Practical pointers for charities on mortgaging property

Lots of charities have asked us about borrowing to help with short term needs arising from the coronavirus pandemic. Our coronavirus Q&A includes an outline of the steps which charities considering mortgaging their land and buildings need to take, but, given the interest, this note contains some extended thoughts on the question.  

We are in emergency talks with a lender to cover our short-term cash needs. The lender wants security over our head office and other operating premises. We have checked our constitution, which clearly allows us to borrow and grant security, but what else do we need to do?

Assuming you are a registered charity, you need to follow the Charities Act rules, which require the trustees to take written advice about the loan from a financial expert before you approve and sign the loan documents. You must also ensure the mortgage documents contain statements that the land belongs to a charity and that the trustees have taken the necessary advice. Provided you can do both those things, you do not need to involve the Charity Commission. However, if you neglect them, you run the risk of the loan being void. If the Charity Commission subsequently examine the loan, the written advice will be one of the first things they ask to see, so it is worth getting it right.

What does the advice need to say?

The rules exist to give your trustees a framework for assessing the overall suitability, affordability and risk of the loan. Therefore, the advice must address three matters, each of which should be put in the context of your specific circumstances. They are:

• Whether the loan is necessary in order to pursue the course of action it is intended to fund.
  For example:
  - What are you going to do with the money?
  - How much money is required for that purpose?
  - Are there any alternative sources of funding and, if so, would it be better – or not – to.
  
  
• Whether the terms of loan are reasonable, given the status of the charity as borrower.
  For example:
  - What are the main terms of the loan in relation to matters like interest, length, repayment and default?
  - How do those compare with the terms you have been offered elsewhere?
  - What level of risk are you seen to present to the bank and what impact – if any – has that had on what is available to you?

• Your ability to repay the loan on its terms.
  For example:
  - What source of funding will you use to make the repayments?
  - Have you made any forecasts or assumptions about its availability?
  - Are there any alternatives if it fails? 
  - Do the loan terms cater for a deterioration in your financial position, for example with renewal or extension options? 
  - What other borrowings, liabilities and commitments do you have and what impact will the loan have on them? 
  - Will payment of the debt involve reducing or stopping some of your activities?  
  - What is the value of the mortgaged property in comparison with the loan and how far would it need to fall before the charity was in negative equity?

What are reasonable terms?

This turns on your creditworthiness and what is available in the market, so you should expect your expert to understand the current lending climate, including how the pandemic has affected it, and to have done some market testing. Because the advice is specific to you, if your financial circumstances mean that the choice of loans is limited and/or the terms on offer are less favourable than those available to your peers, that does not necessarily make the deal unreasonable, but the expert should acknowledge the position in the advice. It is also important to remember that the assessment of reasonableness looks at overall terms, not just price, so if your existing lender can deliver funds more quickly than a cheaper alternative lender, or if a higher cost loan comes with less stringent repayment terms, those are relevant factors that can be taken into account. 

How do we assess our ability to repay in the current circumstances?

There are no clear or easy answers to this and it is not covered by the Charity Commission’s main guidance on borrowing. There is an isolated suggestion in its internal guidance that a charity “should be able to make repayments without prejudicing its normal activities”, but that does not take account of emergency situations where normal activities are already at risk and, in order to avoid becoming insolvent on a cash flow basis (ie being unable to pay debts as they fall due), the loan might need to be coupled with scaling back or ceasing some operations. A loan of that sort could clearly be in the interests of the charity and should not be ruled out. That is supported by the Commission’s recent guidance on managing financial difficulties caused by coronavirus, which acknowledges that identifying your interests will involve a trade-off between meeting immediate needs and the possibility of future reductions in services, or even closure, and that borrowing might be a sensible alternative to an asset sale.

In practice, the most your trustees can do is to regard the rules as what they are: a risk management tool against which they need to assess the options with expert help, not a requirement to forecast the future accurately. The advice is, after all, just an opinion on what is possible. With that in mind, it should explore the different ways in which you might meet the loan commitment, based on some reasonable best- and worst-case projections. Some of the questions you might consider are outlined above and, ideally, the answers to them should be supported by budgets, income and expenditure projections and business plans, but there might be other matters specific to you which are also relevant. For example, in your case, you are being asked to mortgage your headquarters and operating premises. A worst-case scenario might result in their sale. The rules do not require you to eliminate the possibility of selling the mortgaged property in order to repay the loan, but you should still consider the impact of that and whether the charity would still be able to deliver its purposes from alternative premises or would have to close or re-structure. Any of those eventualities might be reasonable risks in the circumstances, but they should be considered at the outset.

