Part 3: Challenges for licensing trusts
3.1
This Part examines several challenges that licensing trusts have faced in recent years.
3.2
Increasing numbers of licensing trusts are struggling with profitability and financial viability, particularly the smaller trusts. Apart from the strong performers, which are often largely those trusts that have retained exclusive rights, licensing trusts' profitability is generally declining rather than growing. For some, 2012/13 results were negative. If these results continue, these licensing trusts will become unsustainable and will make limited or nil distributions to their communities.
3.3
The licensing trusts that have retained exclusive rights and those with well-established operations have a scale that allows them to employ a management team, greater buying power, and the ability to provide cost-effective administration services to support trading operations.
3.4
In our 2012/13 audit reports, we highlighted that Oamaru Licensing Trust and Rimutaka Licensing Trust face "going concern” issues.12 We considered it necessary to highlight to the readers of the financial statements of these two trusts that we had seriously considered whether applying the going-concern assumption was appropriate. This matter is unlikely to be easily resolved and there is a risk to other smaller licensing trusts in the future.
3.5
Larger trusts have more capability and capacity to consider continuity and plan for future changes than smaller trusts, which often find this difficult. It is not uncommon for smaller licensing trusts to have one member of senior management and one trustee actively involved in overseeing operations. When a trust's profits are diminishing, and it is under pressure to make contributions to meet needs in the community, it becomes very difficult and sometimes unpalatable for elected representatives to spend money on outside support or expertise. It can also be difficult to adequately provide internal management resource to lead the business in an increasingly competitive market. These circumstances make planning for the future very difficult.
3.6
It is important that licensing trusts are able to meet their accountability requirements to their communities, so that their elected trustees can be held to account. There is no other formal external scrutiny mechanism for licensing trusts, such as a select committee.
Governance and accountability
3.7
Effective governance and accountability are important to any entity. For entities in the public sector, where the interests of the community must be taken into account, they are essential. We have observed that effective governance can be difficult for some licensing trusts. Accountability is influenced by the quality of management and by the support that those in governance roles provide to management. We found some instances of trustees not being prepared to address issues critical to the survival of their trust. Others, particularly the larger licensing trusts, have been more active in addressing strategic issues and making changes to prepare their businesses for the future.
Governance issues
3.8
We have also observed that it can be difficult to recruit high-calibre trustees – particularly in small communities. This is an issue for all public entities with elected governors and also affects the not-for-profit sector. It is a concern. We are also concerned about the costs for licensing trusts of holding by-elections. This can happen when the number of nominated candidates for an election is less than the number of vacant trustee positions or when a trustee resigns during their term. Licensing trusts meet the costs of by-elections from funds that would otherwise be distributed to communities or reinvested in the trust.
3.9
There will be a range of reasons why there are not enough nominations for any election, and it is inevitable that some resignations will occur in any three-year term. However, it is apparent that good calibre trustees can be hard to recruit – especially in small communities.
3.10
Te Kauwhata, Portage, Waitakere, and Clutha Licensing Trusts have faced varying levels of challenge. Portage and Waitakere Licencing Trusts incurred by-election costs because elected trustees stood for more than one public office and, following successful election to more than one role, were either required, or chose, to resign to avoid conflicts of interest. Although the specific circumstances differ, the outcome is the same for all: cost to the communities because reduced funds are available to distribute or reinvest.
Te Kauwhata Licensing Trust
3.11
Te Kauwhata Licensing Trust is one of the smallest. It makes low returns to the community. Its financial position has been deteriorating for some time, although it began efforts to address this in 2013. These efforts are continuing. The Trust is realistic about the challenges of operating in a small district with a low population. It is making efforts to market its business to a broader cross-section of the community and to reduce costs to boost profitability. The Trust sold a property in 2011/12 and used some of the proceeds to address cash flow issues. It placed the remainder on term deposit. This has enabled continued use of the going-concern assumption in preparing its financial statements. However, the risks to the Trust's profitability are still very real.
