Relentless Focus on Good Governance in Academies Continues

Good Governance in Academies is Key Focus for DfE

Over the Summer the Department for Education quietly published some documents which show the focus on good governance in academies remains a key priority. The first document was the widely expected new edition of the Academies Financial Handbook which applies from 1 September. Secondly, the Education and Skills Funding Agency (the new name for the EFA) published three financial management and governance reviews into multi academy trusts. These highlight case studies of where things can go wrong. In case you missed them, here we summarise the key points to be aware of.

Academies Financial Handbook

It is a requirement of all Academy Trusts’ Funding Agreements that the Academies Financial Handbook (’AFH’) is complied with, in particular the list of ‘must haves’ in Annex C. The new AFH applies as from 1 September 2017. The main changes in this new edition concern governance and financial control.

Governance

  • There is an emphasis on greater clarity about the roles of members, trustees and salaried employees

There must be clear separation between the roles of member, trustees and executive (paid) managers. For example, employees of the Trust must not be appointed as members, unless permitted by the Articles of Association. The current model articles do not allow members to be employees, but some older versions do. Trusts with older articles may wish to consider revising their articles to reflect best practice.

In addition, the DfE’s preference is that no other employees, other than the Senior Executive Leader, should serve as a trustee. This helps to ensure there are clear lines of accountability through the Senior Executive Leader. Older Articles may talk about no more than one third of trustees being employees. Again, Trusts may wish to adopt this change in line with best practice.

  • Trusts are reminded that the overarching seven Nolan principles of public life apply to everyone holding office in an Academy trust (selflessness, integrity, objectivity, accountability, openness, honesty and leadership).
  • Annual letters to Trusts’ Accounting Officers/CEOs from the ESFA’s accounting officer must be discussed by the Board and appropriate action taken

The ESFA sends letters to Trusts’ Accounting Officers/CEOs from time to time which cover issues pertinent to their role and ESFA reviews. The letter must now be shared with members, trustees, Chief Financial Officer and other members of the senior leadership team. It must be discussed by the Board of trustees.  This discussion should be clearly documented in the Trust board minutes. All “Dear Accounting Officer” letters can be found on the DfE website here.

  • Improving efficiency and value for money in academy trusts

Where the ESFA have concerns about a Trust’s financial management, but not enough to issue a Financial Notice to Improve (FNtI), they may require the Trust to work with an expert in school financial health and efficiency to support the Trust and identify where improvements can be made. They may also prescribe this as a condition of a FNtI.

  • There is an emphasis on the importance of addressing skills gaps on the Board at key transition points such as growth periods. Trusts are recommended to use the DfE’s competency framework for governance to determine skills gaps in the Board (see more here)
  • Trusts should consider the key features of effective governance in the DfE’s Governance Handbook when assessing their effectiveness

Boards should be looking to implement these as part of their annual assessment of their effectiveness and skill-set, as well as minuting these discussions.

  • Edubase must be kept up to date with details of changes to Trustees and members within 14 days

Recent ESFA reports have highlighted that some Trusts are not keeping their records up to date of who are members and trustees promptly following either appointments or resignations. This applies to both Edubase and Companies House records. Someone should be given specific responsibility to complete this task, usually the Company Secretary.

  • Appointment of auditors must be approved by the members, not just the trustees

The Board of trustees may believe they are responsible for the appointment of auditors. However, this is only the case where the Companies Act permits trustees to appoint them e.g. in the Trust’s first accounting period. Thereafter the members must approve the appointment, usually at an AGM.

Financial Control

  • a new section on executive pay states that Boards must ensure their decisions on levels of pay follow a robust evidence-based process and reflect the roles and responsibilities of individuals

The decisions should be backed up with supporting evidence and secure records kept–such as confidential appendices to minutes.

  • ‘Repercussive transactions’ as well as ‘novel or contentious transactions’ now require ESFA approval

Repercussive transactions are those which are likely to cause pressure on other trusts to take a similar approach and hence have wider financial implications for the academies sector.

  • Clarification that the non-statutory/non-contractual element of a severance payment limit of £50,000 is based on the gross amount before any deductions for tax etc.

This is a welcome technical clarification. The full new Handbook can be viewed here.

Financial Management and Governance Reviews

The ESFA can initiate a Financial Management and Governance review at an academy trust following a complaint, or on its own initiative, either at random or as part of its new routine assurance activities. There have been 25 such reviews conducted since 2013. The typical remit of a review is:

  • to assess the financial controls and management in a Trust to see if they are compliant with the AFH and Funding Agreement
  • to assess the adequacy and effectiveness of governance, risk management and internal controls
  • to assess propriety, regularity and value for money

The ESFA’s policy is to publish their findings to inform public debate and scrutiny. The academy trust is usually given 5 working days to comment on the report before it is published. Three such reports were published over the Summer.