Finally, it is critical that, although the rules focus on the new loan, you place it in the context of your general solvency. You should ask yourself not just how you might service the loan, but what effect it will have on your overall financial position (eg, even if you avoid cash flow insolvency, will you become insolvent on a balance sheet basis) and whether your ability to pay your other creditors will be prejudiced. You should also remember that the advice is a one-off assessment of your ability to repay the loan, based on what you know or predict at the time it is agreed. However, the insolvency rules demand that you keep the loan under regular review in the context of your total finances as circumstances unfold; taking Charities Act advice does not alter that.

Who counts as a financial expert?

The rules say that the advice must be given by a person whom the trustees reasonably believe to be qualified to deliver it, based on that person’s ability in and experience of financial matters. The advisor must also have no financial interest in the loan (ie they must not stand to enjoy a material gain or avoid a material loss). A suitable employee or trustee of the charity may give the advice, but the Commission recommends that, whoever delivers it, should be professionally qualified. 

In normal circumstances, many charities choose their finance directors to give the advice. However, in a high-risk scenario, you should think hard about whether that is appropriate or whether independent professional support or joint authorship would be prudent (and the Charity Commission’s guidance suggests that you should record the reasons for your selection). For example, you might want part of the advice to be given internally by someone who is familiar with the charity’s commitments and funding projections, part to be given by someone who knows the lending market and part to be given by an insolvency or restructuring specialist, so you have comfort that each aspect is delivered by a genuine expert. Whatever the case, given the scale of uncertainty and potential risk, an early conversation with your external accountants or auditors to discuss any support they can provide or concerns they might have is recommended.

Will this create a lot more work?

It shouldn’t. In practice, the advice rarely contains completely novel analysis. For most charities, drawing it together ought to be a consolidation process, which records and reflects on a sequence of earlier thinking, which has led to the recommendation being made to the board. That will frequently have included advice from other professionals, and it is normal – even good practice – to annex and cross-refer to copies of some of that detailed analysis.  

Who should make the decision to approve or reject the loan?

The Charity Commission’s internal guidance suggests that approval of some mortgage transactions can be delegated. However, that must be balanced against the general expectation that major, high risk or novel decisions of any kind will involve a charity’s trustees. In a case like this, where you are in an emergency situation, the advice should be considered by the full board and the decision about whether or not to proceed should be taken collectively at a trustees’ meeting, making sure that all those present have the opportunity to participate, ask questions and express their views. The main points of discussion should be recorded in the minutes and a copy of the advice should be attached for future reference.

What are the duties of the trustees in these circumstances?

Charities are entitled to take a degree of risk, where that is based on sufficient and appropriate evidence. Accordingly, your trustees’ duty is to consider the written advice and any other relevant factors, and, based on that, to take a reasonable decision about whether taking the loan and granting the mortgage is the best way of continuing to deliver the charity’s purposes. The only exception is if, in the course of considering the loan, your trustees conclude that you cannot avoid insolvency. In that case, their duty changes to focus on repaying your creditors. 

When reaching their decision, your trustees are expected to take the precautions which a prudent businessperson would take in managing their own affairs, and, if they have any professional qualifications, to bring those to bear in the process. Therefore, it is critical for them to know that, currently, considering the advice cannot just be a tick-box exercise – they must properly explore, question and understand it. If they decide to act against it, they need to be able to explain and justify their decision. They also need to remember that the advice is just the beginning and is not a substitute for careful review of the charity’s finances and ongoing, active, assessment of its ability to repay as the situation develops.

Where can I read the rules and is there any official guidance to accompany them?

The rules are found in section 124-126 of the Charities Act 2011 and the Charity Commission has published some commentary in section 9 of its CC28 guidance on disposals of charity land. In addition, you should look at the Charity Commission’s CC27 guidance on decision-making, in particular paragraph 2.3, which deals with selecting and considering expert advice.  Finally, the Land Registry has issued advice on the statements to be included in the mortgage, including the precise wording it expects different sorts of charities to use and guidance on who should sign the documents in its number 14 practice guide for charities.

If you require further information about anything covered in this briefing, please contact Hannah Whyatt or your usual contact at the firm on +44 (0)20 3375 7000.

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

© Farrer & Co LLP, May 2020