Many schools are keeping a careful eye on their finances at present, following a decline in fee income during the summer term and potentially some reduction in trading income over the summer holidays. Schools are also unclear whether all international students will return in September or whether concerns about future lock downs may deter students coming from China, mainland Europe and elsewhere.
While most schools will be able to navigate through these challenging times, we know there are a number that have already closed or that are struggling. Where this is the case, it is important for Governors to keep a close eye on the school’s financial position to ensure that the ongoing solvency of the school is carefully scrutinised and where further steps become necessary, that these are taken in a timely fashion. Of course, schools are not alone in experiencing difficult trading conditions and the Corporate Insolvency and Governance Act 2020 introduces a temporary relaxation to the rules on wrongful trading, which will benefit Governors of charitable companies in the same way as other company directors, which is covered below.
This article focuses on the schools that are established as charitable companies. References to the Governors in the remainder of this article means those individuals that are the school’s company directors and charity trustees. The observations made in the article will not apply in the same way to schools that are unincorporated or established as Royal Charter bodies, although the practical recommendations will largely be the same however a school is structured.
Governors are required to act prudently and manage a school’s resources, seeking appropriate professional advice where necessary. Where solvency is a concern, it can be helpful for a restructuring specialist to review the financial position and provide advice to Governors on their options.
Where a school is a charity and is facing liquidity issues or serious financial losses, it should make a Serious Incident Report to the Charity Commission, if it is insolvent or likely to be insolvent or closed permanently within the next 12 months. Further guidance on managing financial difficulties provided by the Charity Commission can be found here.
Definition of insolvency
Where a school is insolvent or is of doubtful solvency, the Governors will be under a duty to consider the interests of creditors above pursuing the charitable purposes (which will often be to advance education by running a school and carrying out other educational activities). A 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 school 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 institution’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.
A common concern for Governors faced with insolvency is wrongful trading. This is where a company has gone into insolvent liquidation and it can be shown that before the company entered into liquidation, the company directors should or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation. Where wrongful trading is found to have taken place, there is a risk that the company directors will be required by the court to make a contribution towards the debts or liabilities incurred by the company and cannot simply avoid the issue by resigning. It is rare, however, for charity trustees to incur any liability for wrongful trading.
Insolvency legislation reform
On 26 June 2020, the Corporate Insolvency and Governance Act 2020 (the Act) became law which put into place a series of measures to amend existing legislation (the Insolvency Act 1986 and the Companies Act 2006) to support businesses and charities to address the unique circumstances arising from the coronavirus pandemic.
The temporary measures introduced by the Act relate to the prohibition on winding up petitions and suspension of liability for wrongful trading in order to protect businesses from aggressive creditor action and support directors to continue trading throughout the coronavirus pandemic. These temporary measures are currently in place until 30 September 2020 and may be extended depending on how the coronavirus pandemic unfolds over the next few months - the legislation permits the Secretary of State to amend any part of the Act, so long as the amendments mitigate the impact of the coronavirus.
Wrongful trading suspension
The Act introduces 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 to continue to run their business during the crisis by removing 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.
It is still not clear what the “assumption” introduced by the legislation means or how this will be dealt with by the courts. If there was going to be a complete suspension, the legislation could have been worded more clearly to reflect this position.
Company directors still remain at risk of disqualification as they are still subject to laws regarding fraudulent trading, and are still subject to usual duties owed to their respective companies (which will, of course, include Governors of charitable companies). These obligations have not changed and directors will still be liable for wrongful trading breaches for the time period before 1 March and after 30 September 2020 (or the relevant COVID-19 period if the government decides to extend the temporary suspension). In addition, these provisions are unlikely to be relevant for any schools that were in financial distress prior to the pandemic.
As we look towards lockdown measures easing, and the end of these temporary measures at the end of September, Governors should remain vigilant in reviewing the school’s financial position, and where there are concerns to ensure these are addressed promptly, with the benefit of expert financial advice, where Governors 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