These are challenging times for charities with rising costs and increased demand for services and some may find themselves facing financial difficulties. Explore some of the next steps and key takeaways if your charity is looking for guidance on dealing with financial difficulties.
This blog was co-written by Laura Soley (Partner, Bates Wells), Philip Kirkpatrick (Partner, Bates Wells), Jean Tsang (Partner, Bates Wells), Paul Jennings (Partner, Bates Wells), Jamie Huard (Partner, Bates Wells) and Phil Reynolds (Partner, FRP Advisory).
Jump to:
Trustee duties and responsibilities
How to navigate the “Twilight Zone” where a charity is under threat of insolvency
Key employment considerations for charities managing financial difficulties
Considerations and options for land and property at times when the organisation is under stress
The charity’s resources, including reserves, grant funding, restricted funds and endowments
Thinking about mergers, collaborations and restructuring
Trustee duties and responsibilities
Philip Kirkpatrick
There is a vital difference between corporate charities (like CIOs and companies limited by guarantee) and unincorporated ones (like trusts and unincorporated associations): corporate charities have their own assets and liabilities, whereas with unincorporated charities, it is the trustees personally who hold the assets and are liable for the debts of the charity. Although they can use the assets they hold to meet the liabilities, if the charity doesn’t have enough assets to meet those liabilities, the trustees can be left holding the can. So, it’s very important to understand what the legal structure of your charity is.
All trustees have duties to act in the interests of their charity, and these are well summarised in the Charity Commission’s publication The Essential Trustee. Their main duty is to further the purposes of the charity for the public benefit. However, as concerns about solvency arise, there needs to be a shift in the trustees’ approach; they need to begin thinking more carefully about the interests of creditors. For trustees of unincorporated charities, that is to protect themselves against personal liability to creditors. For companies and CIOs, it is to make sure they don’t find themselves liable for wrongful trading.
A trustee of a charitable company or a CIO will be guilty of wrongful trading if they know, or ought to know, that there is no reasonable prospect of the charity avoiding being wound up insolvent and at that point they don’t take all steps necessary to protect the interests of creditors. So, at this crucial tipping point, the trustees’ duties suddenly change – they still have duties to act in the interests of the charity, but the Insolvency Act 1986 says they must also protect the interests of creditors if they are to avoid being found liable for wrongful trading.
It is very important to take professional advice from an insolvency practitioner or other accountant or lawyer as financial difficulties appear on the horizon so that trustees can safely identify this tipping point and navigate a path through that saves the charity from insolvency or, if that isn’t possible, at least saves the trustees from personal liability.
Trustees will also need to be careful not to prefer one creditor over another, and generally to act responsibly – both the Company Directors Disqualification Act 1986 and the Charities Act 2011 enable trustees to be disqualified for being unfit, and regulators will consider whether these powers should be used in some insolvent liquidations.
At this point, the trustees should also be considering making a serious incident report to the Charity Commission.
How to navigate the “Twilight Zone” where a charity is under threat of insolvency
Phil Reynolds
The key issues for trustees/directors to consider when the organisation is under stress and there are concerns about the ability to continue to trade are:
Time
The more time your organisation has before running out of cash the easier it is to turnaround – a key role of the Trustees is to horizon scan and ensure the organisation is resilient.
A suitable reserve policy tailored to your individual circumstances is essential to provide that time.
Do you have a reasonable prospect to trade through the current difficulties, restructure and come out the other side?
- Reasonable doesn’t mean you need to know the future, but the key test is what would a reasonably competent board do in those circumstances based on the information held at the time.
- The key is to ensure you have the financial and operational information available to support your decisions – e.g regularly updated cashflow forecasts to inform your decision making and a clear view on grant / contract pipelines.
“In case of emergency – break glass”
Have you got multi layered contingency plans so if your primary plan doesn’t work you can pivot to implement additional cost reduction programs, make emergency funding appeals, approach JV/Merger partners in good time.
Restricted Funds
One of the highest risk areas for trustees is when restricted funds have been utilised for general expenditure as on an insolvency any deficit could lead to a personal claim and potential disqualification proceedings.
If there is an imbalance in the organisations funding mix – early engagement to se if more funds can be used for unrestricted purposes is key.
Don’t Panic
Often in times of criticality charities forget that they will have good will with suppliers who may well be supportive and that includes HMRC!
Key employment considerations for charities managing financial difficulties
Paul Jennings
No organisation embarks on a redundancy programme lightly. These processes are inevitably difficult and often upsetting – not only for the employees whose roles are at risk, but also for those responsible for implementing the changes and for the wider workforce observing events unfold. Redundancies can affect morale, trust and organisational culture.
