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Trading Funds' Participation in Joint Ventures Guidance Note on the Requirements of the Government Trading Funds Act 1973ContentsIntroduction and Background The Status of Trading Funds Trading Funds and Joint Ventures Key Issues - Trading Fund and Joint Venture Surpluses - Dividend Policies - Directors' Conflict of Interest - Management of Operations - Source of Income - Accounting for Borrowing - Accountability Further Information Introduction and Background
1. The purpose of this guidance note is to provide a source of reference
on whether and how the operations of Government Departments financed
through trading funds can be discharged through joint ventures under
the terms of the Government Trading Funds Act 1973 as amended by the
Government Trading Act 1990 and further amended by the Finance Acts
1991 and 1993 ( referred to hereafter as "the Act"). It considers:
2. Joint ventures are defined in Financial Reporting Standard (FRS)
9(1). A trading fund would "jointly
control" a venture with one or more other entities if "none of the
entities alone can control that entity, but all together can do so
and decisions on financial and operating policy essential to the activities,
economic performance and financial position of that venture require
each venturer's consent". "Corporate joint venture" as used in this
paper means that the separate entity created has been incorporated
as a private limited company under the Companies Act. This guidance
does not cover publicly quoted companies. 3. A distinction should be drawn between a "joint venture" (in which
a separate entity is created) and a "joint arrangement that is not
an entity" which is defined as " a contractual arrangement under which
the participants engage in joint activities that do not create an
entity because it would not be carrying on a trade or business of
its own". A contractual arrangement where all significant matters
of operating and financial policy are predetermined does not create
an entity because the policies are those of its participators, not
of a separate entity. 4. This note addresses the issues for trading funds' participation
in joint ventures arising from the Act and only these. Other issues
arising from joint ventures which are not necessarily covered by the
Act and which apply to all government bodies will also need to be
considered. The note has been prepared by the Treasury and in consultation
with the National Audit Office who are in agreement with the principles
underlying it. The note takes account of an opinion sought from Treasury
Counsel. It should not be read as definitive advice for any individual
project. Legal advice should be sought in relation to each project.
The Status of Trading Funds
5. The purpose of the trading fund legislation
is to provide an alternative system for the funding of, and accounting
for, certain operations of government departments: an alternative,
that is, to financing from the Vote. Each individual trading fund
is set up by an Order which, inter alia, specifies the fund's "funded
operations" . The order is made by the responsible Minister, with
the concurrence of the Treasury, and approved in advance by Parliament.
6. The key characteristics of a trading fund are that:
7. Further guidance on the establishment and operation of trading
funds is given in The Establishment and Operation of Trading Funds
(December 1991) and Trading Funds (October 1996) both
obtainable from the CA team in the Treasury. Trading Funds and Joint Ventures
8. The Crown has the common law power of a natural
person to establish or purchase a company, appoint directors and engage
in activities through corporate entities, including joint ventures.
The Act neither expressly nor implicitly limits or removes that power.
So there is no reason in principle why incorporated joint ventures
cannot be undertaken by a department whose operations are financed
by a trading fund. This view was confirmed by Treasury Counsel in
his opinion of 15 December 1998 which said: "In Counsel's opinion, there are no legal principles or rules
which prohibit a government department whose operations are financed
by means of a trading fund from entering into joint ventures, whether
the joint venture be corporate or contractual." 9. Income and other assets from the trading fund can be used for
acquiring shares in the joint venture, provided the purposes of the
joint venture come within the operations of the trading fund as prescribed
in the trading fund Order. (A Minister would have to finance from
a Vote any investment in a joint venture which was outside the prescribed
operations of the trading fund.) This may at first sight appear contrary
to the prohibition against investing with private sector bodies in
Government Accounting, paragraph 17.1.6, but the prohibition there
is to investment of funds surplus to those for the immediate requirements
of the operations of the fund. Government Accounting will be amended
to clarify this point. 10. Though there are no barriers in principle, trading funds are
nonetheless, and in contrast to many other parts of government, statutory
bodies whose activities must fall within the scope of the Act. 11. Thus, even though the Act is designed to provide an environment more suited to commercially-oriented bodies, the removal from Vote-financing still imposes a range of controls on trading funds' activities. These need not limit unduly the scope for joint ventures. Several aspects of the Act do, however, create potential difficulties which need to be addressed.
