The Local Government (Contracts) Act - who and what it applies to and the protection it offers

This piece of legislation finally became law on 27 November 1997 and sections 2-9 were brought into force under section 12(2) of the Act on 30 December 1997.




Who is covered by the Act?

The Act applies to "local authorities", as defined:

• County councils;
• County borough councils;
• District councils;
• London borough councils;
• The Common Council of the City of London and the Council of the Isles of Scilly;
• Waste disposal authorities;
• Joint authorities for police, fire services, civil defence or transport established under the Local Government Act 1985;
• Joint or special planning boards constituted for a national park under the Local Government Act 1972;
• Joint planning boards constituted for an area in Wales outside a national park under the Town and Country Planning Act 1990;
• The Broads Authority;
• National park authorities;
• Fire authorities or police authorities established under other relevant legislation such as the Fire Services Act 1947 or the Police Act 1964;
• Probation committees;
• The Receiver for the Metropolitan Police District; and
• Local authorities or joint boards established under the Local Government (Scotland) Act 1994.

What is covered?

The Act introduces a certification procedure whereby local authorities may "certify" certain contracts, in which case the local authority is deemed by the Act to have had the power to enter into that contract. The protection afforded by the certification procedure in the Act only extends to "provision contracts", as defined in the Act, and to contracts entered into by a local authority with a financier in connection with a loan (or other form of finance provided by the financier) where such loan is made to the party to the provision contract other than the local authority.

A provision contract that is entitled to the protection of certification is one between a local authority and another party for the provision of services (whether or not together with assets or goods) for the purposes of the discharge by the relevant local authority of any of its functions. Such a contract must operate or be intended to operate, for a period of at least 5 years. The contract must be directly with the local authority itself, and not a subsidiary of the authority or some other body, and it should be by the provision of a package of services or assets, or both, in connection with any of that authority's functions. This will include functions such as education, waste disposal, public health, town and country planning and conservation, highways and road traffic matters, the administration of justice, police and fire services, passenger transport, and arts and recreation.

The type of contract between a local authority and a financier which falls within the scope of the Act is any contract entered into by a local authority with a person who, in connection with a provision contract of the type described above, provides a loan or some other form of finance for the other party to that provision contract or any insurer or trustee. Again the contract must be directly between the local authority itself and the relevant financier or its insurer or trustee. No requirement for a minimum period for this type of contract is imposed.

Transition Provisions

Section 1 of the Act, which clarifies the contracting powers of local authorities, and Sections 2-9 which set out the terms and the scope of the certification procedures and details of the protection afforded by them, apply to any contract which a local authority enters into after 12 June 1997. The certification process can only apply to contracts of the type described above. Contractual arrangements entered into before that date are not affected by the terms of the Act and cannot be the subject of any protection afforded by it. Transitional requirements apply to any qualifying contract entered into between 12th June 1997 and 30th December 1997 (being the date on which the certification provisions came into force). If a contract has been entered into with a local authority in this period and it is intended that this should be a certified contract, the Act expressly provides that the certification period for such contract will be the period of six weeks beginning on 30 December 1997. Certification requirements under the Act must be satisfied by a local authority within the certification period. This normally means a period of six weeks beginning with the day on which the local authority enters into the contract. It is therefore important that where the protection afforded by this Act is being sought for any contract executed between 12 June 1997 and 30 December 1997 all relevant requirements of the Act are satisfied before 10 February 1997.

Protection offered

Now that the Act has received the Royal Assent, exactly how much protection does it offer parties dealing with local authorities in relation to PFI projects? One of the areas of concern raised is that the Act does not appear to provide a complete "safe harbour" provision. This is because the various presumptions set up in relation to the capacity of a local authority to enter into a certified contract and any relevant discharge terms appear to be capable of rebuttal by the courts on an application for judicial review or an audit review. (The expression "relevant discharge terms" is given a technical definition within the Act but effectively refers to compensation provisions agreed between the parties to the contract which are to apply in the event of an audit review or a judicial review). It seems disturbing that despite the strong terms in which the presumption regarding the effectiveness of relevant discharge terms is put in Section 6(4) of the Act, the terms of Section 7(3) indicate that there may still be circumstances in which a successful challenge may be made to the capacity of a local authority to enter into such. Section 7(3) effectively provides that a certified contract may not have relevant discharge terms if a court determines that such terms in a certified contract do not have effect.

