by Alan Aisbett
My article in the Estates Gazette of July 22 1989 sets down in broad outline the provisions of the then Local Government and Housing Bill which would affect the ability of local authorities to undertake joint ventures with the private sector. The Bill became the Local Government and Housing Act 1989 (“the Act”) on November 16 1989. The Department of the Environment has now published details of the matters to be contained in the secondary legislation, although such legislation itself is still awaited. This article sets down the likely effect of these proposals for local authorities who intend to enter into a joint venture of one type or another with the private sector.
Leases
It should be recalled that the 1989 Act treats the acquisition of a lease by a local authority as a credit arrangement. These are arrangements entered into by local authorities which have the equivalent effect to borrowing. Since borrowing is controlled by central government through the allocation of borrowing approvals (termed “credit approvals” in the 1989 Act), credit arrangements will be treated in the same manner, ie the local authority will need to allocate capital resources to cover the cost of the credit arrangement.
The DOE has indicated that operating leases relating to equipment, plant, vehicles and machinery will not constitute credit arrangements. Operating leases have not been defined, but it is envisaged that the definition of operating leases will be similar to, if not the same as, that contained in the Prescribed Expenditure (Amendment and Consolidation) Regulations 1987, an operating lease being one where at the end of the leasing period the leased goods are worth at least 10% of their value at the beginning of the lease.
There is a further exemption to cover leases where not less than 90% of the capital cost of the lease is paid before the end of the first year. These will usually be long leases at a premium and will still leave the authority to find the means of financing the 90% acquisition cost in the first year.
Short-term leases not exceeding a term of three years are also exempt from being credit arrangements. Previous leases will be aggregated to the current lease for the purpose of calculating the three-year period. There will also be aggregated to the term of a current lease any interest of any other authority which Part IV of the 1989 Act applies, and which has been held by that other authority in the past 10 years. This will prevent a local authority transferring land and taking a three-year leaseback and also taking a three-year lease of land which has been owned or leased by another authority within the past three years. Local authorities will thereby be unable to use the three-year-lease route to circumvent the capital controls by assigning three-year leases between themselves.
As previously indicated, since leases, as credit arrangements, are treated by the 1989 Act as being equivalent to borrowing, a local authority must have the capital resources available to cover their cost. The resources can be met from:
(a) an authority’s credit approvals, ie its annual borrowing approvals, which, if used, will proportionately reduce the authority’s ability to borrow for other projects.
(b) usable capital receipts (it should be recalled that when a local authority receives a capital receipt in return for a disposal of an asset a prescribed percentage, usually 50%, must be set aside to redeem debt, with the remainder being available for capital reinvestment; usable capital receipts are the latter);
(c) revenue (this will obviously have effect upon an authority’s level of community charge).
The cost to be “covered” by the capital resources will be the capital cost of the lease rather than the previously suggested freehold value. The capital cost will be calculated by aggregating the premium paid at the outset and subsequent payments over the term of the lease. Subsequent payments will be discounted over the period of the lease by a rate to be prescribed by the Secretary of State. It has been suggested that this rate will be set annually for all authorities and will be equal to the forecast average rate for local authority borrowing for the financial year concerned. The discounting arrangements will obviously penalise authorities who accept a lease where the cost of that lease is greater than the cost of borrowing to acquire the asset at the outset. This of course presupposes, in the light of prevailing market conditions, that the authority would have been in a position to acquire the asset outright.
Where a lease is acquired by a local authority and is subsequently varied, then if the variation had taken place at the beginning of the lease and the credit arrangement would have been at a greater cost the local authority will need to provide extra capital resources. The DOE has suggested that a variation may also occur where a local authority holds over under the Landlord and Tenant Act 1954 and no statutory notice is served either by the authority or by the landlord. However, the operation of a rent review clause will not involve a variation of the lease or credit arrangement, since this review is seen as growth to the landlord rather than a cost of the lease.
There is some uncertainty as to the position of a lease taken by a local authority at a nominal rent with no premium. Following the definition of the capital cost of a lease it would seem that, since the capital cost of such a lease will be nil, the cost to the authority in capital resource terms will be nil. However, it was suggested that this may be an over-simplistic approach, since unless the authority receives the lease as a gift there is likely to be some other consideration moving from the local authority.