3.12
Our auditors have identified a significant number of internal control issues in recent years, caused by limited management and governance capability. For the Trust's 2012/13 financial statements, our auditors expressed a qualified audit opinion because they could not get adequate assurance about the completeness of revenue.
3.13
A trust by-election was to be held because of a vacancy caused by a lack of nominations at the 2013 local elections. However, because of an incomplete enrolment process, the sole candidate's nomination was invalid. As a result, the Governor-General was invited, by public notice, to exercise his powers to appoint a suitably qualified person.
Portage Licensing Trust and Waitakere Licensing Trust
3.14
Portage Licensing Trust and Waitakere Licensing Trust each held a by-election on 11 February 2014 because of two resignations after the 2013 elections. We understand that the two elected trustees resigned because they also stood for, and were elected to, local boards of Auckland Council. They chose not to continue in both roles, although this is allowed.
3.15
In addition, the Waitakere Licensing Trust trustee resigned because he also stood for, and was appointed to, a District Licensing Committee. Because he could not legally hold both positions, he stood down as trustee. The Trusts each successfully appointed new trustees after holding by-elections. Voter turnout was low – about 12,000 people voted out of more than 70,000 eligible voters.
Clutha Licensing Trust
3.16
Clutha Licensing Trust does not have exclusive rights in its region, so it operates in a fully competitive environment.
3.17
During 2013, we investigated whether two elected trustees of Clutha Licensing Trust breached the rule in the Members' Interests Act that prevents elected members from entering into contracts that are worth more than $25,000 with the entity they govern in any financial year. We confirmed that, towards the end of 2010, two trustees each exceeded the contracting threshold of $25,000 each year. From that point, sections 3, 4, and 5 of the Members' Interests Act combined to mean that the trustees were no longer capable of holding office, their office was automatically vacated, and they each committed an offence by continuing to participate in Trust business for the rest of the three-year term.
3.18
The Trust was not aware that the Members' Interests Act applied to the Trust until new auditors identified this issue in 2013.
3.19
The Trust had been trading with the relevant companies for many years before the two trustees were elected. There is no suggestion that their position as trustees influenced the Trust's purchasing decisions.
3.20
The Trust asked us to consider giving retrospective approval under section 3(3) of the Members' Interests Act. This would mean that the two trustees would be deemed not to have been disqualified from office. We decided that we would likely have given approval if it had been sought at the time, which would have been done if the organisation had understood its statutory responsibilities properly. We were also aware that leaving the situation unresolved would expose the Trust to an undesirable level of legal risk as well as the cost of a by-election. We therefore gave the necessary approvals for the current and previous terms of office.
3.21
We also carefully considered whether we should bring a prosecution against the individuals for the offences they had committed. Even if the law is old and arguably out of date, it is still the law. Those holding public office or running public entities should be careful to comply with it. However, we decided that the public interest did not warrant a prosecution in this instance. We decided that recording the facts in this report to Parliament would provide enough transparency and accountability.
Accountability issues
3.22
Licensing trusts have a legal obligation to account to their communities for the assets that they hold and operate on their communities' behalf. The 2012 Act sets out the accountability obligations of licensing trusts. They must prepare financial statements in keeping with generally accepted accounting practice within five months after the end of each financial year, which must be audited by the Auditor-General. The audited financial statements must be publicly notified after the audit has been completed.13
3.23
We are concerned that several smaller licensing trusts are not complying with their statutory accountability and reporting obligations. This has particularly been an issue when a licensing trust winds up. However, some licensing trusts do not report in a timely manner on an ongoing basis. See Figure 7 for a list of licensing trusts that, after the five-month statutory deadline for the 2012/13 year, were behind with their accountability obligations.
