Charities will no doubt have been keeping a careful eye on their finances following a decline in income from a variety of sources since the start of the pandemic and imposition of social distancing measures earlier this year. Even as lockdown eases further over the coming months (absent national or local second spikes), the long-term financial impact of the pandemic on charities remains uncertain.
In this article, we set out trustees’ duties in relation to managing a charity’s resources and what to do where solvency and financial performance is a concern. We also set out the impact of the Corporate Insolvency and Governance Act 2020 (the Act), which was passed on 26 June 2020 and puts in place a series of temporary measures to support charities and businesses during the crisis.
This article is largely aimed at the trustees of charitable companies (to which, amongst some other structures, the Act applies directly), but some of the practical points will also apply to all types of charity.
Financial struggles: what should trustees consider?
At all times, charity trustees are required to act prudently, including in managing their charity’s resources, seeking appropriate professional advice where necessary. When doing so, trustees should have particular regard to the Charity Commission’s guidance on Managing a charity’s finances: planning, managing difficulties and insolvency.
Where financial performance is a concern, trustees will want to bear in mind the following:
- Whether to engage a restructuring specialist to review the financial position and provide advice to the trustees on their options.
- Where a charity is facing liquidity issues or serious financial losses, or if it is insolvent or likely to be insolvent or close permanently within the next 12 months, it should make a Serious Incident Report to the Charity Commission.
- Where a charity is insolvent or is of doubtful solvency, the trustees will be under a duty to consider the interests of creditors over and above pursuing the charitable purposes set out in its governing document. A charitable company is considered insolvent by applying one or both tests for insolvency, known as the “cash flow” test and the “balance sheet” test.
- The cash flow test is where the charity is unable to pay its debts as they fall due.
- The balance sheet test is where it is proven to the satisfaction of the court that the value of the charity’s assets is less than the amount of its liabilities, considering its contingent and prospective liabilities.
- Their obligations in relation to wrongful trading under the Insolvency Act 1986 when a charity is faced with a potential insolvency process (discussed below).
What is wrongful trading?
This is where a (charitable) company has gone into insolvent liquidation and it can be shown that before the charity entered into liquidation, the trustees (as its company directors) knew or ought to have known that there was no reasonable prospect of the charity avoiding insolvent liquidation. Where wrongful trading is found to have taken place, there is a risk that the trustees will be required by the court to make a contribution towards the debts or liabilities incurred by the charity. They cannot simply avoid the issue by resigning. It is rare, however, for charity trustees to incur any liability for wrongful trading.
Thankfully, the Act has introduced temporary measures until 30 September 2020 (but which may be extended depending on how the pandemic unfolds) to protect businesses from aggressive creditor action and support trustees to continue trading throughout this period by:
- prohibiting winding up petitions from creditors (who would ordinarily be able to make such a petition if they were owed £750 or more and were able to prove that the charity was not able to pay them); and
- suspending liability for wrongful trading by introducing an “assumption” by the court that company directors are “not responsible for any worsening of the financial position of the company or its creditors that occurs between 1 March and 30 September 2020”. The time period for this assumption may be extended by up to six months and may also be ended early if it is clear that the pandemic is no longer having an impact on businesses (which seems unlikely at present). The purpose of this suspension is to help company directors maintain their business during the crisis. It removes the threat of personal liability if they do not take every step with a view to minimising the potential loss to creditors, by, for example, continuing to incur new debts. However, it is not yet clear what exactly the “assumption” introduced by the Act means or how this will be dealt with by the courts.
What are the other risks?
Trustees of charitable companies remain at risk of disqualification as they are still subject to laws regarding fraudulent trading, and to usual duties owed to their respective companies (which will, of course, include trustees of charitable companies). These obligations have not changed and directors will be liable for wrongful trading breaches for the time period before 1 March and after 30 September 2020 (or the relevant period under the Act if this changes). In addition, these provisions are unlikely to be relevant for any charities that were in financial distress prior to the pandemic.
As we look towards further lockdown easing, and the end of these temporary measures at the end of September, trustees should remain vigilant in reviewing the charity’s financial position. Any concerns should be addressed promptly, with the benefit of expert financial advice, where the trustees consider this necessary.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, August 2020