Reclassification of Colleges - an important change which will have far reaching consequences

On 29 November 2022 the Office for National Statistics (“ONS”) reclassified further education corporations, sixth form college corporations and designated institutions in England (“Colleges”) as part of the central government. This means that colleges and their subsidiaries are now subject to the framework for financial management set out in Managing Public Money (“MPM”). In development is a new Colleges’ Financial Handbook which is due to be published in March 2024 with implementation from August 2024.

Sector concerns

Despite the support announced by the DfE so far to help colleges transition from the private sector back to the public sector, such as £300m being brought forward before the end of this current financial year and providing an additional £150m in capital grant funding in 2023-2024, many concerns within the sector have yet to be addressed. Fears remain within the sector in relation to over-regulation and a move toward colleges being seen as large academies despite their crucial differences.

The DfE has not yet decided to act as Local Government Pension Scheme guarantor for colleges as they currently do for schools, nor have they announced or confirmed any provision for capital funding to compensate for borrowing restrictions to help colleges save energy. It seems unlikely that future energy support will be available for public bodies. At present, the VAT regime for colleges also remains unchanged.

While the DfE says that day-to-day operations will continue with minimal changes, and the DfE’s approach to the transition is a collaborative one, there are a number of changes now that colleges are subject to MPM that mean colleges will find themselves facing new red tape.

Immediate changes and considerations needed

Management of surpluses

The DfE and the ESFA recognise that colleges can experience good years and bad years financially and not placing a limit on retention allows colleges to engage in long term financial planning and smooth out the peaks and troughs between years. Colleges will, therefore, be able to carry forward any surpluses (including any unspent grants) at year end without limit, including for investment in capital assets, despite now being subject to MPM – a likely source of relief for the sector.

Asset disposals

Currently colleges are able to dispose of fixed assets without approval and keep the proceeds from disposals without approval. While it has been confirmed that this will remain in place, colleges will now be required to ring-fence proceeds from asset disposals for reinvestment in capital assets and will not be able to use the proceeds towards other projects.

This will remain the approach at least until the end of the current spending review period (31 March 2025).

Senior pay controls

Colleges now fall within the scope of HMT’s senior pay controls, allowing the government to ensure that senior pay is set at an ‘appropriate level’.

For new appointments, the Chief Secretary to the Treasury must approve remuneration when an appointment will attract:

• total remuneration at or above £150,000 (or pro-rata equivalent for part-time staff); or
• performance related pay (i.e. bonus) arrangements exceeding £17,500.

DfE has confirmed that more detailed advice on this will be coming shortly. From 1 February 2023, colleges should submit applications for pay approvals in time for implementation from 1 May 2023.

Special severance payments

Colleges will now need to follow HMT’s guidance on Public Sector Exit Payments. MPM’s position is that special severance payments do not normally provide good value for money or offer fairness to taxpayers and should therefore only be considered in exceptional circumstances. MPM prevents, without HMT authorisation, the payment of non-contractual sums to employees or ex-employees as these are usually novel, contentious and potentially repercussive. Colleges will therefore need to refrain from entering into legally binding agreements before obtaining approval (subject to the below delegated authority).

This will restrict the ability of colleges either to settle litigation, or seek to enter into settlement agreements ahead of potential litigation on a commercial basis. The additional management time spent by colleges on either resolving difficult employment issues, if that is possible, or defending litigation where it is not, and where DfE/HMT approval for a settlement is not granted (having followed the prescriptive approvals process), is unlikely to be welcomed.

Colleges will however have delegated authority to make special severance payments, provided any non-statutory/non-contractual element is under £50k or under three months’ salary, whichever is the lower. Beyond this, DfE approval will be required. Any proposed payments of any value that are linked to a non-disclosure agreement will also require DfE approval. Where supported, DfE will then refer such payments to HMT for final consent.

Colleges must obtain prior DfE approval before making a special severance payment where:

• An exit package which includes a special severance payment is at, or above, £50,000 or three months’ salary (whichever is lower), and/or
• The employee earns over £150,000.

Special severance payments are likely to include the following types of payment:

• Payments reached under a settlement agreement;
• Any special leave, including gardening leave;
• Any honorarium payments or gifts;
• Any hardship payments;
• Compensation in lieu of notice;
• Payments agreed as part of a judicial or non-judicial mediation.