3.24
We are concerned that our Office seems to be the only agency interested in endeavouring to hold licensing trusts to account to meet their financial reporting obligations or to help trusts meet their accountability obligations to their communities. No government department or select committee is responsible for monitoring licensing trusts or can assist trusts that are having difficulties meeting their financial accountability obligations. We note that the Department of Internal Affairs operates a rigorous audit process to ensure accountability of charitable organisations operating class 4 gaming machines, including those related to licensing trusts. This includes holding these organisations to account for publication requirements, to ensure that communities are informed, and monitoring minimum return rates.
3.25
Parakai Licensing Trust, Wainuiomata Licensing Trust, and Hawarden Licensing Trust have recently failed to meet their statutory accountability obligations to their communities.
Parakai Licensing Trust
3.26
Since 1972, Parakai Licensing Trust has owned one tavern, which it leased to independent operators. The Trust was effectively only a landlord, and its sole income was rent.
3.27
On 12 June 2013, the Trust was dissolved and became a community trust under the 2004 amendments to the 1989 Act (see paragraph 1.23). Although Parakai Licensing Trust completed all the necessary steps to become a community trust, including public notices, notification in the New Zealand Gazette, and an Order in Council, it had not provided appropriate financial statements and supporting information to complete the audit requirements for 2009/10 onwards.
3.28
On 10 July 2013, the assets of the Trust that had vested in the Parakai Community Trust were gifted to the Helensville District Health Trust. The Parakai Community Trust was dissolved at the same time. The outstanding annual financial statements for the Trust were not completed before both Trusts were dissolved and have not all been completed since then.
3.29
Despite the legal process of notifications about the dissolution that has occurred, the community has not received audited financial statements that set out what has been done with the assets that the Trust held on the community's behalf.14 A contributor to this delay has been the Trust's significant reliance on the auditors' help in preparing the financial statements. The Trust has needed this help because it lacked its own capability to address the accounting requirements associated with dissolution. Our appointed auditor does not expect to be able to fully recover these costs (see Part 5). The auditor is currently working with the Helensville District Health Trust to resolve this.
Wainuiomata Licensing Trust and Wainuiomata Licensing (Charitable) Trust
3.30
Wainuiomata Licensing Trust ceased operating around 2003 and was wound up by court order in 2013. For several years before being wound up, the Trust operated only as a landlord of its premises, which it leased to a third party for a peppercorn rental. During this time, the Trust was not "engaged in activities associated with the sale of liquor”, as required by the 1989 Act. It also did not hold elections to maintain governance of the Trust. From 2002 until it was wound up in 2013, the Trust failed to complete its statutory accountability obligations in an appropriate time frame.
3.31
The financial statements for the group, which included the Wainuiomata Licensing (Charitable) Trust, a trust controlled by Wainuiomata Licensing Trust, for the nine years to 31 March 2011, and for 2011/12, were eventually prepared on a disestablishment basis for the Trust's financial position as at 31 March 2012. Our appointed auditor drew attention to the Trust's going-concern disclosures in the audit opinion dated 8 August 2012. This opinion confirmed that the Trust had appropriately not used the going-concern assumption because the Trust was about to be disestablished.
3.32
The assets of the Wainuiomata Licensing Trust group were subsequently vested in the Wainuiomata Bush Fire Force.
Hawarden Licensing Trust
3.33
Hawarden Licensing Trust owns one tavern, which it leases to independent operators. The Trust is effectively only a landlord, and its sole income is rent. Because the Trust is not directly involved in selling and supplying alcohol, it is unlikely that the Trust has been meeting its objectives under the 1989 Act or the 2012 Act.15 Our appointed auditor drew this to the Trust's attention in 2007 and recommended that it consider reconstituting as a community trust. The Trust has not yet acted on this recommendation. Given the Trust's limited income, the costs of reconstituting may be prohibitive.
3.34
The Trust receives a qualified audit opinion each year because it does not complete financial statements that comply with current accounting standards. The Trust argues that the standards are too complex for the simplicity of its operations and, therefore, that the expense involved is unwarranted, especially given its limited income.
3.35
Although we have some sympathy with this position, which we have previously expressed in various publications,16 this does not meet current accounting requirements.
