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All charity trustees have a fundamental duty to protect the assets of their charity and to use them to further the purposes of the charity for the public benefit. Given the variety of activities that charities undertake, the different types of funding that they receive and the effect that any changes in the economic climate will have on their funding sources, many charities will at some point face financial uncertainty. If a charity finds itself in financial difficulties, the risk of insolvency may be greater if the trustees do not take prompt action to address the situation.
This guidance provides advice and information for trustees of charities that are facing financial difficulties. It will also be of general use to charities that want to minimise the risk of insolvency by putting in place effective financial management.
The guidance also gives advice on aspects of the Insolvency Act 1986, as amended by the Insolvency Act 2000 and the Enterprise Act 2002. It describes;
Where we refer to 'insolvency' in this guidance, it is a convenient term we use in relation to all charities regardless of their legal structure. Where there is a legal distinction between what applies to incorporated and unincorporated charities, it is made clear in the text.
Insolvency is a complex matter and we strongly recommend that professional advice is taken as soon as the trustees are aware that the charity is facing an insolvency situation.
In this guidance, where we use 'must', we mean it is a specific legal or regulatory requirement affecting trustees or a charity. Trustees must comply with these requirements. To help you easily identify those sections which contain a legal or regulatory requirement we have used the symbol next to the section heading.
We use 'should' for items we regard as minimum good practice, but for which there is no specific legal requirement. Trustees should follow good practice guidance unless there is a good reason not to.
We also offer less formal advice and recommendations that trustees may find helpful in the management of their charity.
This version of Managing Financial Difficulties and Insolvency in Charities has been updated and rewritten in a new format but contains no change in policy.
The guidance aims to explain:
The information and advice in this guidance is relevant to charities of all sizes and structures. However, some of the details may be different if a charity:
The Charities Act means the Charities Act 2011.
Bankruptcy is a procedure that is available to insolvent individuals - someone who has insufficient assets with which to pay their debts and liabilities. The assets of the bankrupt individual are realised and distributed to those who are owed money.
Charitable company means a charity which is a company formed and registered under the Companies Acts.
A custodian trustee is a corporation appointed to have the custody, as distinct from the management, of trust property. A custodian trustee is not a charity trustee.
Endowment funds are funds which are held subject to specific trusts which are declared by the donors. An endowment fund may be a charity in its own right or a special trust of a charity. An endowment fund may be expendable or permanent.
Going concern means the ability of an organisation to operate for the foreseeable future.
Governing document means any document that sets out the charity's purposes and, usually, how it is to be administered. It may be a trust deed, constitution, memorandum and articles of association, scheme of the Commission, conveyance or will.
Holding trustees: Holding trustees are individuals appointed to hold the property of the charity. They can only act on the lawful instructions of the charity trustees and in accordance with any provisions contained in the governing document.
The Insolvency Act means the Insolvency Act 1986, as amended by the Insolvency Act 2000 and the Enterprise Act 2002.
An insolvency practitioner (IP) is an authorised person who specialises in insolvency, usually an accountant or solicitor.
Reserves are the resources that a charity has, or can make, available to spend for any or all of the charity's purposes once it has met its commitments and made provision for its other planned expenditure.
Restricted funds are funds to be used for specific purposes, set out by, for example, the donor, grant maker or the terms of a public appeal. Often restricted funds can be spent at the discretion of the trustees in furtherance of some particular aspect(s) of the purposes of the charity as determined by the donor, grant maker or the terms of an appeal. Restricted funds may not be spent on any other part of the charity's work.
Subsidiary trading company means any non-charitable trading company, wholly owned, or the majority of which is owned, by a charity to carry out trading activities on behalf of the charity with a view to raising funds in a tax-efficient manner.
Trustees means charity trustees. Charity trustees are the people who, under the charity's governing document, are responsible for the general control and management of the administration of a charity. In the charity's governing document they may be called trustees, managing trustees, committee members, or governors, or they may be referred to by some other title. The directors of a charitable company are the charity trustees.
Unincorporated charity means a charity that is not:
The short answer
It is essential for a trustee body to have a good knowledge and understanding of the charity and its finances so that, as far as possible, the continued viability of the charity and its charitable activities can be assured.
