School borrowing: unlocking funds for future success?

Borrowing money is a common practice for schools to finance various projects, from building new facilities to upgrading technology. However, this process comes with its own set of challenges and considerations. This article explores the key issues schools face when borrowing money and offers tips on how to navigate these challenges effectively.

Powers to borrow and grant security

Before lending to a school, a lender will need to be satisfied that the school has the power to borrow (and, if relevant, grant security). Most schools 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 schools, particularly those whose governing documents have not been updated for a long time, may not have such express powers, or their powers may be difficult to interpret. In these circumstances, a lender may require a legal opinion confirming the school’s capacity to enter into the loan agreement and any associated security.

Documentation

The loan and security documentation will contain a number of representations, warranties, covenants and events of default. The school should discuss these clauses with its legal adviser to ensure that these clauses don’t prevent it from carrying out its day-to-day activities.

Be aware that a bank's standard form loan and security documentation is often unsuitable for schools. Even a small, secured loan may require bespoke drafting and legal advice. Simple things, such as correctly identifying the borrowing and/or securing entity, can sometimes be overlooked if standard form templates are used. Additionally, there are sometimes less obvious issues that need resolution. For instance, in a recent case in which we acted for a leading private school, the bank’s standard form documentation allowed it to visit the school property at any time. This clause was inappropriate due to the school’s safeguarding policies. We negotiated this clause so that the bank could visit the property during working hours only and provided that sufficient prior notice was given.

Limited recourse

If the borrowing school entity is a trust, and individual (and sometimes corporate) trustees are transacting on behalf of the school, the transaction documentation must include appropriate language to limit the lender’s recourse to the trust’s assets. It should also specify that the trustees are entering into the documentation solely in their capacity as trustees, not in their personal capacity. Without this language, there is a risk that trustees could be held personally liable if the loan’s interest or principal payments are not paid when due.

Security

Most lenders will require borrowers to secure their loan with certain assets, such as property. One of the benefits of this is that the interest rate on a secured loan tends to be lower than an unsecured loan. For schools that are charities, it is important to note that a charity cannot normally grant a mortgage of land without Charity Commission consent, or without the trustees of the charity having obtained and considered formal written advice on the mortgage terms. Failure to adhere to these statutory requirements risks voiding the loan, so it is important to get them right. Obtaining Commission consent is rare in practice because, as a matter of policy, the Commission will not grant consent for actions that a charity can undertake without its involvement. It is therefore more common to obtain written advice, which will need to cover:

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

The advice can be provided by external advisors or by a trustee or employee of the school who is reasonably believed by the trustees or governors 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.

Timing

Many schools only conduct business at meetings of their governors or trustees. These meetings are often infrequent, and it can be difficult or impossible to call short-notice meetings when governors and trustees are travelling or involved in other projects. This can lead to delays or frustrate timings if not properly planned.

It is often possible for trustees to delegate authority to consider and negotiate documentation to a committee or smaller group of trustees or employees (the governing document and internal scheme of delegation will normally set out the powers of delegation available to the trustees). Delegating to a smaller number of trustees, employees or a committee is often a good idea to optimise flexibility around negotiation and timing. However, the final or near final form documents will in most cases still need to be approved by the full board of trustees, with authority sometimes delegated to an individual or small group (often the bursar) to approve any final non-substantive amendments.

In light of the proposed removal of the VAT exemption for private schools, it is more crucial than ever for educational institutions to navigate their financial landscapes with precision and foresight. Our expertise in assisting schools with their borrowing needs ensures that institutions can secure the necessary funding to continue providing high-quality education, despite the evolving economic challenges.

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

© Farrer & Co LLP, September 2024