However, in a challenging economic environment, organisations may have little choice. Sector pressures, structural change, funding reductions or strategic refocusing can make workforce restructuring unavoidable. When that point is reached, employers must ensure the process is handled carefully, lawfully and with appropriate sensitivity.
Unlike many other dismissal scenarios, redundancy processes can usually be carried out in a relatively efficient and structured way. The key legal requirements and elements of good practice are well established. They are also, comparatively speaking, less personal in nature, since the focus is on the organisation’s structure and operational needs rather than on scrutinising the conduct or capability of the individuals affected.
The most important initial step is the development of the underlying redundancy proposal. This document forms the foundation of the entire exercise. It should clearly set out three key elements: first, the business rationale explaining why redundancies are being contemplated; second, the specific organisational changes being proposed; and third, how the process will be implemented in practice, including consultation arrangements and selection methodology.
A well-prepared proposal document serves two functions. It is both the strategic plan guiding the organisation through the process and the document that demonstrates the legitimacy and rationale behind the proposed changes.
For this reason, organisations should seek advice at the stage of drafting the proposal itself. Early input can help ensure the rationale is properly articulated, the structure of the exercise is sound, and potential legal risks are addressed before the process begins. In many cases, this early preparation is what distinguishes a fair, compliant redundancy process from one that carries unnecessary legal and reputational risk.
Where 20 or more redundancies are proposed, it is critically important to obtain legal advice at an early stage. The legal requirements governing collective redundancy processes are highly prescriptive, and the penalties for non-compliance can be very substantial. This is also an area of law that is the subject of significant upcoming statutory changes, which makes it especially important to seek advice at the planning stage.
Considerations and options for land and property at times when the organisation is under stress
Jamie Huard
Current property liabilities
It is crucial that if your organisation is struggling to pay rent or meet loan repayments, that you speak to your landlord or lender at an early stage to discuss and potential temporary rent reduction or adjusted repayment terms. They will likely offer some level of assistance if possible. It is very important not to delay or hold-back on speaking to them. It will be important to be realistic about what can be achieved and not over-promise, for example, on repayments.
Know your properties
It will be important to ensure you have a property audit recording the types of properties your organisation holds (freehold, leases), their use, their condition and whether these are all un use or whether they could be better utilised, for example by renting them out or selling.
Quick exits
For under-used leased property, look at exercising any break clause (though do take advice on serving these as conditions must be strictly complied with). Other options if there is no upcoming break right includes negotiating a surrender with the landlord, transferring the lease or subletting it (subject to charity law compliance). If you have missed a break right in a lease of a quiet or empty property, you could also relocate services or offices to that property and then exit from the other property.
Raising funds
If you need funds quickly, look to keep any sale simple. Avoid conditional sales, complicated transactions and difficult properties. Auctions are sometime a good option as they give a set time for exchange of contracts. For the purposes of complying with the Charities Act 2011, you must set a reserve price at the level an appropriately qualified surveyor or estate agent advises represents the best terms reasonably obtainable.
Charity law compliance
Remember on any disposal by a charity, including sales of property, grants of leases or surrenders of lease, the charity will need to comply with the advice requirements of sections 117-121 of the Charities Act 2011 to ensure the disposal terms are the best reasonably obtainable for the charity. The advice must be provided by a RICS surveyor, estate agent (member of National Association of Estate Agents) or Agricultural valuer in the form of a designated advisers’ report. Ensure the adviser is aware of the context of the sale for the purposes of their advice.
Finance
If you are considering a loan to be secured against property owned by the charity, consider if it is the right option and is to cover a temporary situation rather than simply to put off a more major re-structuring. Consider the choice of lender (sector knowledge) and type of loan and avoid bridging loans. On taking any loan to be secured against charity-owned real estate advice is required under the Charities Act 2011 to confirm:
- The loan terms are reasonable for the charity
- The loan needed for the trustees’ proposed course of action
- The charity will be able to repay the loan
Final takeaways
- Know your properties and monitor these to ensure they are performing, needed by the charity and in good condition.
- If struggling to meet loan repayments, speak to or Lender at an early stage.
- For leases, ensure break clauses are included and contact landlords early if struggling with rent.
- If you need funds quickly, in any sale “keep it simple” – identify properties that will not be complicated to sell, consider auctions and take advice early.
- On any disposal, trustees must follow statutory rules and obtain a Designated Adviser’s Report for legal compliance.
- Adopt a varied approach to your properties – not one size fits all.
The charity’s resources, including reserves, grant funding, restricted funds and endowments
Laura Soley
In times of financial stress, it’s a good idea to take an early look at the charity’s available funds.