A deferred consideration from the authority could fulfill the second part of the definition of credit arrangement and as such will have a cost attached to it. Alternatively, the acquisition of a lease by the authority as part of a larger transaction (involving, for example, the transfer of other land by the authority) could be a barter arrangement, the consequences of which for the authority (by way of redemption of debt) were explained in my earlier article.
Under the current legislation, if a local authority acquires a lease for a term of three years or more it must set aside from its capital resources an amount equivalent to the freehold value of the land acquired. It will be interesting to see whether the shift from freehold value to capital cost will further deter authorities from acquiring leasehold interests.
In passing it should be recalled that the grant of a lease by an authority at a premium will yield a capital receipt of which only 50% may be reinvested. The disposal of a lease at a rent will not yield a capital receipt (and as such the whole of the rent may be expended) unless a sum is paid by way of rent more than three months before the beginning of the rental period to which it relates or any sum is paid by way of rent in respect of a rental period which exceeds one year. In other words, rent disguised as a receipt will not escape through the net.
Site assembly
The earlier article touched upon the difficulties encountered by local authorities in assembling a site for redevelopment and the consequential establishment by the DOE of the so-called “in and out” scheme to compensate authorities where acquired sites are subsequently resold. The current scheme, which is dependent upon ministerial discretion, will be replaced by a scheme which will be enshrined in regulations. The basic principle of the scheme will be that a local authority will be able (for redemption of debt purposes) to reduce the capital receipt received on disposal by an amount equivalent to the acquisition cost. In other words, for debt redemption purposes there will be no receipt received and therefore an authority will be able to use 100% of the receipt received to offset the acquisition cost. The fundamental problem with this proposition is that the authority will have to have the capital resources in the year of acquisition to effect an acquisition (and that is by no means certain), since the balancing receipt may be received in a later financial year. This can be contrasted with the current scheme, which (although at ministerial discretion) does increase an authority’s capital resources in the year of acquisition.
The “in and out” arrangements apply to two different categories of arrangements:
(a) resale — where the authority acquires land with a view to resale; and
(b) replacement — where an authority intends to dispose of land used for operational purposes or unused land and it is necessary in the case of the operational land for alternative land to be provided for the same purpose or in the case of unused land it is necessary to exchange land to facilitate development.
To take advantage of the scheme where the local authority acquires land with a view to resale there must be either:
(a) a current contractual arrangement covering disposal of the land; or
(b) a contractual arrangement to be entered into within three months of acquisition.
Furthermore, the land acquired must be finally disposed of within three years of acquisition.
Are these arrangements practical? If the land acquired is the first land on a site to be acquired for redevelopment would a developer be willing to accept a contract for the disposal of that land within three months of the acquisition by the authority? Clearly, any contract would have to be a contract conditional upon the acquisition of the remainder of the site, planning, stopping-ups etc. Most authorities undertaking the compulsory purchase of the site will find it extremely difficult to fit within such a constricted timetable where there may be a multitude of interests to be acquired, and which, of course, do not necessarily come up for acquisition at convenient periods. Disposal must be effected within three years of acquisition and this therefore begs the question as to the position of the authority if the condition precedents are not fulfilled.
The tenure of the disposal interest must be either:
(a) the same as that acquired, ie freehold to freehold or leasehold to leasehold. However, because the method of compensating the authority is by enabling the authority to use the whole of the capital receipt, a leasehold disposal cannot be at a rent; or
(b) a superior interest to the acquired interest (assuming the local authority actually holds a superior interest to the interest acquired). This enables the authority to acquire a lease where it holds the reversion and subsequently dispose of the merged interest; or
(c) leasehold where a freehold was acquired, provided the term of the lease is not less than 125 years and 90% of the capital cost of the lease is received before the end of the first year. Therefore, an authority can only retain a maximum of a 10% interest in the equity. This will cause difficulties for the favoured side-by-side leasing structure with geared rents. The position where a local authority enters into a joint venture with an adjoining owner, the consequence of which is that the adjoining owner transfers its land to the authority in return for a lease is unclear. There is clearly no acquisition cost, but whether a credit arrangement may be implied because of the deferred consideration from the authority has yet to be tested.
