This article first appeared in the December 2024 edition of the Journal of International Banking and Financial Law.
This article summarises key issues relevant to lenders and borrowers in loan financings that involve companies limited by guarantee as a borrower, guarantor and/or security provider.
Key Points
- Companies limited by guarantee (CLGs) are a popular legal structure for non-profits, including charities, social enterprises, trade associations and quasi-governmental organisations.
- CLGs share many of the features of companies limited by shares, and as such are often capable of entering into secured and unsecured lending transactions on a similar basis.
- Where a CLG is also a registered charity, community interest company or other regulated structure (as may be applicable to quasi-government organisations), specific requirements will apply if it acts as a borrower, guarantor and/or security provider in loan financings.
Introduction
A company limited by guarantee (CLG) is a type of private company where the liability is limited to the guarantees given by its members, rather than the contributions of its shareholders. Their design makes them a popular form for charities, social enterprises, trade associations, quasi-governmental organisations and other non-profits.
Like a company limited by shares (a “CLS” – the most prevalent corporate form in the UK), a CLG is governed by the Companies Act 2006 and registered with Companies House, has separate legal personality from its members and the liability of its members is limited. It is possible for CLGs to be governed by multiple regulators; for example, a charitable CLG will also be registered by the Charity Commission, whereas a CLG that is also a community interest company (CIC) will also be registered with the Office of the Regulator of Community Interest Companies.
In contrast to a CLS, a CLG does not have any share capital and therefore has no shareholders (except in a rare historic context, which is outside of the scope of this article). When a CLG is wound up and does not have enough funds to pay its creditors, the members (ie the guarantors) will only be obliged to pay an amount up to the value of their guarantee. This is typically a nominal amount – such as £1 or £10 – as set out in the CLG’s statement of guarantee in its articles of association. The value of a member’s contributions cannot increase or decrease in value, which means there is no market for transfer of membership (and transfer is typically restricted by a CLG’s articles in any case). Members’ contributions are also not treated as an asset of the company, which means equity investment into a CLG is not possible and funds must be raised by debt, grants, membership fees, trading income or other sources.
How CLGS are used
As mentioned above, CLGs are most widely used in the non-profit space, as the combination of their limited liability status, lack of share capital and not having any requirement for members to contribute towards its initial working capital make them an attractive legal structure for philanthropic causes.
With respect to registered charities, whilst charities can also be established as a charitable trust, unincorporated association and, since 2013, as a charitable incorporated organisation (a corporate form only for registered charities that allows certain additional flexibility), CLGs are the typical form for larger and more complex charities.
Non-charitable CLGs are often used for organisations spun-out from local or central government, for quasi-governmental or regulatory functions. Use of a CLG allows for them to be independent but prevents distribution of profits which could distort incentives or behaviours.
Non-charitable CLGs and loan borrowings
Given the absence of share capital – and therefore the ability to raise equity investment – CLGs of all flavours often require debt financing. Generally, the process of lending to a non-charitable CLG is broadly the same as lending to a CLS, with key considerations including:
- Power and capacity: When lending to a CLG, as with a CLS, it is important to ensure that the relevant CLG borrower, guarantor and/or security provider (as applicable) has corporate power to enter into the financing, including that it has no relevant restrictions in its governing documents.
- Granting security and guarantees: In the same way as a CLS, and subject to any bespoke restrictions in its governing documents, a CLG can grant fixed and floating charges over its own assets (which is typically achieved by way of a debenture), enter into mortgages, security assignments or pledges of assets, and provide other forms of credit support such as guarantees and negative pledges. As with a CLS, a security document that creates a mortgage or charge will be registrable at Companies House and security created over property must be registered at the Land Registry or the Land Charges Department (and certain security over intellectual property also requires registration).
- Security over membership interests in a CLG: A CLG has no shares and typically contains non-profit provisions in its articles which prohibits any distribution of profits to its members – these provisions are usually very important reputationally for non-profit organisations. Furthermore, CLG members’ guarantees are without meaningful economic value and are typically also not transferrable (as per the default language in Art 22(2) of the Model Articles – though this can be amended). For these reasons, although it is technically possible for a lender to take security over membership interests in a non-charitable CLG, this very rarely happens in practice. This is in contrast to a CLS, where a lender’s security over the shares of a valuable for-profit company may form an important piece of the overall security package.
