School's construction contract void for lack of capacity

We look at a recent case which has provided helpful clarity in relation to a school’s capacity to enter contracts.

Case: School Facility Management Ltd and others v Governing Body of Christ the King College

What happened?

Christ the King College (the College), a maintained voluntary aided school sought to add a new sixth form block. It agreed a 15-year lease of a modular building with BOShire (BOS), a construction company which regularly operated and had expertise in the public sector. The contract involved payment of an initial premium followed by an annual rent. As part of the contract negotiation both the College and the local authority gave written confirmation that the College had power to enter into the lease.

Four years in, the College could no longer meet its financial commitments under the contract. The College claimed the contract was void as it was a finance lease, in essence borrowing for which Secretary of State consent was required, but which had not been obtained.  In turn, BOS sued for breach of contract, misrepresentation and unjust enrichment (more below).

What were the key points raised?

• Was this a finance lease (under which the College was borrowing) or an operational lease?
• Did the College act ultra vires by entering the lease, acting outside its powers?
• Was the College in breach of statutory measures which are there to prevent overspending? 
• Could BOS claim for misrepresentation and unjust enrichment if the College had improperly agreed the contract given the College's written confirmation that it has the requisite power and authority?

What did the Court find?

The Court held that the contract was a finance lease. Distinguishing it from an operational lease, a lease is likely to be a finance lease if:

• it has the same outcome as if the asset (here, a building) had instead been purchased and financed through a loan
• the lease term is for a significant part of the life of the asset in question even though ownership of the asset does not transfer
• the payments made at the beginning of the contract represent a significant portion of the asset value.

Given the nature of the lease, Secretary of State consent to the contract was required pursuant to the Education Act 2002. This was not obtained, and the College therefore did not have capacity to enter the contract, meaning it was void for all purposes.

However, the Court held that the College had acted unreasonably, as well as recklessly, in not ensuring it had the financial ability to meet its commitments under the contract. The College had ignored alternative, perhaps better value, quotes from contractors in preferring BOS.

BOS claimed that it had relied on the College's confirmation that it had the requisite power and authority. The Court made it clear that it was not for the College to assume an “advisory duty” on this specific question; it was for  BOS to rely on its own views and to take its own advice; BOS were in essence the experts. The Court also dismissed BOS’ claim for significant losses of £6.7m because they could not prove this loss. BOS did however enjoy a partially successful claim for unjust enrichment against the College, recognising that the College had received considerable value through its use of the building; the Court did require the College to make some payments to BOS.

What can schools, academies and colleges take from this case?

For maintained schools, borrowing by entering a finance lease will always require Secretary of State consent. Otherwise it is likely that arrangements will be declared as void.  

For academies, there are perhaps clearer safeguards automatically put in place on conversion by way of the Department for Education model funding and commercial transfer agreements. The requirement to obtain Secretary of State consent when borrowing is further reinforced in the Academies Handbook.

Schools may want to look at both current and historic borrowing arrangements, such as photocopying and ICT system contracts, to check if they are pure finance leases and in turn, their validity.