Commercial borrowing by charities

Many charities rely on donated income, income from trading activity or investment returns to allow them to further their purposes. Lots of charities, however, will at some stage turn to debt financing to allow them to purchase or develop property, invest in new technology, or expand their offer to beneficiaries.

This article is a guide for charity trustees on what commercial lenders will bear in mind when lending to charities.

Charitable structures

Lenders will need to understand who their borrower is, which means determining how a charitable borrower is structured. This is easier in some cases than others.

The word “charity” does not denote a particular legal form or structure: it is a legal status which can be applied to a wide range of organisations. By way of example, a charity could be structured as a company (usually limited by guarantee), a charitable incorporated organisation (CIO), or a charitable trust. In addition, we regularly come across charities constituted by Royal Charter and Act of Parliament, as well as unincorporated members’ associations (although these are becoming less common).

These legal forms can be placed into one of two broad categories: incorporated charities and unincorporated charities. Incorporated charities (principally companies, CIOs, Royal Chartered organisations and organisations formed under Acts of Parliament) have legal personality and so can enter into contracts (including loan and security documents) in their own names (although it is likely, for more unusual incorporated structures, that a lender will require a legal opinion from the charity’s lawyers as to its capacity to enter into the loan). In contrast, unincorporated charities (ie charitable trusts and unincorporated associations) do not have legal personality and so are unable to contract in their own names. This means the trustees will be borrowing in their own names (albeit in their capacity as trustees of their organisation). A summary of the particular challenges this raises from a lender’s perspective is contained in our article How to lend to trustees.

Powers to borrow and grant security

Before lending to a charity (regardless of its legal form) a lender will need to be satisfied that the charity has the power to borrow. Most charities will have an express power to borrow and grant security in their governing documents, sight and certification of which will be requested by most lenders as a condition to be satisfied prior to funding. Some charities, particularly those whose governing documents have not been updated for a long time (which is often the case for Royal Chartered or statutory charities) may not have express powers, or their powers may be difficult to interpret. In these circumstances a lender may require a legal opinion as to the borrower’s power to enter into the loan.

Documenting the loan

Loan agreements with charitable borrowers will not be documented in a fundamentally different way to any other commercial loan, but there are some commercial and practical points which lenders will bear in mind (and which will impact upon the terms they are prepared to offer a charitable borrower).

The borrower is usually the charity itself (rather than a special purpose vehicle as tends to be the case in the context of commercial borrowing). Charities will therefore need to ensure when negotiating the representations and undertakings that day to day activities are not unduly restricted (which may be the case if the lender seeks to lend based on its standard form documentation). Some charitable borrowers may also have less reliable income streams than commercial borrowers, which might limit the loan amount the lender’s credit committee can approve.

When the trustees of an unincorporated charity are entering into a loan, it is important to ensure that the personal assets of those trustees are protected and not available to a lender to satisfy the liabilities of the charity. This is done by including a limited recourse provision which limits the trustees’ liability to the value of the trust assets or to the sale proceeds of those assets. The inclusion of limited recourse provisions should not be contentious for a lender with an understanding of lending to trustees (whether trustees of charitable or private trusts). For more information on the form these limited recourse provisions tend to take, please refer to our article How to lend to trustees.

Security over land

A charity’s property interests tend to rank among its most valuable assets, so charity law accords special protection to land held by or in trust for a charity. In particular, a charity may not grant a mortgage of land without Charity Commission consent, or the trustees of the charity having obtained and considered formal written advice on the terms of the mortgage. Obtaining Commission consent is rare in practice, because as a matter of policy the Commission will not grant consent for something which a charity has the power to do without its involvement. Failure to adhere to these statutory requirements runs the risk of the loan being void, so it is important to get them right.

The advice to be provided will need to cover:

• Whether the loan is necessary to allow the charity to proceed with the proposed course of action,
• Whether the terms of the loan are reasonable, and
• The charity’s ability to repay on the proposed terms.
  
  

The advice can be provided by external advisors or by a trustee or employee of the charity who is reasonably believed by the trustees to be suitably qualified, and who does not have a financial interest in the transaction. Most lenders will require a copy of this advice as a condition precedent to making the loan. For more information on what ought to be included in the formal advice, please refer to our article Practical pointers for charities on mortgaging property.

In addition to this requirement to seek advice (or, rarely, the Commission’s consent) the security documents will (from 7 March 2024 onwards) need to contain a statement that (i) the mortgaged land is held by or in trust for a charity, and (ii) there is the power to grant the mortgage, and the trustees have obtained and considered proper advice as set out above.

These changes (which were introduced by the Charities Act 2022 and implemented on 7 March 2024) remove the need for a trustees’ certificate when a charity grants new security. This welcome amendment removes a key point of confusion for incorporated charities at the point of execution. However, this change does not extend to further advances secured by existing mortgages, for which a trustees’ certificate will continue to be necessary.

Security over other assets

Broadly speaking, a charity can grant security over its other assets (for instance an investment portfolio or bank accounts) without formality, as there are no Charities Act restrictions on charging non-property assets. An important exception to this rule is that a charity may not, subject to limited exceptions, charge its participation in a common investment fund to a lender.

Of course, trustees must only charge their assets to a lender where they determine that doing so would be in their charity’s best interests.

Granting security over permanent endowment

Particular considerations apply where a charity seeks to grant security over permanently endowed assets. The Charity Commission recognises that circumstances may arise where permanent endowment may be charged to a lender; similarly, the Law Commission’s view is that permanent endowment assets can (depending on the specific terms of the restrictions applying to the assets) be charged to a lender. Nonetheless, trustees should exercise caution and seek specialist legal advice before taking a decision to grant security over their charity’s permanent endowment assets, to ensure that the grant of such security is consistent with the charity’s powers.

Approval of loan documents

In most cases the final decision to enter into a loan transaction should be taken by the board of trustees. That said, a board can (and often does) delegate authority to a committee or to a senior employee (for example a finance director or CFO) to negotiate the transaction documents before they are presented to the board.

Execution

A charitable company established under the Companies Acts is able to execute documents in the same manner as any other company subject to the same legislation, and similar provisions as to execution are included in the Commission’s model constitutions for CIOs. The governing documents of other incorporated charities will need to be reviewed to ascertain who can sign on their behalf (and may, particularly for older charities, require the application of a formal seal).

As a general rule, all trustees of a charitable trust are required to execute documents where they enter into transactions on behalf of their charity. However, it is possible (and common practice) for trustees to delegate signing authority to two of their number under section 333 of the Charities Act 2011.

Charity trustees tend to work on a voluntary, part time basis, and may not be available at short notice to approve and / or execute documents. The practicalities of approving and signing documents should therefore be raised with a lender at an early stage of the transaction, to ensure that the parties are aligned on timing for execution and transfer of funds.

This publication is a general summary of the law as at the date of publication. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, March 2024