When you're setting up an employee owned entity to take over public service delivery, there are a number of legal considerations. The following non-exhaustive checklist should give you a sense of the points which have to be covered.
Preliminary questions about externalisation
• Establish whether the public body has the power to transfer the service to an external entity.
• Consider the statutory duties which apply to the service(s) that are being transferred and assess whether an employee owned entity is the best option to satisfy the duties.
• Identify the contracts, liabilities, property, other assets and staff that comprise the undertaking that is going to be transferred.
• Identify the working practices and other commercial relationships that support the services' delivery.
• Identify the key stakeholders in the new entity's establishment.
• Consult the key stakeholders early and regularly during the process.
•Consider engaging the relevant professional bodies, other local service providers and the elected members of the local authority if possible.
• Consider whether the new entity could share resources and /or premises with the public body and how any resource sharing or collaboration could be managed.
• Conduct a preliminary analysis of whether an employee owned entity is a viable means of service delivery considering the nature of the service(s).
Business case for the establishment of the entity
• Use the preliminary analysis to develop a business plan.
• Account for the fixed costs and overheads, including insurance, currently carried by the public body.
• Consider the level of funds the public body is able to contribute to the new entity in respect of both start-up and ongoing costs.
• Explore alternative sources of funding.
• Could the new entity apply for grant funding from trusts and foundations, or secure investment from social investors?
• Consider whether the entity will have any assets over which it can secure borrowings.
• If the new entity will be seeking investment from community members financial services regulation may be engaged and specialist advice will be required.
• Consider a range of sources of income for the new entity.
• As well as service contacts, could the new entity undertake other income generating activities such as running training or events and charging subscriptions for membership?
• Consider the new entity's liability for tax.
• Could the new entity be structured as a charity and benefit from charitable tax breaks?
Legal structures
• Will the legal form of the vehicle be:
• Company limited by shares
• Company limited by guarantee
• IPS
• Community Interest Company (which can be structured as a company limited by guarantee or a company limited by shares)
• Charitable company limited by guarantee which registers with the Charity Commission
• Consider the extent to which the potential risks to individual directors can be managed by establishing an incorporated vehicle.
• Consider how the 'social mission' of the new entity will be protected by the constitution.
• Could the new entity's objects (i.e. its purposes) be limited?
• Could the assets of the new entity be protected by an asset lock to prevent assets from being sold undervalue and ensure assets are used for the benefit of the community?
• Remember the constitution must also be sufficiently flexible to permit the entity to take advantage of any business opportunities that may arise.
• Consider how the new entity will access finance and the implications on the legal structure.
• Can tax liabilities be avoided be reducing or avoided by adopting charitable status?
• Tax breaks for charities include:
• Exemption from income tax, capital gains tax and corporation tax on profits (although profits may only be used to achieve the charity's purposes);
• Exemption from paying Stamp Duty Land Tax on properties purchased;
• 80% rate relief (for properties that are completely or mainly used for charitable purposes); and eligibility for gift aid on donations.
• Will any directors of the new entity receive a salary?
• Consider the formalities that are required for establishing the relevant structure, including registration requirements, and how long this is likely to take.
Charitable status
• If the new entity is established as a charity, consider the extent to which its activities will be charitable as defined by law.
• Remember charity law will apply and the new entity will be regulated by the Charity Commission.
Governance
• How will the key stakeholders be integrated into the legal structure?
• Consider who will sit on the board of directors (or trustees) of the new entity.
• Who will the members be?
• How much involvement does the public body want?
• If the new entity will have a trading subsidiary, consider how it will be governed.
Establishing and running the separate entity
• Allow time in the planning of the transfer for registration with Companies House and an application to the Charity Commission or CIC Regulator to be prepared and processed.
• Ensure establishment costs are accounted for including:
• company registration fees;
• Acquiring premises and equipment;
• Establishing office management, HR, IT and other systems; and
• Expert financial, legal and other consultancy advice.
• Decide who will be the:
• Bankers;
• Auditors;
• Accountants;
• Insurers;
• Legal advisers; and
• Who will manage the company registers.
• Ensure the new entity has the insurance policies that are required by law as well as any other policies it needs.
• Ensure the necessary HR and PAYE systems and other staff management systems are in place.
• Consider the systems that are needed to ensure the new entity satisfies any other regulation it is subject to, for example, in respect of data protection and safeguarding children and vulnerable adults.
THE TRANSFER
• Due diligence
• Undertake a comprehensive due diligence exercise of the contracts, liabilities, property, other assets and staff that were identified during the preliminary stages of the project.
• Critically review the title documents to any properties, employee service agreements, any key service delivery support contracts and all other pertinent documents.
• Treatment of premises, assets and liabilities
• Consider how the entity will hold any property. Will the public body continue to hold the freehold / leasehold and lease, licence or sub-let the property to the new entity?
• Consider what will happen to any existing contracts with suppliers.Will the contracts terminate? Can the contracts be assigned? Can the contracts be novated?
• To what extent will the new entity have access to or rights over confidential information, know-how and other intellectual property rights belonging to the public body after the transfer? Consider the intellectual property rights that will be needed for the new entity to operate. Will these rights be transferred to the new entity or will the new entity licence these rights from the public body?
• Consider tangible property (instruments/equipment).
• Consider ongoing liabilities.
Staff
• Consider how many staff will transfer and conduct thorough due diligence of the terms of their employment.
TUPE will protect the terms and conditions on which the transferring staff are employed and the new entity will be legally required to honour them. Beware that where staff have transferred out of public employment, the new entity may be expected to treat them as though TUPE applies, even in circumstances where technically it does not.
• Consider the extent of the new entity's exposure to TUPE and pensions liabilities.
• Will the transferring staff support the project?
• Consider whether there are any consultants that support the delivery of the service(s) by the public body, that are not subject to TUPE who could be engaged by the new entity after the transfer.
• Could staff from the public body be seconded to the new entity and vice versa to facilitate resource sharing after the transfer?
Implications of the transfer
• Consider the risk that the public procurement rules may apply if the public body intends to award a contract to the new entity.
• Consider the risk of breaching the rules against state aid if the public body will be offering assistance to the new - entity with establishment costs or working capital.
• Consider any tax and accounting implications.
DOCUMENTS
Transfer deed
• Negotiate how the contract will allocate risk between the public body and the new entity.
• Define as precisely as possible the service(s) the new entity will deliver.
• Consider including a schedule listing the assets, including any intellectual property rights, property, contracts and staff, which comprise the undertaking.
• Ensure the new entity is protected by warranties from the public body including.
• Include provisions for assigning and sub-contracting if appropriate.
• Ensure the contract includes procedures for the event of contractual breach.
• Consider including an 'Exit Management Plan' to ensure consistent standards of service delivery if the contract is terminated.
• Consider the term of any service delivery contracts to give the entity sufficient stability to encourage investment.
Abbie Rumbold is a partner at Bates Wells & Braithwaite, a commercial law firm servicing a wide range of commercial, statutory, charity and social enterprises, and their owners and managers.
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