In more detail
There may be rare cases where insolvency can happen overnight, for example where a charity is wholly or almost wholly dependent on grant income that is cut at short notice and cannot be replaced by other sources of income. In most other cases, provided there are proper financial controls in place, it should be possible for trustees to identify financial risks and plan for their management at an early stage, despite changes in the economic environment in which it is operating.
The overall responsibility for effective governance and the implementation of proper financial management rests with the trustees, but may well involve all staff members whether paid or volunteers. Trustees may find it useful to read our related guidance:
The trustee body should be made up of people who are able to devote time to running the charity and possess the appropriate skills and abilities. The charity should have in place a long term strategy for the achievement of its objectives which covers finance, operations and governance. As insolvency is a financial risk, it is important for there to be regular trustee meetings at which financial reports and updates are provided and the financial position, budgets and financial projections of the charity are fully considered.
The trustees should regularly consider the overall financial position of the charity. This includes ensuring that:
Some of the key considerations for trustees will be:
Professional advice will normally need to be taken when investing charitable funds. More information on investing charitable funds can be found in our guidance Charities and Investment Matters: A guide for trustees (CC14).
It is important for planning purposes that the trustees are aware of the ways in which their charity's assets and resources can be used. Some funds can be used for all of a charity's purposes and some have restrictions on use placed on them by their donors.
An understanding of the nature of the separate funds of a charity is crucial to the understanding of its financial position. Such considerations must be taken into account when analysing and assessing the solvency of a charity.
It is a breach of trust to use endowment or restricted funds for purposes other than those for which they were given by the donor. The Charities Act now provides a simplified procedure for the expenditure of permanent endowment which is applicable to most charities. For larger permanent endowment funds it may be necessary to seek our approval before the trustees can spend the capital.
However, section 31 of the Trustee Act 2000 provides that a trustee is entitled to pay out of (or be reimbursed from) the charity's funds any expenses that have been properly incurred on behalf of the charity. In the case of an unincorporated charity, this may mean that permanent endowment or restricted funds of that charity could be used to cover the liabilities of the charity. These permanent or restricted funds may be available to the charity if there are no other assets available. However the trustees may need to take professional advice about this.
It is important to determine whether endowment or restricted funds are in fact separate charities, perhaps linked by way of a uniting direction or by way of common trusteeship. The funds belonging to separate charities are only able to be used to settle the debts of the specific charity that they belong to.
A charitable company cannot hold permanent endowment as part of its corporate property. However, a charitable company can act as a corporate trustee of a permanently endowed charity. If the company is facing insolvency, these permanently endowed funds (and any other funds held on special trusts) would not normally be available as part of the company's corporate property to settle debts not relating to the permanent endowment or special trusts.
A charity may have substantial funds tied up in functional fixed assets, eg its premises, a hospital building or a care home. This type of asset is normally used to enable the charity to carry out its purposes (or functions). Unless effected by way of a sale and leaseback arrangement, disposal of these assets could result in the charity being unable to continue its charitable operations. It may be difficult to realise the value of such assets quickly, and any disposal is likely to be part of an overall restructuring of activities.
It tells them whether the charity has sufficient (realisable) assets to meet its actual and contingent liabilities at a particular date.
Balance sheets are normally prepared on the basis that the charity will continue as a going concern for the foreseeable future. Functional fixed assets such as office premises or vehicles, for example can be shown at either cost or market value in a balance sheet. If the charity can no longer operate as a going concern then trustees will need to consider the basis of the valuation when assessing solvency.
If the going concern assumption, referred to above, no longer holds true, then trustees will need to consider an alternative valuation for their functional fixed assets – perhaps a forced sale value.
Also, certain future commitments or contingent liabilities may not be shown on the balance sheet but still need to be taken into consideration. The trustees must determine whether such commitments are legally binding. Some commitments may not be legally binding, but if not honoured, might expose the charity to reputational risk that is so significant that settlement can be justified.
There may also be new liabilities to be taken into account which would only arise on liquidation, such as redundancy costs for staff, costs incurred in realising assets and professional charges.
