Five common questions from charity trustees when facing financial difficulties

How do I know if my charity is facing insolvency?

Reliable financial information is key. The financial reports provided to the trustees need to provide enough information to assess the financial position of the charity. These reports need to be fully considered by the trustees. Below are some questions to ask to find out if your charity is facing insolvency. The more “yes” answers, the more likely that the charity is facing insolvency, but more analysis is needed to assess whether that is the case. Professional advice should be sought.

• Are the current assets plus investments less than the current liabilities?
• Are the total assets and foreseeable income less than the total liabilities and expected expenditure?
• Is there a need to use reserves as the incoming resources are not enough to meet all the charity’s commitments?
• Is the charity relying on using cash from restricted funds to finance general day-to-day needs because there are no unrestricted funds available?
• Is the charity reliant on bank loans with unclear renewal or extension options in order to continue its operations?
• Is there pressure from creditors who are chasing overdue payments?
• Does the charity have potential significant contingent liabilities?
• Does a cash flow show that there are insufficient monies to make all payments as and when due?

We are a charity facing cashflow difficulties, can we use the reserves and restricted funds?

In the first instance, trustees should consider what all the available options are, for example:

• Emergency appeal
• Alternative funding
• Amendments to existing financial commitments and facilities
• Engagement with stakeholders for assistance
• Reduce expenditure
• Consider amending or discontinuing service provision
• Realisation of surplus assets
• Discussions with other charities on handing over service provision or even merging
• Reserves can be spent to help cope with unexpected events
• The restrictions that are on the reserves must be fully understood
• Internal allocations can be reprioritised
• Restricted funds can only be used for the particular and defined purpose for which they were given. In some very limited instances, there may be ways to amend these restrictions, but accessing or releasing restricted funds should only be considered if other options such as reserves are not possible. Implications on the relationship with funders should be considered
• You should seek professional advice.

What is the personal liability of a charity trustee if the charity enters insolvency?

The legal position of charity trustees in an insolvent situation varies according to the legal structure of the charity and whether it is a charitable company or an unincorporated charity.

Trustees/directors of a charitable company will not normally have personal liability for that charity’s debts unless:

• They have given a personal guarantee
• Certain circumstances where they have committed fraud
• If they act as a trustee or director whilst being disqualified to act as a director.

Trustees of an unincorporated entity may have personal liability where the assets of the charity are insufficient to meet its liabilities. There may be agreements between the trustees on how this is shared. Specific creditors may have agreed no personal liability (common in property leases).  The concern for trustees is that they may have to meet any debts of the charity out of their own pocket. A creditor may be able to sue an individual trustee for the whole liability. If the liability is more than a trustee’s personal assets, then they may have to become bankrupt.

What are the implications on me personally if the charity enters insolvency?

We discuss personal liability above which can be a concern. Where the charity is a charitable company the conduct of the trustees as directors will be assessed, and a report submitted to a government body that can take action to disqualify a director if that director is found to be unfit. When disqualified, a director can’t act as a director for any company, so if a trustee has other directorships they will have to resign from all other positions.

A recent high-profile court case looked at this; Kids Company was a high-profile insolvency appointment in 2015. It was a large charity and there was lots of press coverage at the time. Action was taken to disqualify the trustees as directors. In addition, action was also taken to disqualify the Chief Executive who did not hold a trustee or directorship position. It was defended and the judgement issued in February 2021. No unfit conduct was found and there are some interesting points to be taken from the judgement for those acting as Charity Trustees.

The main allegations against the trustees included poor governance, mismanagement and inadequate financial scrutiny. The judgement discussed the role of charity trustees and that, as effectively acting in public service as an unpaid charity trustee, they should not be rewarded by being sued for mismanagement. The perceived risk of disqualification action following a general allegation of incompetence is a deterrent to acting as a charity trustee.  For those professionals operating in regulated arenas with valuable experience, disqualification can be catastrophic. If these individuals perceive a risk, they may only choose to assist the most solvent and well-run charities that are arguably much less in need of their skills. The suggestion is that the court will look at charity trustees more benevolently than those directors operating in a purely commercial field. The judge commended the individuals in this case for their care and commitment in highly challenging circumstances.

Continuing to operate with insufficient reserves was another claim made against the trustees.  Many charity trustees will appreciate the challenges around securing long term charitable funding and the balance between building reserves, being penalised by certain funders perceiving modest reserves as too high and the impact of reducing services provided to vulnerable beneficiaries. Trustees can take comfort that operating with an insufficient reserves level will not lead to unfit conduct on its own account.

Another point made was that those trustees who are more involved and engaged in the affairs of the company should not be held to a higher standard than those who were not. Those who remain in office and try to stop the charity from falling to bits should not be more severely dealt with because they did not step back. On the other hand, not attending meetings or participating in sub-committees does not mean a trustee should be treated more leniently.

All of this should provide comfort to trustees who are trying to do the best in challenging circumstances. There was no dishonesty, no personal gain or lack of probity and the inference from the judgement is that disqualification, in this case, should not have been pursued and was not in the public interest. In any event, trustees do need to make efforts to ensure robust financial reporting that is revied and that they identify key issues and address them.

What are the options when a charitable company is facing insolvency?

First thing to do is to take professional advice. When the trustees/directors of a charitable company know, or ought to know, that there is no reasonable prospect of avoiding insolvent liquidation, from that time they must take every step necessary to minimise the potential loss to the company’s creditors. Paying professional fees for advice obtained is justifiable if incurred with a view to ensuring the best outcome for the charity’s creditors.

Early identification of potential insolvency will mean more options and more time to explore and implement those options. Some of the things that can be considered:

• Obtaining new funding
• Amendments to existing financial commitments and facilities
• Engagement with stakeholders for assistance
• Reduction in expenditure/reviewing service provision
• Realisation of surplus assets
• Mergers with other charities or organisations
• It may be possible to enter into an arrangement with creditors.

A company voluntary arrangement is a statutory process governed by the Insolvency Act by which the creditor may agree to accept a reduction in their debt or delay payment. An Insolvency Practitioner is required to supervise. If agreement is obtained, then the charity may be able to survive.

For smaller charities it may be possible to enter into an informal arrangement with the creditors. Trustees should take professional advice before committing to this.

If the above is not possible then the charity may have to cease trading and enter liquidation.

If trustees do nothing, it’s likely that a creditor will take action to wind up the charity. Charity trustees could be found personally liable. They could also find themselves being disqualified as directors.

Need help?

If you’d like to discuss anything in more detail, please get in touch.

You can find contact details on the Our People section of our website. Alternatively, call 0330 024 0888 or email enquiry@larking-gowen.co.uk

Lee Green