The first review concerns the DRB Ignite MAT. The review was instigated following a complaint about a leasing arrangement for whiteboards at one of their schools. However, the remit soon expanded to cover scrutiny of wider governance arrangements in the MAT.  The key findings of the review were:

  • There was a lack of separation of the roles of members, trustees and executive managers. The Accounting officer was a member as well as being a director. The Accounting Officer was not on the Trust’s payroll and the role had rotated among the directors three times. There was no written agreement in place setting out the role and responsibilities of the Accounting officer – in breach of the Academies Financial Handbook. The AFH requires that the role be allocated to a Single Executive Leader, who is accountable for the use of public money. The CFO role was contracted out to another group company and the Trust board did not have any independent directors with accountancy experience or qualifications. This created a risk of inadequate oversight and challenge. The named member of the trust was a company which had since become dormant, thereby breaching the Articles of Association.
  • The trust was using related commercial companies and connected parties to provide 83% of its central functions and expenditure without following a proper procurement process. Remember that delivery of services by related parties can only be ‘at cost’ (see below) and a contract for services or goods may need to advertised and comply with EU procurement rules if over a threshold of £164,176 (unless it can be argued that by their nature the services fall under the Light Touch Regime in which case a higher threshold of £589,148 may apply). The ESFA was not satisfied that adequate procedures were in place to manage conflicts of interest between the Trust and connected companies. The same people sat on the Trust board and the boards of group companies providing the services. Directors were approving invoices from their own group companies for payment. This was potentially a breach of Companies Act duties and charity law, as well as the AFH.
  • The award of a contract for smartboards at one of the trust’s primary schools to a group company did not follow best practice and could not demonstrate value for money
  • The trust had failed to keep EduBase updated with details of members and trustees within 14 days.
  • There was no central of register of contracts, making it difficult to coordinate the re-tendering to drive value for money
  • There was a failure to publish details of business and pecuniary interests of trustees on the website and failure to keep adequate minutes of trustee meetings.

The Trust was ordered to undertake a review of its governance arrangements and carry out urgent corrective actions.

The second review was published on 28 June and concerned the Rodillian MAT. The investigation was triggered by complaints about the Accounting Officer staying at a luxury hotel several nights a week, despite living within travelling distance of the schools. The review quickly broadened in scope and found other issues which are documented in the ESFA report:

  • The Accounting Officer had been reimbursed for hotel accommodation – although there was no policy on approved subsistence and travel in place to measure the reasonableness of this and no evidence of Board approval for the expenditure
  • The trust had rented a flat for the Accounting Officer – although the benefit was not documented – this should have been regarded as a novel or contentious payment and ‘ex gratia’ benefit for which ESFA approval was required
  • The Trust had awarded a contract worth £1.45m for alternative education for students excluded from mainstream provision without following a competitive tendering procedure. Although the contract was for 5 years, the liability in the accounts was only shown as a 3 year commitment.
  • The Trust did not have an up to date financial procedures manual in place
  • There were no proper procedures for authorising payments to suppliers
  • The Trust had entered into supposed ‘operating leases’ of smart boards which were in fact ‘finance leases’ (which require prior approval from ESFA).
  • The Trust Chair was paid for consultancy services – as the Chair was also a member this is not allowed and would have required prior consent from the Charity Commission.

The third review concerned Enquire Learning Trust. According to the report, similar themes came to light:

  • Senior managers were employed ‘off payroll’ through limited companies
  • There was lack of skills and oversight of managers by the Trust Board
  • The role and responsibilities of the Accounting Officer were not documented in a contract
  • The financial reports presented to the board were inadequate and did not give trustees a picture of the overall consolidated financial position of the trust. There was no 3-5 year consolidated forecast.
  • Two significant related party transactions in 2015/16 were not disclosed
  • Financial controls over purchasing, including the use of corporate credit cards were inadequate. The lack of segregation of duties and independent oversight of purchasing and payment arrangements increased the risk of inappropriate expenditure.
  • Trust officers had claimed irregular payments for valuations of trust premises in connection with a scheme to transfer the Trust premises into their personal pension funds and lease it back to the Trust
  • There was no central asset register to keep track of valuable items such as laptops issued to staff
  • There was no audit committee or independent Responsible Officer to carry out assurance checks

Lessons to be learned

A complaint can be triggered by a disgruntled employee or governor – once the process starts it can be very resource intensive to manage and the scope of the inquiry can quickly widen.