There is no statutory definition of 'insolvent' although the Insolvency Act 1986, when referring to a state of insolvency, uses the phrase "unable to pay its debts". In practice there are two separate tests for insolvency and failure of either might be an indication of insolvency:
An unincorporated charity cannot technically be insolvent as it has no legal identity separate to its members and trustees. This means that any liability of the charity is the liability of its trustees or members. However, the term 'insolvency' is used in this guidance to describe a situation where a charity's available assets are not sufficient to cover the liabilities of the trustees or members.
Section 123 of the 1986 Act provides that a company is deemed to be unable to pay its debts where:
Generally insolvency law aims to rescue or restructure a business rather than liquidate it. A rescue can maximise the return for creditors. A rescue often involves selling a business (free of its liabilities) to another party and using the proceeds of sale to pay its creditors. This is not usually relevant to charitable companies as it is unlikely that an insolvent charity's 'business' will be sold to another party to pay off its creditors.
The basic tests are set out in C1 above:
The cash flow or short-term liquidity test shows whether a charity has sufficient easily accessible resources available to meet all of its liabilities as they fall due and to continue to meet them in the short term. Simply, can the charity pay its debts when they fall due for repayment?
The balance sheet test focuses on the overall asset position of a charity. It will show whether the charity has enough assets (fixed and current) to meet all of its actual and anticipated liabilities. The balance sheet test is not normally sufficient on its own to determine whether a charity is insolvent and is normally applied together with the cash flow or short term liquidity test above.
There are a number of other indicators that a charity might be running the risk of insolvency. It is not possible to provide a comprehensive list as the situation will vary from one charity to another, but listed in the box below are some questions that trustees might find useful to ask themselves:
The answers to these questions ought not to be looked at in isolation. Further detailed analysis would be required before any conclusions on solvency could be made.
If the trustees consider that their charity might not be able to continue to operate due to its financial situation, they should consider the following actions:
Yes, but only if great care is exercised. Despite failing the tests referred to above at a particular point in time and therefore appearing insolvent, an organisation may, depending on the precise circumstances, continue as a going concern and not be forced to wind up.
Charities may, in the short term, have to operate over and above agreed credit terms, or to resort to short-term financing, whilst they await an expected influx of cash. For example, this may arise when there are administrative delays in the payment of a grant.
However, directors of charitable companies will need to ensure that the company does not continue to trade if they knew or ought to have concluded that there was no reasonable prospect that the company would avoid insolvent liquidation. This is known as wrongful trading and if proved in court can entail personal liability for the directors. Trading while insolvent may not necessarily be wrongful if there is a reasonable prospect of avoiding insolvent liquidation.
We recommend that the trustees of any charity that appears to be insolvent take professional advice before any remedial action is taken. A charity can approach an independent insolvency practitioner, but should consider contacting their own auditor or professional accountant first (if they have one). Their auditor or accountant may be able to recommend an insolvency practitioner who specialises in charities. The charity's internal accountant, finance director or treasurer might also be able to offer support to the trustees in deciding whether there is an alternative to insolvency proceedings. They may also be able to comment on how the charity's procedures could be changed in order to ensure there is sufficient evidence that the trustees have acted properly in the circumstances. The Insolvency Service web site includes a database of all insolvency practitioners on www.bis.gov.uk/insolvency
If effective financial management and controls are in place, then insolvency may be prevented or foreseen in its early stages. It is in the gap between the identification of approaching insolvency and the actual commencement of insolvency proceedings that the trustees must take action in order to rectify the position. In the case of an unincorporated charity this point will be where the trustees are actually faced with the possibility of personal liability.
We recommend that appropriate professional advice is taken at an early stage because corrective action needs to be carefully considered and planned. Such advice should be in writing, and any remedial action suggested should be monitored along with new or revised budgets and cash flows. The accuracy of these will depend on reliable financial information, which will now be of even greater importance. In exercising control over this process the trustees are advised to meet more frequently and record key decisions, including the reasons for the decisions and any arrangements made.
The steps that the trustees can consider taking to deal with issues such as shortage of income and the establishment of more effective structures and procedures will depend very much on the nature of each individual charity and the reasons for the financial difficulties it faces.
