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Charities in Financial Distress - What Trustees Need to Know

on Thursday, 17 December 2020.

The further lockdown measures in response to the pandemic unfortunately mean that the risk of financial difficulties for charities and their trading subsidiaries is more real than ever.

In these challenging times it is important that trustees remain mindful of their duties and are aware of the options open to them.

Trustees' Duties

Trustees will be aware that generally their duties include to act in the best interests of their charity and the charity's beneficiaries;  to protect and safeguard the charity's assets; to act with reasonable care and skill. However, in situations of doubtful solvency, trustees must change their focus so that their primary duty is to act in the interests of the charity's creditors.

This may mean that trustees have to make difficult decisions, particularly if the interests of creditors do not align with those of the charity's beneficiaries.

Identifying Insolvency

A key thing for trustees to be aware of is the need to identify when a charity becomes insolvent. There are two formal tests that can be applied when ascertaining insolvency and a charity only has to satisfy one of the tests to be deemed insolvent:

  • Cash flow test - a charity is insolvent on a cash flow basis if it is unable to pay its debts as they fall due.
  • Balance sheet test - a charity is insolvent on a balance sheet basis if its liabilities, including prospective and contingent liabilities, outweigh its assets.

When considering whether a charity is insolvent, trustees should be mindful, particularly when applying the balance sheet test that the focus should be on unrestricted assets. For example, any assets which are held by the charity or trust, or comprising restricted funds, should not be taken into account. The lack of free assets for a charity may well mean that the charity is deemed to be insolvent, even if its general asset position appears relatively healthy.

What Are the Options For Insolvent Charities?

Whilst there are a number of solutions available for charities in distress, the options available will depend on both the legal structure of the charity in question as well as the extent and stage of financial distress. Generally speaking, the sooner that trustees seek professional advice, the wider the range of options likely to be open to them.  

  • Charitable company - The usual corporate insolvency procedures such as liquidations and administrations are available to incorporated charities.
  • Charitable Incorporated Organisation (CIO) -  The usual corporate insolvency procedures are modified before being applied to CIOs.
  • Charitable Community Benefit Society (CCBS) -  The usual corporate insolvency procedures are also modified for use by CCBSs. However, trustees should be mindful that there will be specific exemptions in respect of providers of social housing.
  • Unincorporated Charities - Trustees of unincorporated charities are personally liable for the charity's liabilities and the usual corporate insolvency procedures cannot be used.

Coronavirus charities blogs

Corporate Insolvency and Government Act 2020 (CIGA)

Earlier this summer, and partially in response to the coronavirus (COVID-19) pandemic, CIGA was enacted, bringing about some of the most fundamental changes to insolvency legislation in England and Wales in decades. Whilst some of these changes are temporary and are expected to be lifted once the pandemic has settled, other provisions introduced by CIGA have been in contemplation for a number of years and represent permanent changes which some insolvent charities may be able to avail of in the future.

Of particular relevance to trustees is the new standalone statutory moratorium introduced by CIGA. Trustees of incorporated charities may be able to apply for a moratorium for an initial period of 20 business days to benefit from protection from creditor pressure and a payment holiday in respect of certain debts, whilst considering options to restructure and rescue the charity.

In the right circumstances, the period of the moratorium can be extended. Whether a standalone moratorium is suitable will depend on a number of factors, including the nature of the charity's debts and the charity's ability to fund trading during the moratorium period.

Unfortunately unincorporated charities, associations and trusts are outside the scope of CIGA and are unable to benefit from its protective measures.

Mitigation of Risk

Whilst the risk of personal liability to trustees of unincorporated charities is well known, trustees of all types of charities should be aware that there is the potential for personal liability if their decisions result in losses to creditors.

In incorporated charities, the level of risk and exposure depends on the conduct of the trustees at the relevant time. That risk can be mitigated by acting conscientiously, taking advice and making decisions objectively, even if insolvency cannot ultimately be avoided.

It is important for trustees to document all factors which are considered and all decisions that are made so that if their conduct is questioned in the future, they have clear evidence of the thought process behind their actions and can demonstrate that their acts were reasonable. 

Key Considerations and Practical Tips

In these challenging times we recommend that all trustees arm themselves with all available tools and information that may help a charity if the worst happens.

Trustees should:

  • familiarise themselves with CC12 - the Charity Commission's guidance on managing charity finances, as well as the enhanced guidance issued by the Commission in response to the pandemic
  • keep up to date financial information and monitor that information frequently
  • hold regular board meetings and document all decisions made during those meetings
  • be aware of distress in trading subsidiaries and any potential conflicts of interest which may arise and Charity Commission guidance in that regard
  • take specialist professional advice at an early stage
  • be mindful of reporting obligations to the Charity Commission and other relevant regulators

For specialist legal support with your charity's finances, please contact Ambuja Bose in our Insolvency and Restructuring team on 07469 850 886 or complete the form below.

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