Depending on the terms of the individual’s contract, relevant statutory provisions, any non-statutory applicable schemes and other relevant terms and conditions, pay in lieu of notice may also be considered a special severance payment.

Compensation

Colleges will need to base any decision to award compensation on careful appraisal, including seeking legal advice where relevant, and ensure value for money. Colleges will have delegated authority to approve individual payments provided any non-statutory/non-contractual element is under £50k. Where the compensation payment would be £50k or more, colleges must seek approval from the DfE.

Ex gratia payments

All ex gratia payments, which include payments to meet hardship caused by official failure or delay, and to avoid legal action due to official inadequacy, must now always be referred to the DfE for prior approval. Unlike with compensation payments, colleges will have no delegated authority to make ex gratia payments. In circumstances where colleges believe an ex gratia payment should be made, this should be referred to the DfE before entering into any agreement to pay.

Write-offs

Colleges will be able to write off sums where the individual loss/write-off does not exceed 1% of annual income or £45k individually (whichever is smaller), or 5% of annual income cumulatively up to a ceiling of £250k.

Novel, contentious and repercussive transactions

Colleges will be required to seek DfE consent in relation to novel transactions, which are any transactions where the college has ‘no experience’ or are ‘outside of its range of normal business’. DfE have not yet issued guidance or criteria for assessing consent, but Colleges will now likely require consent for an array of transactions such as mergers, joint ventures and acquisitions.

Colleges will also require DfE consent for any transactions that might cause criticism by Parliament, the public or media (contentious transactions) and those transactions that may have a knock-on effect throughout the sector and cause other colleges to take similar approaches (repercussive transactions).

Future borrowing

Going forward, colleges will only be able to borrow from private sector sources if the transaction delivers better value for money, which is often unlikely to be the case. This could make it more difficult for colleges to secure grants from Levelling Up schemes, the OfS, Salix, UK Infrastructure Bank or others who require matched funding. When considering projects going forward, colleges will need to keep an eye on what government funding is available. With private borrowing typically off the table, it may be difficult to find a funding stream for certain projects (even where those projects are part of the government’s plans for skills and levelling up). Depending on available funding and further DfE guidance, this may become a sore point of contention for the sector as they try to balance reclassification with the obligations placed upon it.

Existing borrowing

No consent is needed for existing debt balances up to 29 November 2022. Colleges can continue to pay such debts under the agreement terms to maturity. It is expected that colleges will ensure that any balances on variable type facilities (overdrafts and revolving credit facilities) are worked down to nil or repaid in full at the maturity of the facilities. Any additional usage of existing overdrafts, RCFs or drawdowns, will require consent and be limited to essential operational needs. Consent will only be granted for a limited time.

For term loans with balloon payments at maturity, if the loan cannot be refinanced by a commercial lender in compliance with MPM and the college does not have sufficient reserves to pay in full, the DfE will consider a request for financial assistance in the form of a repayable loan. Requests for financial assistance must be made at least six months before maturity or immediately for loans maturing up to 31 May 2023—if your college has yet to put in a request if required, this should be done as soon as possible.

Commercial operations and subsidiaries

Colleges will remain free to conduct commercial operations, including through subsidiary companies, and will continue to be able to set up subsidiaries without DfE approval (unless the purpose of the subsidiary is novel, contentious or repercussive). All subsidiaries will also be subject to MPM controls and the DfE has confirmed that guidance for the sector on commercial operations and subsidiaries following classification will be coming.

Indemnities

Indemnity clauses in commercial contracts arising in the normal course of business will not be restricted and DfE consent will not be required.

For any indemnities beyond the normal course of business, guarantees and letters of comfort in excess of 1% of annual income or £45k (whichever is smaller), or 5% of annual income cumulatively subject to a ceiling of £250k, DfE consent will be required.

Finance leases

Colleges’ ability to continue with existing finance leasing and enter into new ones is unchanged.

Insurance

DfE is currently exploring an alternative to commercial insurance for colleges, as commercial insurance generally does not provide better value for money for the taxpayer. For the time being, colleges can continue with their existing insurance arrangements and the DfE has confirmed that colleges can continue to renew or take out new commercial insurance.

In summary

Incoming guidance will no doubt be welcome as the sector transitions following reclassification, as many of the longer term details remain unknown or unclear at this time. The collaborative approach taken by the DfE will hopefully ease some of teething issues the sector will face in the immediate future, but please do not hesitate to contact us for a further discussion about your college’s specific circumstances.