20 February 2018

Keeping it in the family: Wholly owned subsidiaries in the NHS

Introduction

There is an increasing interest in the establishment of wholly owned subsidiaries in the NHS and this article examines the key drivers for this interest, the legal requirements for such new companies and some of the practical issues that Trusts will need to consider.

Why wholly owned subsidiaries?

There are a range of drivers for individual Trusts but in the main the drivers identified by Grant Thornton in a recent report (NHS Companies – An enterprising approach to health – 2017) are:

Reducing expenditure
Increasing income
Improving services
Managing risk.

Whilst financial drivers may be the initial catalyst for the discussion about a wholly owned subsidiary any business case has to clearly demonstrate a service improvement and better outcomes for patients.

It is fair to say that wholly owned subsidiaries have attracted some criticism – notably from trade unions such as Unison who claim that the drivers for the new company are “exploit[ing] a tax loophole” and are an aim to privatise the NHS “by the back door”. In particular, trade unions are against the transfer of staff from the NHS to the company as those staff (whilst terms and conditions are protected by TUPE) are no longer employed by the NHS (Unison Parliamentary Briefing January 2018 – NHS Wholly Owned Subsidiary Companies).

The issue has recently been raised in the House of Commons with both written questions being raised (John Grogan MP 22 November 2017) and an Early Day Motion tabled on 16th January by Liz Twist MP which calls on the Government to block the creation of any further NHS wholly owned subsidiary companies (Early Day Motion 802).

Nonetheless the interest in subsidiaries remains strong, for the reasons set out above, and we are receiving an increasing amount of queries in relation to this topic (e.g. see HSJ articles on 14 February 2018).

The legal framework for wholly owned subsidiaries

The first key point to note is that, at present, only NHS Foundation Trusts have a clear statutory power to establish separate companies. There is growing pressure for this same freedom to be extended to NHS Trusts but at present no changes have been made to give this aspect any clarity (a change in the law may be on the DHSC radar).

In terms of procurement law, there is no “public body to public body” exemption in procurement law – if one public body awards a contract to another public body then, if certain conditions are met, that contract has to be tendered in line with the Public Contracts Regulations 2015 (PCR).

However, case law established that there could be an exception to this where, even if two separate entities were involved, there may be no requirement for formal tendering if the arrangement was akin to an organisation awarding a “contract” to an in-house department. A long line of case law, starting with the Teckal case, eventually resulted in a change to the law so that Regulation 12 of the PCR now clearly sets out the position.

The requirements relating to the wholly owned subsidiary are:

The contracting authority has to exercise control over the new company in a way which is similar to that which it exercises over its own departments (the “control test”), and
The new company carries out the essential part of its activities with the contracting authority – no more than 20% of the new company’s activities can be carried out on the open market – it is established essentially to service the contracting authority (the “activity test”),
No private participation in the new company is permitted.

Jointly owned companies are equally permissible provided they meet the rules above such that two or more FTs could decide to jointly set up and own a new company to deliver services to them. Joint control can be exercised where: the decision making body of the company is composed of representatives of all participating contracting authorities; those authorities are able to jointly exert decisive influence over the strategic objectives and significant decisions of the company; and, the company does not pursue any interests which are contrary to those of the controlling authorities.

Are wholly owned subsidiaries bound by the PCR when they purchase supplies, services or works?

The short answer is yes and no! A recent Court of Justice ruling means that, in general terms (there is a nuance here around the activity that the new company carries out and whether these are activities that are needed in order for the Trust to carry its own activities but this outside the scope of this article), the wholly owned subsidiary has to comply with the PCR whenever it makes relevant purchases and in general terms, given the control test, we would always advise that the new company adopts the same or very similar standing financial instructions as the parent Trust.
However – the company will not have to tender for relevant supplies, services or works where it obtains them from its parent – this is known as the “reverse Teckal” rule and conveniently allows subsidiaries to acquire back office services such as HR, payroll and IT from its parent Trust without having to go out to tender.

Practical issues for wholly owned subsidiaries

It is important to take expert financial advice if the Trust wants to reduce expenditure/increase income in order to deliver an improved service to benefit patients. In particular, it is critical that VAT and general tax advice is received and considered in parallel with the legal advice so that the structure of any new company is legally compliant as well as financially efficient. In this regard, Trusts must have regard to the letter issued by the Department of Health (as it then was) on 28 September 2017 in relation to tax avoidance.
In order to meet the control test the company’s governance structure needs to be carefully thought about. However, from a finance perspective the company needs to be seen as independent from the Trust. As a result the Articles of Association of the company will need to be carefully drafted to satisfy both procurement law and finance requirements. Standard “off the shelf” Articles will not therefore be appropriate.
The governance structure of a company is very different to that of an NHS Trust so whilst appointments to the company are very often individuals from the Trust this needs careful consideration because of the risk of conflicts of interest. Directors have a duty to act in the best interests of the company and staff newly appointed to this role are likely to need training and support. Regard should be had to the Cabinet Office “Guidance for directors of companies owned or partly owned by the public sector” (January 2016) which is helpful in this context.
A business transfer agreement will usually be required between the Trust and the company under which the relevant staff, equipment, contracts and any intellectual property will transfer from the Trust to the company. The Trust and the company will have to agree how they share risks and liabilities under that agreement.
A services agreement will be needed between the Trust and the company under which the company provides the relevant services etc. and the Trust agrees to pay for those services. A further agreement will be needed if the company is getting services from the Trust, such as back office services.
Effective communication with representatives and affected staff is essential to the success of a new company. Our experience shows that early and clear engagement with staff can make a significant difference to the project. The Trust should anticipate that recognised unions are likely to object to the setting up of the company and so providing a full and clear rationale for the change should help minimise any risk of disruption.
Consideration should be given to whether the company is able to call off from existing framework agreements, both in its own right and on behalf of its host.

Conclusion

For any Trust considering the establishment of a wholly owned subsidiary it is critical to have a clear business case setting out the anticipated service improvements and benefits to patients as well as a clear communications strategy. At the present time there is no indication that the appetite for setting up wholly owned companies is subsiding. This is a very fast moving area and it is therefore important that specialist legal and financial advice is obtained to ensure that the new company is legally compliant with procurement rules, has robust governance arrangements and is financially efficient.