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Charities and the Risk of Failure

on Monday, 28 September 2015.

It is difficult to draw too many firm conclusions from the recent failure of Kids Company, at least in advance of the Charity Commission completing and reporting the findings of the inquiry it instituted in August 2015.

However, in our experience, there are some themes which are common to the failure of charities.

The Funding Environment

Charities are currently operating in one of the most competitive and challenging funding environments, competing with social enterprises and private sector operators, as well as with other charities. Many charities have responded proactively by looking at the opportunities available to them to diversify their sources of income and to develop new ways of working. However, this can import new risks into a charity's existing framework, which the charity will not have had to grapple with previously.

Strategic Response

It is critically important for a charity's trustees to adopt a clear strategic approach to all of the challenges it faces. Setting an effective strategy and business and operating models which are fit for purpose depends upon two critical areas:

  • the charity's ability to assess, manage and mitigate the range of risks it faces
  • the quality of the charity's management information and reporting, the quality of the leadership team and trustees, and the professional advice available to them

Making judgements about risk (or any other sensible business decision for that matter) without accurate and up to date management information is, in many ways, like trying to navigate a ship with a compass that isn't functioning properly. The serious risks of doing this are self-evident.

Key Areas of Risk

The focus of much management information is on a charity's financial position and, in particular, whether it has a positive balance sheet.

However, there is a range of other issues for which good management information is required. These include areas such as impact, client or customer feedback, the effectiveness of its debt collection and relationships with key suppliers. Given the serious consequences, we also believe it should include regulatory compliance.

Any of these areas could be key areas of material risk and one we have seen in practice is a failure to understand that restricted funds should be maintained properly and not used to support a charity's general cash flow. Failure to demonstrate this understanding can adversely impact public confidence.

The Legal Implications of Failure

Perhaps the most significant legal risk is posed by insolvency law, which can make trustees of an incorporated charity personally liable for losses suffered by a charity's creditors after the point at which the trustees realised (or ought to have realised) that there was no reasonable prospect of the charity avoiding going into insolvent liquidation. If a charity does enter into a formal liquidation, trustees who did not act properly in the lead up to the insolvency can also be disqualified from holding office as director of a company (for up to 15 years in serious cases).

Trustees of unincorporated charities are in a position which is potentially more invidious, because they will not have the protection from the limit on liability that will generally apply to protect the trustees of a charitable company from personal liability in respect of the company's debts and other liabilities.

There is also the risk of personal liability for the trustees in respect of a breach of trust if the charity is using its restricted funds to support its general cash flow.

For further information, please contact Emma-Jane Dalley in our Charity Law Team on 0117 314 5465.

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