Set out below are two key areas for consideration by the trustees and under each are suggestions for the type of action that might be appropriate.
Dealing with shortages of incoming resources:
Restructuring the charity's operations:
The short answer
Administration is a court procedure that gives a company some breathing space from any action by creditors – in effect it is a rescue process.
A court can grant an administration order to enable a company to:
The procedure is managed by an administrator, who must be an authorised insolvency practitioner.
When a company goes into administration, an administrator is appointed to act in the interests of all the creditors of the company and attempt to rescue it as a going concern.
When facing potential insolvency, charities can consider entering into an arrangement with their creditors as a rescue mechanism to avoid compulsory liquidation or winding up. The nature of the arrangement will depend on whether it is incorporated or not.
Charitable companies: Under s.1 to s.7B of the Insolvency Act, a charitable company may enter into a Company Voluntary Arrangement (CVA) with its creditors. The creditors may agree, as part of the arrangement, to accept a reduction in their debt and/or a delay in payment. The directors would need to apply to the court with the help of an authorised insolvency practitioner, who would supervise the arrangement and pay the creditors in line with the accepted proposals.
A CVA can be implemented during an administration.
The Insolvency Act 2000 introduced a new procedure to enable a small company to obtain a moratorium where a CVA is proposed. A moratorium provides a breathing space to give a company's directors time to put a rescue plan to its creditors. It prevents the company's creditors from proceeding against the company during the relevant period, whilst allowing the directors to remain largely in control of the company.
A company is eligible for a moratorium where it can satisfy two or more of the following criteria:
If a company is already in administration, liquidation or administrative receivership, it is already protected from the actions of creditors by these procedures and so would not need to seek a moratorium. In addition, a moratorium is not available where a company currently has a CVA in place or has already had a moratorium in the previous 12 months and the proposed CVA did not come into effect or ended prematurely.
Unincorporated charities: It is possible for the trustees of an unincorporated charity facing insolvency to enter into an informal arrangement with their creditors. The creditors under such an arrangement might agree to defer payment of the debts and liabilities that the trustees have incurred on behalf of their charity, and/or agree to reduce the size of their claims. Such an arrangement falls outside the provisions of the Insolvency Act. If the arrangement is legally binding, it will only bind those creditors who are party to the agreement. We recommend that appropriate professional advice is taken before entering into such an agreement.
If the rescue mechanisms described above are not possible, then liquidation or winding up is the last resort.
Charitable companies: When the directors of a charitable company know, or ought to know, that there is no reasonable prospect of avoiding insolvent liquidation they must from that time take every step necessary to minimise the potential loss to the company's creditors. This may involve cutting down or stopping some or all of the charity's activities. Paying professional fees for advice obtained is justifiable if incurred with a view to ensuring the best outcome for the charity's creditors.
The court will not normally order the compulsory liquidation of a charitable company on the ground of inability to pay debts until after a creditor has either:
In these circumstances the creditor can petition the court to wind up the company. Once a charitable company is being wound up, whether voluntarily or compulsorily, it is placed under the management of an insolvency practitioner as liquidator. It is then too late for the directors to take action of their own to bring the charity out of insolvency.
Members of charitable companies can voluntarily place the company into liquidation. Where the members of a company pass a resolution to liquidate the charity, this will be a creditors' voluntary liquidation if the company is insolvent. It will be a members' voluntary liquidation if the company is solvent. The main difference between the two is that in a creditors' voluntary liquidation, the creditors rather than the members control the choice of insolvency practitioner.
Unincorporated charities: The decision to wind up an unincorporated charity will normally be one taken voluntarily in accordance with the provisions of the charity's governing document.
Although unincorporated charities cannot be compulsorily wound up, their trustees may face legal demands from creditors in relation to liabilities that they have incurred on behalf of the charity.
Where the trustees of an unincorporated charity see that there is no reasonable prospect of avoiding insolvency, their duty to act prudently may involve cutting down or stopping some or all of the charity's activities. This means that there is more likelihood that sufficient property will remain in the charity to cover the costs of meeting the debts and liabilities they have incurred in the administration of the charity.