Financial viability and performance
3.36
As noted earlier, licensing trusts are facing growing pressure through increased competition, declining revenue, changing social attitudes, and tougher legislation, combined with pressure to return more funding to their communities. These challenges have been prevalent for some years now. They have become more pronounced in recent years, with 14 licensing trust groups recording at least one loss within the five years to 31 March 2013. We recognise that the challenges of the recent economic down-turn and the competitive nature of the hospitability industry affect all those involved, not just licensing trusts. There has also been a reduction in class 4 gambling nationally since 2004, which has also affected licensing trust groups' profits.
3.37
We expressed doubt about the going-concern assumption for Oamaru Licensing Trust and Rimutaka Licensing Trust in their 2012/13 audit reports.
Oamaru Licensing Trust
3.38
Oamaru Licensing Trust does not have exclusive rights in its district, so it operates in a fully competitive environment. The Trust provides accommodation, conference facilities, and restaurant and bar services. The Trust has reported significant operating losses in recent years. Its operating cash flows, while positive, remain tight and have been deteriorating. Some structural and managerial changes implemented in October 2013 have improved its 2013/14 results.
3.39
The Trust's funding facilities are for 12 months. They are renewable in October each year, at the discretion of the Trust's bank. The short-term nature of these facilities has resulted in them being classified as current liabilities in the Trust's financial statements. This means that the Trust has a significant short-term liquidity risk. The Trust depends on the bank renewing the facilities in October each year. The cost of debt is a significant expenditure for the Trust, and renewing these banking facilities is crucial to the Trust's ongoing operations.
3.40
Our appointed auditors considered that the short-term nature of the loans and the significance of the Trust's dependence on the bank, coupled with financial pressures on the Trust, meant that there was a significant risk that the going-concern assumption would not be an appropriate basis for the preparation of the Trust's 2012/13 financial statements if the financial facilities provided by the bank are not renewed.
3.41
For this reason, the auditor's report contained an emphasis-of-matter paragraph to draw the attention of readers to the situation set out in those financial statements. The emphasis-of-matter paragraph also referred to the Trust breaching one of its banking covenants on 31 March 2013 and its bank agreeing not to act on the breach.
Rimutaka Licensing Trust
3.42
Rimutaka Licensing Trust owns and operates a tavern in the Hutt Valley. Rimutuka Licensing Trust has a management contract with Trust House Limited to provide operational and administrative support.
3.43
For 2012/13, the Trust recorded an operating loss of $89,499, and sustained a negative operational cash flow of $50,980. The Trust had positive net current assets of only $7,000 as at 31 March 2013.
3.44
Rimutaka Licensing Trust has a loan from Rimutaka Trust Limited for $317,000. This loan is on commercial terms. It was due for repayment on 1 October 2013. However, the term of the loan has subsequently been extended to 1 October 2018.
3.45
For this reason, the auditor's report contained an emphasis-of-matter paragraph to draw the attention of readers to the situation set out in the financial statements. The emphasis-of-matter paragraph noted that the validity of application of the going-concern assumption in future years would be determined by the trustees' decisions about the Trust's future during 2013/14.
3.46
The Trust is currently considering its position and future options, and is taking community views into account.
3.47
It is pleasing to note that the trustees have committed to wind up the Trust promptly if a solution cannot be identified. The Trust's facilities are dated and need substantial renovation.
12: See Figure 9 for further details.
13: The 1989 Act required licensing trusts to prepare a balance sheet and a profit and loss account annually and to publicly notify a summary of them.
14: Since August 2013, we have been endeavouring to work with the Trust's representatives to help them meet the Trust's accountability requirements from an accounting perspective. The audit for 2009/10 was completed in April 2014. A process is now in place to complete the remaining outstanding reporting.
15: It is likely that there are several other licensing trusts that are also operating in this position at the current time. To meet the objectives of the legislation this should be addressed.
16: See, for example, The Auditor-General's views on setting financial reporting standards for the public sector, available at www.oag.govt.nz/2009/financial-reporting-standards.