Knowing the limits of ring-fencing

As housing associations move into more commercial activities, it is a good piece of sound advice to try to ring-fence the risk in any such venture in a separate legal entity.

It has the effect of insulating the registered provider (RP) in the event of failure of the commercial venture in that, if appropriately structured, the RP’s legal liability should be limited to the amount that it has agreed to contribute.

But are there other factors, going perhaps beyond strictly legal points, that might mean that this liability may not in fact be limited in this way?

Attitude of boards

Have sufficiently robust discussions taken place at board around the possibility of a venture sponsored by the housing association becoming insolvent? 

There may be good reasons why insolvency may be the best option for a failing venture and a clear limit on the amount of investment that the board is prepared to make should be agreed at the outset and kept under regular review.  

This may not necessarily be the same as any legal limits on the RP’s obligations and should bear in mind any investment policy that the RP may have.

Reputational risk

Will a housing association wish to be associated with a venture that has failed? 

This may be a particular issue if the brand name given to the venture is obviously associated with the association. (This may be a reason to use a different brand or perhaps the brand of a joint venture partner). 

However, even if the brand is not linked in this way, publicly available information is likely to lead back from the failed venture to the housing association.  

Is the RP ready to deal with any adverse publicity?

Attitude of Regulator

This is a really difficult issue and pulls both ways. 

On the one hand, the regulator will want and indeed actively encourage RPs to mitigate their risk in this way. They will expect to see clear limits on the RP’s appetite to invest. 

However, the  Regulator could well take an interest in why a particular venture is going wrong and the steps that an RP may propose to take in response, which could include further investment.

This may especially be the case where there is a link back to social housing assets, for example where an RP has invested in a provider of services to its own housing stock and/or that of other RPs.

Charity law issues

Again an area which could be quite nuanced and will depend very much on the particular circumstances. Making further investments in a failing commercial business is likely to be a breach of charity law. 

The Charity Commission is very clear on this: ‘if the trading subsidiary starts to fail, the charity must not bail it out; this would be putting the charity’s funds at risk’. (The essential trustee: what you need to know, what you need to do (CC3))

But there may be circumstances where further investment over and above the RP’s legal obligation to do so could be justified, for example as a means of improving the overall return on investment.

Joint venture partners

Many RPs will carry on more commercial activities through a joint venture vehicle, which of itself should be a risk mitigant. 

Well-drafted joint venture documentation will set out clear limits on the RP’s obligations to invest of course, but the commercial reality may be that a joint venture party will expect further support as the venture progresses. 

There may also be wider relationships elsewhere with the same partner which could be put at risk by a failure to support one particular venture. 

Whether or not a joint venture partner would be prepared to invest further in any given scenario looks to be a key indicator of the merits (or otherwise) of the RP doing likewise.  

What about lenders?

Some loan agreements provide that significant adverse events, such as an insolvent liquidation, occurring in a subsidiary would be an event of default.  There are a number of points here:

(1)  try to make sure that these type of clauses are not included in the first place or, to the extent they are, try to agree that they would only count as events of default if this could lead to a “Material Adverse Change” or similar at borrower or (possibly) group level

(2) be aware and try to take account of the existence of these types of clause at the point of agreeing the terms of the original investment

(3) consider the relevant terms of all loan agreements if things start to go wrong – they could for example restrict an RP’s ability to invest further, even if it wanted to.

An answer?

An answer to all of these points looks to be around setting out clearly at the outset what the limits of an RP’s exposure should be in any particular case and to keep this question under review. 

This may be different from the strict legal liability position and needs to bear in mind the board’s own risk appetite as well as the views of key stakeholders, including the regulator, lenders and any joint venture parties.