1. Procurement & appointment of Natural Retreats (2013-2014)
1.1 The Cairngorm mountain funicular railway came into operations in 2001 and was operated by Cairngorm Mountain Limited. The operating company entered into financial difficulties and HIE provided a range of support until, in 2008, the decision was made to bring the company into public ownership, recognising the importance of the Cairngorm Mountain to the local and regional economy. HIE's position, stated to the Parliamentary Audit Committee in 2010, was that it did not envisage itself as the most appropriate owner of the operating company. Nevertheless, as owner and custodian of the mountain and resort, HIE was responsible for ensuring appropriate long-term operating arrangements were in place. To this end, in 2011, HIE appointed [REDACTED] as advisers to carry out a market sounding in order to ascertain appropriate next steps for the ultimate re-privatisation of the company. This was a broad-based exercise which involved the consultation of a wide range of potential operators with a wide range of business models. In 2012, [REDACTED] undertook an options appraisal on behalf of HIE to assess the preferred way forward for the operations of Cairngorm Mountain resort. In April 2012 the HIE Board approved the preferred option which was the "award of an exclusive Licence Agreement to an external operator to operate and develop the Cairngorm Mountain resort" and the procurement process commenced shortly afterwards. The operating period was intended to be 25 years.
1.2 HIE ran the procurement as a competitive dialogue process in order to allow for the broadest possible discussion of all risks and to ensure to accommodate the consideration of alternative business models.
1.3 HIE were supported throughout the competitive dialogue by financial and commercial advisers [REDACTED] and legal advisers [REDACTED] (subcontracting to [REDACTED]). Our review of documents provided by HIE indicates that an appropriate level of due diligence was undertaken by HIE officers and their advisers and that the process was run in line with good procurement practice. Following competitive dialogue, Natural Retreats was appointed as the preferred bidder by the HIE board on the 12th of February 2014, with contract award (approved by the Chief Executive) following on the 19th of March 2014. Natural Retreats were the highest scoring bidder across all categories evaluated, being:
- Maintenance and Investment;
- Transition Plans;
- Legal; and
1.4 Please refer to Annex B for a summary of the transaction structure and Annex C for the group structure of Natural Retreats. The key parties for the purposes of this report are:
- Natural Assets Investments Limited (NAIL) – investment company
- Natural Retreats UK Limited (NRUL) – management company
- [REDACTED] – investor.
We use Natural Retreats to refer to these entities/individuals, and those referred to in Annexes B and C, collectively.
1.5 HIE's advisers [REDACTED] noted the following significant financial risk at final tender stage:
"[the] company and NAIL and its subsidiaries are fully reliant on the support of [REDACTED] to continue operations. The ability of the group to continue is therefore fully contingent on the ability and intention of [REDACTED] to fund these businesses"
This is a risk because where there is significant reliance on one individual then, by necessity, the company is more open to external shocks and changing business objectives.
1.6 A board paper notes that Natural Retreats initially failed the financial standing tests at final tender stage by scoring beneath the minimum threshold agreed. Assuming this was a pass/fail test and no further moderation to the scoring had been applied then this would have disqualified them from the tender. However, the procurement route allowed a "qualitative moderation" of the financial standing test, which HIE applied in effectively treating the company's shareholder loans as equity following additional declarations and clarifications from the bidder. The potential for the score derived from the minimum financial standing threshold test to be amended to reflect the "qualitative moderation" process was explicitly provided for in the tender documentation. This moderation is normal practice in procurement and does not then preclude the bid so long as it is supported by sound reasoning. The result of this moderation was that Natural Retreats passed the financial standing test and ultimately won the tender (it should be noted that Natural Retreats was still the highest scoring bidder across each category of assessment at this point).
1.7 HIE's advisers noted the following options which could be considered in order to mitigate this financial standing risk:
- Conversion of loans to equity;
- Failing to achieve this, a parent company guarantee and/or personal guarantee should be put in place; and
- A performance bond should be put in place.
1.8 HIE ultimately obtained the additional following assurances and security in order to mitigate the financial standing risk including:
- An assessment of the main investor's assets as a High Net Worth Individual;
- A letter of comfort from the main investor;
- Due diligence on the wider business plan by Natural Retreats supported the assessment that they had sufficient resources available to deliver on their investment proposals. This included access to capital.
- Further due diligence by [REDACTED] on the nature of the intercompany loans and their ability/and likelihood to be called upon by the main investor, including extension of the repayment terms of NAIL's shareholder loans;
- A parent company guarantee; and
- A shareholder guarantee from the main investor.
1.9 HIE's advisers stated that the security package obtained "represent[s] a favourable outcome from the negotiations to date and offer HIE an acceptable level of protection from risk during the crucial first 5 years of operation".
1.11 HIE's board ultimately agreed that the "qualitative moderation" to the financial standing test was appropriate, having achieved these additional assurances. The papers presented to the board detailed the considerations around the financial standing and the mitigations obtained by HIE and the recommendation to accept Natural Retreats as preferred bidder was accepted by the board. The papers asked that the board consider that the moderation to the financial standing scoring remained appropriate and it would be reasonable to expect that the rationale to this decision would be documented given the judgement applied and the reliance ultimately taken from the letter of comfort.
1.12 Given the potential adverse impact on public finances of any contractor failure, SG finance officials enquired of HIE as to whether this financial standing risk informed how they subsequently engaged with Natural Retreats throughout the operational period. We could not find evidence that any additional handling plan to monitor the additional measures put in place (as noted at paragraph 1.8) and the ongoing financial standing of the contracting entity was put in place, although "key account monitoring" was highlighted in a board paper. It is reasonable to expect that such a handling plan would consider ongoing monitoring of the financial standing of the contractor and regular reviews of the appropriateness and value to HIE of the guarantees in place. This is not to suggest, however, that there was any consequent reduction in the monitoring and oversight arrangements.
Key issues - procurement
Was it appropriate for HIE to undertake this "qualitative moderation"?
Response & mitigation
The moderation was allowable under the terms of the procurement, and we note that it is common practice to follow a moderation process such as this within a procurement.
A board paper was considered which set out that assurances from the main investor were received, alongside detail of the wider due diligence undertaken on the main investor, though there is limited recorded evidence of the HIE Board's reasoning why this moderation was considered appropriate in the circumstances and why the balance of risk this decision resulted in was appropriate for HIE to take on.
Did HIE achieve sufficient additional protection having done so?
Response & mitigation
The board paper noted that a parent company guarantee was to be put in place alongside a shareholder guarantee from the main investor. These were ultimately agreed between the parties.
A HIE board paper prepared by HIE officials involved in the procurement noted further potential mitigations were advised based on the due diligence undertaken to be pursued including pursuing a performance bond and seeking the conversion of shareholder loans in Natural Retreats to equity. These were not obtained as HIE were content with the outcome negotiated. It would have significantly strengthened the package had either of these further protections been obtained.
HIE's advisers stated that the security package obtained "represent[s] a favourable outcome from the negotiations to date and offer HIE an acceptable level of protection from risk during the crucial first 5 years of operation".
The board was sighted on these issues and it is therefore reasonable to assume that they were considered as part of the decision-making process. The board papers asked that the board consider that the qualitative moderation to the financial standing scoring remained appropriate and it would also be reasonable to expect that the rationale for this decision would be documented given the judgement applied and the reliance ultimately taken from the letter of comfort. We feel that this is of particular importance given the potentially significant impact on HIE's and the wider public finances in the event that the guarantees would need to be called could have reasonably been anticipated.
Did HIE put in place sufficient processes to manage this risk throughout the contract?
Response & mitigation
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