Whilst it is not entirely clear when such circumstances would arise, some guidance on this was provided in the discussion of this provision in the House of Lords. Certain Law Lords indicated that the circumstances where both the contract and the purported relevant discharge terms would both be struck down would be rare and extreme. Examples given included where there had been fraud, collusion or corruption used in order to induce parties to enter into the contract or where the terms of the contract were "outrageous". Various attempts were made to define the latter circumstance, including discussions of language more appropriate to statute drafting such as "gross unreasonableness", but the general consensus appeared to be that "outrageous" conveyed the right sense and the point did not require more detailed definition.

" target="_blank">Basic structure of a typical Local Authority PFI contract

The Act provides that in circumstances where there are no relevant discharge terms the other party to the contract shall be entitled to be paid by the local authority such sums as he would have been entitled to receive if the contract had been effective up until the time when the relevant court ruling is made but had then been terminated by the local authority by a repudiatory breach of the contract. In essence the normal contractual measure of damages would then apply to compensate the agreed party. Although this is not the complete "safe harbour" provision that some have sought, it does represent a substantial improvement for any party dealing with a local

Basic structure of a typical Local Authority PFI contract authority in a PFI structure. It may also be argued that the process of setting up rebuttable presumptions which is followed in the Act is the same as the true protection afforded by the terms of section 44(6) of the Local Government and Housing Act 1989 in connection with local authority borrowings.

Further benefits

In addition to the residual right to contractual damages the Act does offer other significant benefits namely:-

(a)The effect of the presumptions raised in respect of a certified contract and any relevant discharge terms is to prevent the local authority and any private sector party entering into a certified contract from claiming in private law proceedings that a certified contract is outside the capacity of the local authority whilst retaining the right of local council tax payers and district auditors to make challenges in public law proceedings.

(b)The courts have now been given an express power to preserve a certified contract in effect notwithstanding that the court is of the opinion that the local authority did not have power to enter into such contract, or exercised any such power improperly. In deciding to make such a determination the court is obliged to have regard to the likely consequences for the financial position of the local authority, and for the provision of services to the public, of a decision that the contract should not have effect. In practice this may yet prove to be one of the most significant provisions of the Act. It effectively overturns the absolutist view of the effect of a lack of capacity that was taken by the court of appeal in the Allerdale judgment. That view meant that a court had no option but to strike down a contract in its entirety if it was in any way ultra vires. The express provisions of section 5(3) of this Act will now give the courts greater flexibility in such circumstances when dealing with certified contracts.

The significant improvements provided by this Act do not remove the need for any party dealing with a local authority to check that it is satisfied with the capacity of the relevant authority and to proceed with a degree of caution on this issue. The significant difference is that if it subsequently proves to be the case that the local authority did not have the relevant capacity, the other party to such a transaction is now likely to obtain a significant level of compensation rather than being simply left without remedy. The residual risk is that if the termination compensation terms which are set out in the contracts are not considered by the courts to be a proper measure of contractual damage then the court will impose its own terms. This may mean that some provisions would be struck down to the extent that they are regarded as penal or go beyond what the courts regard as proper compensation in the circumstances.

This would appear to bring the legal risk associated with contracts of this type more into line with those as associated with normal dealings between corporate entities. There will always be a certain level of risk associated with dealing with public bodies because of the need to balance public against private interests in any judicial consideration of the activities of a public body. However this Act offers significant benefits to the private sector in its dealings with local authorities.

Health Sector

In this regard it may be adversely contrasted with the approach adopted to ultra vires issues in the health sector. Whilst this Act has attempted in some detail to deal with the consequences of adverse judicial review proceedings the point seems to have been largely ignored in the National Health Service (Private Finance) Act 1997. In that act the issue of the capacity of a NHS Trust to enter into an externally financed development agreement is deemed to be settled by the granting of a certificate by the relevant Secretary of State. However the granting of such a certificate is potentially the subject of an application for judicial review. In this regard the actions of central government are themselves subject to the doctrine of ultra vires although their powers are often considerably greater than those given to local authorities. Whatever the reason for this omission the legislation in the health sector does not offer the kind of fall-back position which is provided for in the Local Government (Contracts) Act 1997. It therefore remains to be seen which is the more successful approach to promoting confidence with regard to the manageability of legal risks associated with dealing with public bodies.