If a charity is facing insolvency, the trustees should bear in mind the following points:
It is essential that the charity trustees keep a full written record of all decisions and actions taken through any closing down period and the reasoning behind them. The process of taking full detailed minutes can encourage a structured thought process and will help to protect those taking the decisions.
Charity trustees have a duty to act prudently and reasonably in administering the financial affairs of the charity. They must ensure prudent financial management and compliance with the law, including insolvency law. The legal position of charity trustees in an insolvent situation varies according to the legal structure of the charity.
Where a charity has been incorporated under the Companies Acts, the company is itself normally liable for the debts which the directors have incurred on its behalf. Charitable companies are normally limited by guarantee and the members of the company will have no liability for the debts of the company beyond the (usually nominal) amount of their guarantee. The directors themselves will normally have no personal liability for the company's debts, because the company has a separate legal identity (unless, for example, they personally guarantee the payment of the debts). However there are certain limited circumstances involving fraud, transactions at an under value, wrongful trading or breach of trust where directors may face personal liability.
As officers of the company, the directors:
As mentioned in B3, assets held by a charitable company as trustee, rather than as part of its corporate property, do not form part of the property available for distribution to the company's creditors in accordance with the law of company insolvency. Only liabilities which have been properly incurred in the administration of the particular trust can be met out of the trust property. It could be a breach of the charitable company's duty as trustee to allow assets held on trust to be distributed to its creditors as if those assets were simply a part of the charity's corporate property. Any director, liquidator etc who is responsible for committing the charitable company to such a breach of duty could be in breach of his or her fiduciary duty towards the charity. They could, therefore, be liable to make good a loss of its trust property.
In the course of winding up a charitable company which is unable to meet all its debts, a director can be ordered by the court to contribute to the assets of the company if it appears that, some time prior to winding up, he or she:
The contribution referred to above is required specifically for the purpose of reducing the creditors' losses. The director is judged by the standards of a reasonable director as well as by reference to his or her individual qualifications and capabilities.
If someone acts as a director of a charitable company while disqualified from doing so, he or she becomes directly liable to creditors for any liabilities of the company incurred while he or she is involved in its management. This applies whether or not he or she has been formally appointed as a director. Full details of such matters are in the Company Directors Disqualification Act 1986. Acting as a trustee while disqualified is also an offence under s.178 - 180 of the Charities Act.
The short answer
Where a liability has been properly incurred by the trustees of an unincorporated charity, but the charity does not have sufficient assets to meet the liability, those trustees are likely to have to meet the shortfall personally.
How this liability is to be shared between the trustees can depend on the terms of the agreement that gave rise to it, but normally the creditor will be able to sue any of the trustees for the whole liability. A trustee who has to pay more than their share may claim a fair contribution from the other trustees. This means, in effect that any liability will be shared equally between those of the trustees who can be found, and who have the means to pay, unless they agree otherwise among themselves.
As long as the decision to incur a liability on behalf of the charity was properly made in accordance with its governing document, then each and every trustee shares the responsibility for that liability (unless the terms of the agreement incurring the liability specify otherwise). Trustees normally have a right under the Trustee Act 2000 to look to the charity's assets for reimbursement of any liabilities properly incurred. In most circumstances both the responsibility and the right to reimbursement remain even after a trustee has retired (but note that this is not the case when the liability stems from a contract of employment - any claims against the trustees under that contract are against the trustee body as it stood at the time the contract was breached).
The concern for trustees is that, in the absence of any relevant insurance, they will have to meet any debts and liabilities out of their own pocket if the charity cannot meet them. This will not be the case where the debts and liabilities have been incurred on the basis that the other party has agreed that they will only have to be met if there are sufficient funds in the charity to do so. For example, this type of clause is sometimes included in property leases. If the liabilities of the charity are more than the trustees' personal assets, the trustees themselves could be forced into personal bankruptcy or individual voluntary arrangements.
The Charities Act allows for the incorporation of the trustee body of an unincorporated charity. This means that the trustee body as a whole will be able to enter into contracts or other commitments as a corporate entity rather than as individual trustees, but the individual trustees still retain personal liability for the debts of the charity. More information about this can be found in our guidance Incorporation of Charity Trustees (CC43).
