that the company should be a success, and this led to 'institutional blindness within the council as a whole to the escalating risks involved'.

How could the issues have been avoided and are there lessons for other councils? Well, to the first question the answer is difficult as the nature of the energy market would always mean that the company's success was going to be difficult. As to the second question, the recommendations in the report could serve as a useful starting off point for councils to review and reflect on their own governance arrangement for corporate entities.

The report suggested, amongst 13 different recommendations:

• A review of the council's overall approach to using councillors on the boards of its subsidiary companies and other similar organisations which should be informed by a full understanding of the role of and legal requirements for company board members.

• Where it continues to use councillors in such roles, it should ensure that the non-executives (including councillors) on the relevant board have, in aggregate, the required knowledge and experience to challenge management. This is of particular importance where the company is operating in a specialised sector which is outside the normal experience of councillors.

• Where councillors are used in such roles, the council should ensure that the councillors are provided with sufficient and appropriate training which is updated periodically.

• The council should ensure that all elements of its governance structure, including the shareholder role, are properly defined and that those definitions are effectively communicated to the necessary individuals.

• When allocating roles on council-owned organisations to individual councillors, the council should ensure that the scope for conflicts of interest is minimised, with a clear divide between those in such roles and those responsible for holding them to account or overseeing them.

• The council should ensure that risks relating to its companies are considered for inclusion in its overall risk management processes, with appropriate escalation and reporting, rather than being seen in isolation.

• The council should ensure that financial information is provided in accordance with its requirements and is fully understood by those holding the company to account, and that robust action, with the oversight of the s151 officer, is taken if suitable information is not provided.

• The council needs to ensure that responsibilities for scrutiny and risk management are given sufficient prominence, including giving the audit committee explicit responsibility for scrutiny of governance and risk management across the group.

There is nothing ground breaking or even slightly challenging in any of those recommendations. They are merely the ingredients of good governance. Put them all together and any council can have well run subsidiary undertakings, whose activities are fully understood, challenged and scrutinised where necessary, and supported by a well informed council parent.

Scott Dorling is partner at Trowers & Hamlins LLP

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