  • Understanding the separation of roles between members, trustees and executive managers is absolutely critical. A clear Scheme of Delegation, Code of Conduct, policies and procedures are your first line of defence in demonstrating compliance. Be clear about who your members are and keep the register up to date so it is clear who actually holds the voting rights. Make sure they are involved in relevant key decisions and due process is followed.
  • Remember the ‘at cost’ requirement if awarding contracts to a ‘connected party’. An individual or company can supply good and/or services up to £2,500, cumulatively, in any financial year which can include profit; however, beyond £2,500, all transactions must be ‘at cost’ without profit. Where ‘at cost’ is triggered, a statement of assurance is required from the supplier to support the arrangement, which the Accounting Officer must review to ensure that there are no issues with the transaction. ‘Connected parties’ include members, trustees, sponsors (as well as their family members and business associates).
  • Develop a set of Standing Orders and Financial Regulations which set out the requirements for obtaining competitive quotes, authorisations for expenditure, delegated limits and the limited circumstances in which this can be waived. Remember that contracts with a value in excess of £164,176 may be subject to EU competitive tendering rules.
  • Be very careful about awarding contracts to ‘connected parties’. These will almost always be spotted during the external audit and will be flagged up in your annual accounts attracting further scrutiny. The Articles of Association will usually set out the process which must be followed to properly authorise such a transaction – any trustees with an interest in the contract must declare this and must withdraw from the meeting.
  • Develop a set of policies on subsistence and accommodation expenses, gifts and hospitality so that everyone knows where the boundaries are.
  • “Off payroll arrangements” – whilst there may be the odd time such arrangement is appropriate, for standard roles payments should be on-payroll, which also helps ensure that the individual is meeting their tax obligations.
  • Make sure that novel and contentious issues go to the Board for discussion and that decisions and the justification for them are properly minuted.
  • Understand the difference between finance leases and operating leases . Under an operating lease all risks and rewards related to asset ownership remain with the lessor for the leased asset. In this type of lease, the asset is returned by the lessee after using it for lease term agreed upon. The ownership of the asset remains with the lessor. However, under a finance lease the risks and rewards related to ownership of asset leased are transferred to the lessee. The lessee usually has an option to acquire ownership at the end of the lease by making a further payment. In accounting terms, this is usually treated like a loan.
  • If these Trusts had had an effective Audit Committee providing oversight and challenge, these situations could probably have been avoided. As one review commented: “Audit Committee functions should be established in such a way as to achieve internal scrutiny that delivers objective and independent assurance. Where the Responsible Officer function is provided by [a group company] it cannot be shown to be independent and hence is in breach of the Academies Financial Handbook”. See more on the role of an Audit Committee.
  • It is always good practice to take a step back before entering into any unusual transactions and consider the wider implications. Could this transaction attract adverse media coverage? Is it outside our normal business activity? If we enter into the transaction and another academy trust hears of this, will it impact upon the wider sector? Whilst this  comes down to judgement and perception, it may be safest to consult with ESFA before performing the transaction rather than being criticised later for making the wrong decision.
  • Consider undertaking a governance review facilitated by an external provider to check your house is in order and that you are following best practice. We offer a fixed price service GovernanceCHECK360.

 

Mark Johnson is an independent solicitor and chartered company secretary helping academy trusts, schools, colleges and not for profits to stay compliant, manage risks and plan for success. Contact us today for a no-obligation chat or check out our website at elderflowerlegal.co.uk or call 01625 260577.  Find out for more details of our service packages here.
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The Rights and Responsibilities of Members

What is the Role of Members in Ensuring Good Governance?

In a limited liability corporation, as well as unincorporated associations, the members can play an important constitutional role, acting as a check and balance on the powers of the board. Unfortunately, the rights and responsibilities of members are often misunderstood.

In our work with companies, social enterprises and charities, we find there is often confusion or a lack of clarity about the precise role of the members. But the relationship and balance of power between the board of directors/ trustees and the wider members of an organisation is really a vital fulcrum at the heart of the system of governance for any enterprise. In this piece, I attempt to explain and demystify the position.

Who are the members?

‘Members’ here are the persons who have a form of relationship with the organisation that enables them to exercise some right or power in relation to it. The nature of that relationship will vary for different organisations, depending on the way they are constituted and, specifically, what the constitution says about membership rights.