The trustees will want to understand the basis on which funds are held, which will help them to identify what funds can already be accessed for spending and whether they might be able to take steps to, for example, re-purpose restricted funds or seek to release endowment to increase available resources.
Here are some key things to think about:
Reserves
Does the charity have an up-to-date reserves policy? Is it holding enough reserves? Or is it holding too much and can release some for spending?
Restricted funds
Does your charity understand the basis on which your restricted funds are held?
It’s quite common, when reviewing restricted funds, to discover that some funds that are accounted for as restricted funds are not restricted at all (e.g. legacies given subject to a non-binding expression of wish can sometimes wrongly be accounted for as restricted funds) which could mean that the charity has more funds available for general spending than it thought.
Are the purposes of the restricted funds still suitable? Otherwise, the trustees may be able to use the statutory power in s280A Charities Act 2011 to seek to change the purposes and other terms of the fund to free up these funds to spend on other purposes. Changing the purposes (and certain other changes) requires the Charity Commission’s prior consent and so you will want to consider this early in order to allow enough time to get consent.
Permanent endowment funds
Again, does your charity understand the terms on which any endowment funds are held? Are the funds actually permanent endowment or might they be expendable endowment? These different types can sometimes be muddled up.
The trustees may want to consider whether they can use any of the powers in the Charities Act 2011 to:
- Release permanent endowment capital for spending (with Charity Commission consent for funds over £25,000, but no need to seek consent for smaller funds) (s281/282)
- Change the purposes of the fund (with Charity Commission consent) (s280A)
- Borrow from permanent endowment subject to repayment over a period of up to 20 years (s284A)
The power to borrow, which was introduced by the Charities Act 2022, can be particularly useful in times of financial difficulty. Trustees can borrow up to 25% of the endowment capital, subject to the provisions of the Act, where the trustees are satisfied it is expedient in light of both the purposes of the charity itself and of the fund, with no need for Charity Commission consent.
Grant funds
Your charity may have received grants under the terms of grant agreements or similar (which would usually be accounted for as restricted funds).
The trustees will want to make sure they understand the terms of any grants. It is quite common for grant agreements to include provisions which bite when the grant recipient is in financial difficulty, such as:
- Provisions allowing the funder to suspend or reclaim the grant If the charity fails to deliver the project or if the charity becomes insolvent
- Ongoing reporting obligations including to notify the funder of any financial changes or other changes in circumstances
- Termination provisions and amendment provisions
The trustees will want to make sure they check grant agreements early on and consider engaging with the grant funder to seek to agree changes.
Thinking about mergers, collaborations and restructuring
Jean Tsang
Financial challenges can often be the trigger for charities considering collaborations, mergers and restructuring, but the core consideration should always be about impact.
1. Merger
A full merger is the ultimate collaboration. Is it for you? If so:
- Consider it now and don’t wait for a crisis. An insolvent organisation has a much lower chance of achieving a merger and it will also have much weaker bargaining power.
- Be impact-driven. What will create the most impact for your charity? Work for the best outcome with the best partner and leave egos at the door as far as possible.
- Start preparing and work out what makes your charity a suitable and attractive merger partner. Gather financial data (and be honest about your financial position) and build a cultural fit case. Ensure that your missions, values and cultures are compatible with those of your potential merger partner. Transparency will be essential to build trust.
- Undertake full due diligence on your merger partner to understand the state of their legal, operational and financial health. This will help you identify if there are any dealbreakers for you.
- Consider whether you need any third party consents (e.g. from funders or from regulators) and leave enough time to obtain them.
- Don’t forget about communications – a good communications strategy is key to ensuring the merger announcement lands well with your key stakeholders (staff and volunteers, funders and beneficiaries) and they feel positive about the benefits of merger. In some cases, you might also need to get formal members’ approval to the merger.
- Plan integration carefully. The real work begins post-merger. Integration planning should cover systems and processes, staff structures, alignment of your programmes and branding and communications.
If full merger isn’t for you, you might consider collaboration or restructuring.
2. Collaboration
Possible collaboration models include shared services (finance, HR and IT) and joint delivery of programmes. Considerations for that collaboration will include: what is the project plan; how exactly the joint-mechanisms will work; staffing; brand and IP; an exit strategy and termination.
3. Restructuring
This will usually involve making significant changes to your charity’s operating and/or staffing structure. Examples of restructuring include: ‘hiving off’ a part of your charity’s operations to another entity, or selling part of your valuable IP to another entity to generate income.
The material in this article is provided for guidance and general information only and is not intended to constitute legal or other professional advice upon which you should rely. In particular, the information should not be used as a substitute for a full and proper consultation with a suitably qualified professional. Please do contact the Bates Wells team if you require further advice or information about management training which we offer.