Leisure wary
The impact of the Coronavirus Pandemic on public leisure centres has received national attention in the press. The latest lockdown of leisure facilities in November 2020 and the likely continuation of restrictions on leisure services as they once again re-open will have a huge impact on the revenues that are relied upon to provide community leisure centres, despite promises of government support. To add to an already complex situation, hundreds of leisure centres across the country are operated by private businesses and charitable trusts each with their own contracts and risk-sharing mechanisms in relation to the closures.
After more than seven months of restrictions imposed on the delivery of leisure services, and in the face of further enforced closures, this bulletin looks at the patterns that have emerged in response to the pandemic and at what the future may hold.
Changing Law and Change in Law
The fundamental challenge to both leisure operators and contracting authorities is how to manage the shortfall in revenues when legal restrictions prevent facilities from operating at full capacity (or indeed close them entirely). The first step has been to mitigate costs as far as possible by mothballing facilities and (in the case of private employers) furloughing staff. However with footfall reduced to zero, the costs of keeping closed facilities ticking over is not being covered. Further, once facilities re-open costs will continue to exceed revenues for some time due to low demand.
There is no obligation at law for contracting authorities to plug the gap in revenue for an outsourced contractor, as Procurement Policy Notes 02/20 and 04/20 confirmed. However, the longer term contracts typical in the leisure sector often have sophisticated provisions that allocate the risk (and cost) of certain changes in law to the contracting authority. The closure of leisure centres from April-July and during November by government regulations and any on-going operational restrictions imposed are being viewed (including by the Local Government Association and Sport England) as such a specific change in law.
Each contract is different and needs to be interpreted individually, but where the change in law risk is transferred to the contracting authority it can find itself balancing its many other budgetary pressures against a contractual obligation to make payments under change in law provisions. Even where the contract does not transfer the cost to the council, many are finding that providing financial support now is a more commercial approach than risking contractor default (and being forced to take the services back in-house). We have found that working with suppliers (as recommended by PPN 04/20) to identify specific and appropriate commercial solutions is key to fulfilling the contracting authority's duty to obtain value for money for its residents.
In such discussions, authorities need to be aware of all of the negotiation strategies available to them. These include:
- taking the contractor's performance in the three months leading up to lockdown and off-setting any deductions against any agreed settlement;
- asking for evidence on an open-book basis for actual costs incurred and revenue generated (if any) during lockdown and ensuring costs claimed are challenged and revenues are used to reduce support payments;
- keeping the matter continually under review, perhaps by agreeing to provide financial support on a monthly or quarterly basis and requesting reports each month on the continuing impact;
requiring that contractor profit is given up (as encouraged by PPN 02/20 and 04/20) while services remain offline and requesting evidence of this; - requiring contractors to make claims under business interruption insurance (if in place) and apply monies received to the contract if claims are successful;
- requiring contractors to make claims for available support (government, industry bodies, etc.);
- considering recovery of support sums paid through changes to surplus revenue sharing provisions should trading conditions improve in future; and
- agreeing a cap on overall support and working towards a fixed date when support will end.
We have seen that the best results have come from where contracting authorities and their leisure operators have worked together to agree the minimum support needed to keep facilities ticking over and documenting this in formal variations or side agreements. This has been the case even where Change in Law risk has not been allocated to the relevant local authority.
These arrangements have fostered strong working relationships and enabled centres to re-open at the earliest opportunity – providing much needed services to communities and starting the process of returning demand (and revenues) to normal levels. The alternative would be a costly legal battle over contractual interpretation and liabilities which neither provides value for money nor encourages reopening of facilities for residents.
Plan B
While joint working to maintain an outsourced contract will be appropriate for some authorities, the fact remains that others may not be in a position to do so for the long-term. Similarly, private operators may not be able to maintain some contracts with permanent reductions in the expected revenues. We are being asked by clients to look at the possible options for long term solutions, including:
- Re-baselining the financial model of the contract to acknowledge the permanent change to revenues. While likely to be more expensive for authorities, this provides certainty of the long term financial position and can remove further Change in Law risk;
- Insourcing of the services following termination of the contract (there are a number of possible termination routes depending on contractual terms including mutually agreed termination, voluntary termination, termination for insolvency, termination for breach and termination for force majeure);
- Quasi-insourcing of the services by transferring them to a council-owned Teckal company.
There is no one size fits all solution to this situation due to differences in councils' policy priorities, financial capabilities, resources to take back leisure service and contractual positions. Weighing up all of these factors in dialogue with leisure operators and documenting any agreed solution is, in our view, the most likely way to achieve value for money in addressing this unprecedented situation.
What's next?
Councils will have started their budget setting processes for the 2021-2022 financial year and a key part of that will be the level of support needed by their leisure services (whether in-house or outsourced). Even the most optimistic of forecasts through to the end of March 2021 are showing an operating deficit due to reduced footfall. In addition, as the pandemic drags on the expiry dates of many outsourced contracts are coming into view. So how should Councils approach their medium term decisions around leisure services?
The starting point is the acceptance that revenue reductions will make the operation of leisure centres more expensive in the medium term. This will be the case whether services are delivered in house or under contract. Budgets for next financial year will need to accommodate this or else difficult decisions around the provision of these services will need to be made. With the health benefits of leisure activities better known than ever – especially in the context of surviving Covid 19 – such decisions are likely to be politically fraught.
Where contracts are coming to an end, there may be the possibility to extend them. Either using terms already contained in the contract or under a permitted modification to the contract under Regulation 72 of the Public Contracts Regulations 2015.
In addition, we are starting to see the re-awakening of the competitive market for the procurement of leisure services after the initial shock brought on by the pandemic. Key to this is the acknowledgement that trading conditions are uncertain. Where Councils have allowed bidders to price based on a pass-through cost and/or risk sharing basis for the next two-to-three years, bidders are responding positively to invitations to tender. Therefore the signs for the sector are that something approaching normality could be on the (albeit distant!) horizon.
Trowers has a team of experts on public sector contracting – with particular experience in leisure – who would be happy to help with any queries.