Key Issues
12. Caution should always be exercised, in developing any joint venture
to ensure that the arrangements provide value for money and suitable
safeguards for the shareholders' interests. Joint ventures are by
their nature complex entities. Where one of the shareholders is a
department operating through a trading fund, there are additional
considerations that will apply because of the issues raised above.
The following paragraphs consider the key areas in which the Act requires
trading funds to ensure that potential risks have been identified
and necessary steps taken to avoid them. There are, of course, a host
of other issues which apply to any joint ventures - for instance,
restrictions on share transfers; pre-emption and exit rights; guarantees;
competition clauses; limitations to liability; confidentiality; default;
voting rights; deadlock etc - on which any trading fund should seek
expert advice. Advice should also be sought on the sector classification
of the proposed joint venture for national accounts and expenditure
control purposes (see paragraph 26). Trading Fund and Joint Venture Surpluses
13. Section 2A(5) of the Act provides for the responsible Minister
(with the concurrence of the Treasury) to require the payment of a
return on the public dividend capital and reserves of a trading fund
which has regard to any balance in the fund at the end of the year
and the amount of the balance which appears to be in the nature of
a distributable profit. There is no requirement for the Minister to
set a figure in every year and trading funds are often given a dividend
holiday for a few years when they are first set up, but there is a
general requirement for trading funds to earn a specified level of
surpluses with the intention that they be used to pay interest on
the loan capital and distributed to the Exchequer in the form of dividends
on the public dividend capital. 14. It is a requirement of the Companies Act that a company may not
distribute by way of dividend any more than its accumulated and distributable
reserves, and similar considerations would apply to joint ventures
involving trading funds. Similarly the Minister can only set a level
of dividend which reflects the distributable surpluses in the trading
fund and must not take into account any undistributed profits in the
joint venture. However, care should be taken to ensure that profits
are not, without good commercial reason, trapped in the joint venture
rather than distributed to shareholders. 15. Trading funds' Accounting Officers should reflect the responsibility
Ministers have under sections 2A(5) and 4(1) of the Act in their Framework
Document and Corporate Plans, and should consider in each case whether
ministerial agreement is needed. This is to ensure that, where any
joint venture is contemplated, the Minister and the trading fund are
satisfied that nothing in the proposed joint venture could conflict
with the responsibilities of the Minister under these sections. 16. Where joint ventures do not materially affect the overall asset
base of the trading fund, there should not be difficulties with Sections
2A(5) and 4(1) since it is unlikely that such arrangements would materially
affect the trading fund's ability to pay a dividend. As the proportion
of the assets of the trading fund vested in joint ventures increases
so does the risk that a breach of these sections of the Act could
occur. There are a number of contractual structures which the trading
fund may consider to prevent breaches occurring. These include:
Dividend Policies 17. A provision to regulate the dividend policy of the joint venture
should be agreed between the shareholders in a joint venture at the
outset. The provision should be included within a shareholders' or
joint venture agreement. Such a provision might include a presumption
that amounts in excess of an agreed level should be distributed; or
that (to the extent permitted by law and subject to the joint venture's
cash requirements) a prescribed percentage of post-tax profits will
be distributed. Directors' Conflict of Interest 18. Crown servants owe duties to the Crown whereas directors of companies
owe duties to the company. In practice these duties are often indistinguishable
but there is the possibility that the interests of the Crown and the
interests of the company will diverge. 19. This is not by any means unique to trading funds. Employees of
any company nominated to the board of a joint venture face similar
potential conflicts between their duties to the shareholders of the
company of which they are employees, both in their capacities as employees
and as nominees of the joint venture, and their duties to the joint
venture as director. 20. One way round this problem (ie conflicts of interest) would be
a shareholders' agreement requiring unanimity by the shareholders
before major reconstruction could be undertaken. Management of Operations 21. Care should be taken to ensure that, in setting up a joint venture, a Minister is not put in breach of his responsibility to manage the funded operations in the way stipulated by section 4(1) of the Act. In other words, the joint venture company should not be structured so that it acts as a substitute for the funded operations. As further protection, the joint venture should be structured in such a way that a sufficient element of shareholder control is retained. Source of Income 22. In order to avoid a private trading interest financing the operations
of a government department (which Parliament has determined should
be financed by a trading fund in accordance with the Act), the objects
for which the joint venture company is established should be carefully
defined so as to tie in with the operations of the particular department.