- Lending to CIC CLGs: A CLG that is also a community interest company (CIC) generally has the same borrowing powers as any other company and generally will be able to borrow and pay normal commercial rates of interest to lenders. However, if the interest rate is linked to the performance of the CIC CLG, this rate will be subject to a performance-related interest cap (which, as at the date of this article, is 20% per annum) (reg 21 of The Community Interest Company Regulations 2005).
- Lending to quasi-government CLGs: If the CLG is an emanation of government, public law considerations may apply if they are carrying out public functions. This could mean that entering into a loan financing could be a decision capable of judicial review and that other legal regimes, such as freedom of information, procurement or subsidy control, may also be relevant.
Loans involving charitable CLGs: additional considerations
For loan transactions involving a charitable CLG as a borrower, guarantor and/or security provider, there are a number of additional key considerations arising from the CLG’s charity law duties. Commonly arising issues include:
- Power and capacity: As with non-charitable CLGs, it is important to check whether the charitable CLG’s articles contain express powers to borrow, guarantee and/or grant security (as applicable). Where any of these are absent, the loan parties might seek to rely on the general “catch-all power” – if this is present in the charity’s articles – to “do all things necessary or expedient for the fulfilment of its charitable objects” (or similar). If the parties intend to rely on the catch-all power, it is worth noting that the decision in Rosemary Simmons Memorial Housing Association Ltd v United Dominions Trust Ltd and another [1986] 1 WLR 1440 casts some doubt as to whether a charity can solely rely on the catch-all power where it is guaranteeing the obligations of a non-charitable company with which it has no legal connection.
- Granting security over land: Where a charity’s real estate property or land is used as security for funding (including for loans or grants), an Order from the Charity Commission is required unless certain advice requirements are met before the funding agreement is entered into and the property charged. These requirements are set out in s 124 of the Charities Act 2011, and involve certain statements being included in the security document(s) and the trustees certifying that they have obtained the required formal written advice required under the Act.
- Security over membership interests in a charitable CLG: It has been recently held – The Children’s Investment Fund Foundation (UK) v HM Attorney General and others [2017] EWHC 1379 (Ch) – that members of a charity can owe a fiduciary duty in respect of the charitable objects of that charity, and therefore are obliged to exercise their powers in a way that would most likely further its charitable objects. This means that, even if a lender takes security over a charitable CLG’s membership rights, upon enforcement the lender – or any subsequent buyer or transferee of these membership rights – could not exercise such rights in their own personal interests, but would need to do so in the furtherance of the CLG’s charitable objects.
- Security over restricted funds and endowments: Where a charitable CLG has restricted funds (such as restricted grants) forming part of its charitable funds and/or it is a corporate trustee of a charity with permanent or other endowments, it will be important to check in advance whether granting – or enforcing – security over these types of assets could trigger a breach of the grant or endowment terms. This is particularly relevant where a charitable CLG is being asked to provide security by way of floating charge (including pursuant to a debenture), which would cover these types of assets.
- Guarantees for obligations of trading subsidiaries: Where the trading subsidiary of a charitable CLG is the entity receiving the loan, lenders often ask the “parent” charitable CLG to provide a guarantee – which is sometimes secured – in relation to the trading subsidiary’s borrowing obligations. The trustees of the charitable CLG will need to carefully analyse on a case-by-case basis whether giving this guarantee is in the interests of the charity; for example, whether the charity’s purposes will (at least in part) be directly achieved by giving the guarantee, and the guarantee will therefore fall within the scope of being a “social investment” for the charitable CLG, in accordance with the Charity Commission’s guidance.
Conclusions
When transacting with a CLG on loan financings, it should not be assumed that normal practice that would be relevant for a CLS will necessarily apply. Careful thought should be given to the wider context of the entity and other legal regimes that it may be subject to.