Financially distressed charities—issues to be aware of

As a matter of charity law, charity trustees are those persons who have the general control and management of the administration of a charity (and therefore includes the directors of a charitable company).  A detailed overview of a trustees’ duties is outside the scope of this article, but those duties will include a duty to act in the best interests of the charity.  Where the charity is a charitable company, the directors will also need to comply with their duties under the Companies Act 2006, which includes a duty to promote the success of the company which means the delivery of its purposes.

When a charity is experiencing financial difficulty, additional factors come into consideration.  Most importantly, if the charity is a charitable company, the directors must also have regard to the interests of the company’s creditors.  In these circumstances it will be important for charity trustees to take expert professional advice at the earliest opportunity, to minimise their potential liability. 

In addition to ensuring compliance with their duties, charity trustees must also consider potential liability on an insolvent liquidation of the charity.

Where a company goes into insolvent liquidation, a former director of the company can be liable for wrongful trading if they knew or ought to have concluded at some point before the commencement of the liquidation or administration that there was no reasonable prospect that the company would avoid going into insolvent liquidation. That director can be ordered to make a contribution to the assets of the company in question.

A director has a defence to a wrongful trading claim if they can establish that every step he/she took was taken with a view to minimising the potential losses to the company’s creditors. It is therefore important that the directors take steps to minimise potential losses to creditors.

Any decision to continue trading should therefore be taken very carefully and in light of expert professional advice to avoid the risk of claims later being brought against directors of the company at the relevant time. It is also important that directors are careful to ensure that transactions are not undertaken which could be reviewable by a liquidator on a subsequent insolvency (such as transactions at an undervalue and preferences).

Charitable trusts and unincorporated associations lack legal personality, meaning they cannot enter into contracts or hold property. Instead, individual charity trustees are personally liable for the charity's obligations, including day-to-day liabilities. Charity trustees can be indemnified from the charity's assets, including insurance, for liabilities incurred in their duties. However, if the charity's assets are insufficient, charity trustees may face unlimited personal liability, unless otherwise contractually limited. This risk of personal liability is greater for charity trustees of unincorporated charities compared to those of incorporated charities.

There are various practical matters that trustees might want to address as soon as the solvency of the charity becomes a concern.

1. Consider a restructuring. Is the charity able to merge with another charity, or is another charity willing to acquire the assets?  Can you restructure your operations so as to continue to operate – perhaps by making some redundancies, reducing costs, agreeing compromises with any creditors?  Is it possible to obtain further funding (whether through donations or grants or even third party borrowing)? Can you release any restricted funds for use by the charity?

2. Record all decision making. Frequent board meetings should be held, and there should be an open flow of information relating to the company’s financial position.  Minutes should be kept of those meetings, with the reasons for decisions carefully documented.
3. Maintain up to date and accurate financial records for the company, and keep the costs and expenditure of the company under review. Ensure that the cash flow position of the company is carefully considered, and any contingencies properly catered for. Consider whether any ongoing expenditure can be reduced.

The critical point for all charity trustees to be aware of is that they should take professional advice at the earliest possible opportunity.  Many issues may be able to be resolved, or if not a plan can be put in place to deal with the consequences. Ignoring the financial difficulties or dealing with them at a late stage can lead to criticism at the very least or potentially claims being brought against the trustees.