23. This can be effected through the Memorandum and Articles of Association
and enforced as discussed above through a shareholders' agreement
requiring unanimity on certain matters. Accounting for Borrowing 24. Legal Position One of Parliament's controls
over trading fund finance is that trading funds are prohibited from
obtaining private loan capital: section 2B of the Act. It might
be seen as a circumvention of this requirement if a Minister
invested in a joint venture company not bound by the section 2B prohibition,
particularly where the accounts of the joint venture had to be consolidated
with those of the trading fund. Counsel said, however, that in strict
law there would be no contravention of section 2 since there would
be no borrowing by the trading fund from the private sector. The borrowing
would be undertaken by a separate legal entity, the joint venture
company. In practice, if the joint venture is classified
to the private sector and its borrowings are arranged without recourse
to the trading fund there is unlikely to be any concern.
25. EFR/EFL Accounting. It is important to bear
in mind that the classification of a joint venture for audit purposes
does not automatically determine its classification in the national
accounts. It is the sector classification of the joint venture as
determined by the Office for National Statistics (in line with the
European System of Accounts) that determines whether it should be
consolidated into the EFR calculation.(2)
Accountability 26. Trading funds should ensure that they have full rights of access
to the joint ventures in which they are shareholders. 27. Where effective Parliamentary scrutiny of trading fund accounts
and activities requires or may require the NAO to have access to relevant
documents relating to the trading fund's investment in a joint venture
classified to the private sector, an appropriate clause (such as the
one set out below) should be included in the shareholders' agreement.
For the purposes of: a) the examination and certification of the trading fund's accounts;
or b) any examination pursuant to Section 6(1) of the National Audit Act 1983 of the economy, efficiency and effectiveness with which the trading fund has used its resources,
the Comptroller and Auditor General may examine such documents
as he may reasonably require which are owned, held or otherwise within
the control of the joint venture and may require the joint venture
to provide such oral and/or written explanations as he considers necessary.
This condition does not constitute a requirement or agreement for
the examination, certification or inspection of the accounts of the
joint venture under Section 6(3)(d) and (5) of the National Audit
Act 1983. 28. In case of doubt the trading fund should consult the TOA team
at HM Treasury and the NAO. 29. Where a joint venture is classified to the public sector, the
NAO should have the same access rights as apply to the trading fund.
Further Information 30. Further information on trading funds is available from
Nick Bailey in the Treasury's Central Accounting team, details as
follows. HM Treasury Room 6/3 Treasury Chambers Parliament St Tel 0171 270 4535 LONDON SW1P 3AG Fax 0171 270 4545
E Mail nick.bailey@hm-treasury.gov.uk 31. The Treasury Taskforce is available to assist in the development
and sign-off of joint ventures. Adrian Montague, Chief Executive of
the Taskforce should be the first point of contact. His contact details
are as follows: Treasury Taskforce Room 22/G Treasury Chambers Tel 0171 270 4700 Parliament St Fax 0171 270 5760 LONDON SW1P 3AG E Mail adrian.montague@hm-treasury.gov.uk 1. FRS 9 defines JVs as follows: "an entity in which the reporting entity [in this case, the trading fund] holds an interest on a long term basis and is jointly controlled by the reporting entity [the trading fund] and one or more other venturers under a contractual arrangement". 2. For further information see the guidance notes Trading Funds - Measurement of External Finance, Class (97)3, and Public and Private Sectors, Class (97)5. Both are available from the Treasury's Public Enquiry Unit.
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