In a profit-making company, the position is usually clear-cut. The members are the shareholders who have invested their capital in the enterprise in return for certain rights (e.g. sharing in profits and voting on key decisions). However, in non-profit distributing organisations, the position can be more complex. In a company limited by guarantee, there will be no shareholders, but instead there are members who pledge to contribute a nominal sum (usually £1 or £10) if the company is wound up and unable to pay its debts. In the case of charities or unincorporated associations, there may be various types of member who expect to have some say or involvement in the way the organisation is run – these might include beneficiaries and service users, supporters who pay subscriptions or volunteer their time. The constitution may talk about full members, associate members, and supporter members, for example.

The power of members depends on the precise structure and wording of the governing document. At one end of the spectrum is the ‘oligarchical model’ where the members are the same people as the directors/ trustees. These people have absolute discretion to control the organisation. (Many academy trusts have historically been set up using this model, but the Department for Education has recently encouraged schools to appoint a wider group of members who can ultimately hold the board to account). At the other end of the spectrum is a wide membership model, where the members can exercise oversight and control over the board. The members may act as custodians of a particular ethos or values and may take action, if they feel the board is not acting in the best interests of the organisation. There are also hybrid models in between, where members enjoy certain limited rights, such as the right to attend the AGM, receive information or have privileged rights of access to facilities, but no legal right to control any aspect of the organisation’s governance.

Rights of members

The typical rights that members enjoy, either in the constitution or under relevant statute law, include the following:

  • to appoint and dismiss the whole board or individual board members
  • to change the organisation’s constitution
  • to wind up the organisation and distribute the remaining surplus after settling the liabilities (unless there is an ‘asset lock’ in place to prevent this, as with a community interest company or charity).
  • in a private enterprise, the shareholders expect a financial return on their investment, usually in the form of a dividend and/or a capital gain. However, shareholders cannot force the company to declare a dividend. Capital gain is achieved by allowing membership rights (shares) to be transferable (which is usually not allowed in not-for-profit corporations).

The members exercise these rights by calling a general meeting. The organisation’s constitution will lay down the conditions for calling a valid meeting and passing valid decisions (such as the minimum notice, quorum and required majority to pass resolutions). For example, a resolution to change the constitution usually requires a special resolution, which may require a 75% majority. Remember though, that may be 75% of those present at the meeting, rather than the whole membership. So in an organisation with say 500 members, the constitution might state that a valid quorum for a general meeting to proceed is 10% of the membership (i.e. 50 members). To pass a special resolution would require only 38 of those present to vote in favour. For that reason, some organisations choose to set the bar higher for fundamental changes. Sometimes the constitution may permit a decision of members to be made by circulating a written resolution for signature by a minimum percentage of members, rather than calling a meeting.

The constitution forms the basis of a contract between the organisation and its members, and between the members themselves: as such, it can be enforced by the courts. Proper running of general meetings is important: if the organisation is prospering, the members may leave the board alone to run the organisation. However, once problems and disagreements arise, then members may start to flex their muscles. If notice and quorum requirements are ignored, there is a risk that resolutions and decisions reached can be struck down as invalid, which could entail significant costs and embarrassment to unwind the situation.

If the organisation is a company (limited by shares, guarantee, or a community interest company) the Companies Acts also provide certain minimum statutory rights. These include the following rights:

  • to receive notice of, attend, ask questions of the board and vote at general meetings; to inspect minutes of the same and request copies.
  • to appoint a proxy to attend, speak and vote at general meetings if the appointor cannot attend.
  • to requisition a general meeting and to require that a resolution be put to the meeting (if the support of 5% of the members can be achieved). The members can also require the company to circulate a statement of up to 1000 words to other members. If the directors fail or refuse to call the meeting within 28 days, the members can proceed to call the meeting themselves and the costs of doing so are deducted from the directors’ remuneration! (Sections 303-305, 292-295 Companies Act)
  • to propose a resolution (with special notice) to dismiss a director
  • to be provided with a copy of the Articles of Association
  • to receive a copy of the annual accounts
  • to inspect the company’s register of members and other statutory books
  • to inspect copies of directors’ service contracts
  • to appoint and remove auditors or require the company to obtain an audit of its accounts, if it would otherwise be exempt
  • to bring a ‘derivative claim’ in the name of the company against directors or a third party for default or breach of duty
  • to bring an ‘unfair prejudice’ petition to request the court to intervene in the company’s affairs.