Unincorporated charities will often place property in the name of one or more holding trustees or a custodian trustee. As long as they do not exercise any managerial or financial control for the charity but merely hold the property on behalf of the charity, they are not charity trustees, and will not therefore have personal liability for any of the charity's debts. However, a custodian trustee can be held liable if it allows or assists the charity trustees to commit a breach of trust.
Although we are precluded by law from becoming involved in the internal administration of a charity, including restructuring and refinancing, when solvency is an issue, we may have a regulatory interest. However, questions of financial viability must remain a matter for the charity trustees and their professional advisers.
If a charity requires advice about the use of permanent endowment or restricted funds or wishes to enquire about the exercise of any of the Commission's statutory powers, it should contact us at an early stage.
Where there is suspicion of mismanagement, maladministration or risk to property held for charitable purposes, we may open an inquiry under section 46 of the Charities Act. This is dealt with in our guidance Complaints about Charities (CC47).
Where a charity is under a section 46 inquiry we have the power to appoint an interim manager under s.76 of the Charities Act (unless a liquidator had already been appointed). This appointee should not be confused with an administrative receiver appointed in the interests of a secured creditor of a charity whether under the Insolvency Act or otherwise.
An interim manager can be appointed using our powers where we are satisfied that the trustees have not acted properly, or where we perceive there to be a risk to charitable property. In some cases the appointment may be made in co-operation with the trustees.
An interim manager can be given a range of instructions by us and normally fulfils the role of the trustees for the duration of his or her appointment. This may include reviewing the overall viability of the charity.
We may also receive complaints about the trustees of a charity or the way the insolvency was handled. We would consider such complaints in the same way as other complaints about a charity.
Trustees have a duty to tell us when their charity has wound up. Under s.34 of the Charities Act we have a duty to remove charities from the Register of Charities where they cease to exist or do not operate.
Charitable companies: We would expect the liquidator to liaise with us regarding any documentation required for the charity's removal from our Register on its being dissolved. We would also expect the liquidator subsequently to inform us when the liquidation is complete and the company has been dissolved under the Companies Act 2006.
Unincorporated charities: It will be up to the charity trustees to carry out the winding up of the charity in accordance with its governing document, taking appropriate professional advice as necessary.
All assets and liabilities must be identified. Any assets left over after meeting the proper claims of creditors must be applied by the trustees in accordance with the dissolution provision in the governing document of the charity. If there is no such dissolution provision they should seek our advice.
For further information on how to remove a charity from the Register of Charities and access to the online removal form, please see Close or merge a charity.
The Charity Commission produces a wide range of publications and website guidance giving information and advice to charity trustees and the general public on a number of issues relating to charity law, regulation and good practice.
We also list here a selection of other organisations and publications which can be used as sources of information.
The list of our guidance below is a selection based on some of the issues identified in this guidance.
Charity Finance Group (CFG)
This is a membership organisation which helps charities manage their accounting, taxation, audit and other finance related functions. Its website has a useful Recession Watch page.
Charity Finance Group
49-51 East Road
Tel: 0845 345 3192
Web address: www.cfg.org.uk
The main functions of Companies House are to:
It provides guidance on liquidation and insolvency which can be viewed on www.companieshouse.gov.uk/about/guidance.shtml.
Tel: 0303 1234 500
Web address: www.companieshouse.gov.uk
Her Majesty's Revenue and Customs (HMRC)
HMRC's website contains information on a range of issues of interest to charities including Gift Aid, Payroll Giving, tax reliefs and VAT.
HM Revenue and Customs Charities
St Johns House
Charities helpline: 0845 302 0203
Web address: www.hmrc.gov.uk
The Insolvency Service
The Insolvency Service website offers a wide range of advice and information on matters related to insolvency including a database of all insolvency practitioners http://www.bis.gov.uk/insolvency
The Pensions Regulator
The regulator works to improve confidence in work-based pensions by protecting members' benefits and encourage high standards and good practice in running pension schemes.
The Pensions Regulator
Tel: 0845 600 0707
Web address: www.thepensionsregulator.gov.uk
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