District energy projects – corporate structuring considerations for local authorities

Written by Freddie Sedgwick and Andrew Spicer

Introduction

In anticipation of the publication of the Government’s consultation response on heat network zoning, we thought it timely to revisit possible structures for local authority ownership and deliver of district heating projects. We note however, that any consideration of this topic should be viewed through the lens of both the upcoming DESNZ consultation response on heat network zoning in England, and Local Government Reorganisation. 

Currently, the primary consideration is whether to deliver the project directly or to establish a special purpose vehicle (SPV) for this purpose. This decision will be influenced by a number of elements including what assets and services the project will encompass, whether the local authority will own the assets, what design/build and operation/maintenance contracts will apply, who the customers will be, any anticipated returns, tax and the Council’s objectives for establishing the heat network (such as maximising returns, alleviating fuel poverty and a low carbon agenda). 

We have set out below some of the high-level pros and cons of using an SPV versus direct delivery and the form that an SPV may take. There is no one size fits all and the specifics of the project will determine the appropriate structure. The powers that the authority may rely on, any procurement implications and subsidy control are other matters to consider. 

Direct Delivery vs SPV

SPV Advantages

Ring-fencing represents a key advantage, as the SPV operates as a separate legal entity that can enter contracts and incur liabilities independently of its “owners”. The local authority’s liabilities are typically limited to capital invested (though this can be extended where it is also a funder or guarantor). 

Should the local authority decide to sell the business at a later date, an SPV is a standalone entity which can be easily transferred. 

An SPV will have bespoke governance which can be very different to standard council process which can allow streamlined management and decision making.

It is possible to structure to be outside of public procurement rules.

SPV Drawbacks

Insufficient throughput may not justify separation into an SPV, and setup plus ongoing operational costs must be justified by perceived business advantages. For example, where the Council or its tenants are the main customers would the Council actually let the SPV fail (or is the limitation of liability illusory). 

SPVs may remain dependent on local authorities for essential assets, personnel, or services. 

Different governance arrangements require careful consideration, and establishing an SPV creates additional administrative burdens. 

Whoever is appointed to act as a director must understand the additional governance rules which are placed on them, via directors’ duties, and the need to understand the potential implications of non-compliance. 

The tax position may not be as efficient as direct delivery.
Subsidy control must be considered.

Finally, local authorities must consider reputational risks if problems arise.

Direct Delivery Advantages

The Council will maintain complete control, service delivery through existing employees and resources, no setup or operational costs. 

Direct delivery eliminates potential conflicts between the local authority and an SPV. When services are delivered through existing employees and resources, no external activity occurs, meaning there is no public contract award and therefore there is no procurement rule application.  

Direct Delivery Drawbacks

The Council will remain directly liable for the activities of the business. When and if they are procuring goods and services for the project the public procurement rules will appl.

Direct delivery is more susceptible to political leadership changes and may suffer from in-house team inexperience, potentially reducing risk appetite and commercial effectiveness.

Choice of Vehicle

SPVs can take various forms the common forms of which for authority ownership of heat networks are private companies limited by shares, companies limited by guarantee and limited liability partnerships. The choice between these will turn on the purpose of the vehicle and the powers being used. An LLP does not pay corporation tax and so can be attractive, notwithstanding that the Council will need to participate directly and through a wholly owned vehicle (as an LLP is required to have 2 members). 

Conclusion

Each of the possible approaches offers advantages and challenges and must be designed to meet specific project requirements, local authority capabilities, and risk tolerance.  

Recognising that a number of local authorities have already selected a delivery model and have, or are rolling out, heat network projects through those delivery models, whether under AZP or otherwise, we welcome the opportunity to discuss ways of preparing for the changes that heat network zoning, zone coordination and Local Government Reorganisation are likely to bring. Please do get in touch with our specialist heat network corporate advisory team to discuss existing or future delivery vehicles. 

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