Under company law, the definitive test of whether someone is a member is whether their name has been entered into the register of members. Many companies, especially companies limited by guarantee, can be quite lax in keeping this up to date – which can cause problems later. By contrast, the new Charitable Incorporated Organisation set up under the Charities Act 2011 is obliged to keep a register of members and to keep it up to date.

Duties of members

Members also have certain duties, again depending on what the constitution says. Typically, they will be required to:

  • Contribute the agreed sum for their shares if not already paid, or for a guarantee company the nominal contribution of £1 or £10.
  • Sometimes members are required to pay a recurring annual subscription towards the running costs of an organisation, in addition to their upfront capital contribution.
  • Interestingly, the Charitable Incorporated Organisation specifically requires that members are obliged ‘to exercise their powers in good faith in a way which would be most likely to further the purposes of the CIO’. No such explicit rule applies to other types of legal format, however.

Stakeholder members

Sometimes organisations have corporate members such as local authorities, public bodies or other charities who have some interest in what the organisation does. The stakeholder member may often appoint an individual to act as its authorised representative. Sometimes they may have right to nominate, or even directly appoint, a board member. Problems can often arise where this representative (who may be an employee or officer of the authority) wishes to give priority to his appointor’s interests over those of the organisation. If the representative sits on the board, they will usually be obliged to put the interests of that organisation first and exercise independent judgment, rather than being fettered by their appointor. They are allowed to consult with their appointing organisation, however. A possible solution might be to limit the role of the authorised representative to that of observer – with a right to attend and speak at board meetings, but no voting rights.

Problems for not-for-profits

The Charity Commission looked in detail at membership issues after analysis showed that more casework was opened for internal disputes in membership charities than any other type. Their report found that there were clear benefits from membership structures, including enhancing the board’s transparency and accountability, providing better understanding of the needs of beneficiaries, improving the charity’s advocacy role, providing better fundraising opportunities and access to a source of new trustees. However, the most common reasons for problems were:

  • Trustees are often not clear about their role and their responsibility to the members
  • Members were not clear about their rights and responsibilities
  • There were insufficient or inadequate governance structures in place to manage the relationship with members
  • The board puts up barriers to member involvement either deliberately or inadvertently
  • The membership lacks diversity, so the board is change resistant and self-perpetuating group
  • The board deliberately or carelessly disregards proper procedures for calling valid meetings and passing resolutions, leading to disputes.
  • Weak administrative arrangements lead to problems such as invalid elections held on the basis of inaccurate membership lists or inquorate meetings.

How to manage the relationship with members

The following best practice tips could help your organisation to avoid problems:

  • Keep membership registers and contact details up to date – get specific written approval from members to communicate with them via email to keep costs down.
  • Include a provision in the constitution that if the member fails to keep the organisation informed of their current contact details, they forfeit their rights. A practical illustration of this problem is recent attempts by football clubs to move to a community membership model, only to be hampered by the need to trace and obtain approval from numerous shareholder members whose whereabouts are unknown.
  • The constitution should clearly set out the mechanics for a person to become a member, to leave or to be expelled (subject to a right of appeal). The board may usefully have an explicit power to determine conclusively whether a person is a member, if the position is uncertain.
  • Ideally, the detailed mechanics about categories of members and relevant criteria could be set out in a set of standing orders, regulations or a handbook, which can be amended from time to time without the need to pass a resolution to change the whole constitution.
  • New board members should receive an explanation about the various categories of member and their rights, as part of their induction.
  • The organisation should communicate regularly with its members to inform then about developments and keep them engaged.
  • Consider including specific mechanics to resolve disputes involving members without recourse to the courts, such as mediation or expert determination. Judges are reluctant to interfere in the internal workings of membership organisations and have been scathing about the dissipation of funds to pursue litigation relating to internal disputes.

Members can be a vital, but often a missing piece of the jigsaw, in a system of sound governance. Ignore them at your peril. Organisations as diverse as NHS Foundation Trusts, Network Rail and cooperative schools and academies have all sought the benefits of giving wider stakeholders a say in the running of their organisation. The move to create more mutuals for public service delivery, employee-owned organisations and growing interest in community share issues (where member investors contribute start-up capital) will increasingly throw the spotlight on an organisation’s relationship with its members.  The board should have a clear understanding of the role and rights of these members and the constitution should be kept up to date so that it is fit for purpose. Both the Chair and the company secretary can play an important role in ensuring harmonious relations with members and keeping them informed and engaged.

Mark Johnson is an experienced solicitor and company secretary helping SME businesses, charities, social enterprises to manage risk, ensure good governance and protect their legal position. elderflowerlegal.co.uk
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