The other area where the “in and out” scheme will apply is where the authority replaces certain land (which does not include housing or car parks) or exchanges unused land. The replacement land can be provided by the transferee of the operational land or by some other third party. The replacement land or, as the case may be, the exchanged unused land must be acquired at or before the time of the disposal of the authority’s land. Where this applies, the receipt received by the authority for the land disposed of or, in the case where the consideration is works comprising the replacement of the assets, the notional capital receipt is reduced (for debt redemption purposes) by an amount equal to the replacement cost (roughly the cost of replacement land together with cost of replacement structures). The authority can thereby use the whole of the capital receipt received (or it is not penalised in respect of the capital receipt it ought to have received) to offset the acquisition cost of the replacement asset. Since replacement cost is calculated by reference to the replacement cost of the existing asset there does not seem to be any scope for a greater asset to be provided by a developer. If a greater asset is provided by the developer then the authority must set aside 50% of a difference for the redemption of debt.
Planning and barter
The 1989 Act enables the Secretary of State to make regulations to treat receipts which are not defined as capital receipts as being capital receipts (with the debt repayment consequences). Under the current legislation, payments in accordance with agreements made under section 52 of the Town and Country Planning Act 1971 and section 278 of the Highways Act 1980 are treated as capital receipts. However, a local authority is entitled to use 100% of such receipts for reinvestment. It can be seen, therefore, that there is potential under the 1989 Act for the Secretary of State to control planning gain by restricting the local authority’s ability to use the moneys received from a developer. Thus far the DOE has not indicated that such payments will be treated as capital receipts under the new system.
Alternatively, where works are carried out by the local authority and reimbursed pursuant to such agreements, the authority will not be obliged to charge the cost of such works to its revenue account (ie it will not filter through to community charge payers). Furthermore, if a local authority has to borrow to complete the works, provided that the borrowing is repaid within 12 months there will be no need for the authority to use a valuable borrowing approval. Works carried out by a developer in return for a planning permission would not seem to come within the definition of a barter arrangement, as there is no disposal of an asset by a local authority in return for the works. Of course, a planning agreement with provisions beyond straightforward works for planning permission — involving a transfer of land by the authority in return for the works, for example — will be treated as a barter arrangement.
Joint ventures
The majority of joint ventures entered into by local authorities will involve the use and development of local authority land. Other than joint venture companies which will be the subject of specific legislation contained in Part V of the 1989 Act, a joint venture between a local authority and a third party will embrace some of the elements already discussed. Any acquisition of freehold or leasehold land and/or disposal of land, whether for monetary consideration or non-monetary consideration, should be carefully considered with regard to the consequences for the local authority’s capital resources.
On first sight there may seem to be an advantage with an overage agreement, in that the overage sum received by the authority will be in respect of the performance by the developer rather than the initial transfer of land. However, since the overage payment would not have arisen but for the transfer of the land, it is likely that it would be a sum received by the authority in respect of a disposal of an interest in an asset, and as such a capital receipt. The position as regards side-by-side leases has already been covered.
The effects of Part V of the 1989 Act upon joint venture companies involving local authority participants were covered in the earlier article. Much of the detail to be contained in ministerial regulations has been published, but the overall principle that companies controlled or influenced by local authorities are to be treated virtually as an arm of the authority has not been changed. Local authorities are free to enter into joint ventures using the vehicle of a joint company but, to avoid capital expenditure problems for the authority, such a company should be neither a controlled nor an “influenced” company as defined in the 1989 Act.
The authority will therefore be looking to have an interest in the company of 50% or less and not to be involved in the company to such a degree that the business nexus test is fulfilled (that is where, roughly speaking, the local authority provides 50% or more of the business or financial assistance to the company). For the authority to participate in such a minority-interest company the company must be an “authorised” company, ie the purpose of the company must come within a category that is defined by ministerial regulations.
