When your trading subsidiary pays your trustees – a recent Charity Commission inquiry

The Charity Commission inquiry report

This subject came up in a recent Charity Commission inquiry report into an unnamed grant making charity.  Three of the charity's trustees had provided consultancy services to the charity's wholly-owned subsidiary. Over a ten-month period, they were paid approximately £650,000 for these services, which the subsidiary considered to be market rate. 

The subsidiary's decision to pay the trustees was said to be have been made “with the agreement of charity trustees [sic]”. The report does not elaborate on what form this agreement took but notes that the charity did not have any records relating to the remuneration because “none of the trustees thought of it…as being a decision for the charity to make”. 

The payments to the three trustees were not permitted by the charity's governing document, which (subject to exceptions that did not apply in this case) prohibited trustees from receiving payments from the charity. 

The Commission became involved after the charity's newly-appointed solicitors informed the trustees that the payments constituted unauthorised trustee benefits and wrote to the Commission to ask it to relieve the remunerated trustees from liability to repay the sums they had received. At this time, the trustees were hoping to sell 99% of the charity's shares in the subsidiary to the three trustees (who had, by that point, stepped down from the board), so the solicitors also asked the Commission to authorise this transaction.

The Commission found that the payments by the subsidiary amounted to a breach by the charity trustees of their duties to act in the charity's best interests, not to profit, and to avoid conflicts of interest. Although the Commission accepted that the charity trustees acted in good faith, it refused to grant relief from liability to the trustees who had been paid, on the grounds that its power to relieve from liability only applies where a breach of duty has resulted in a charity making a loss. Where a breach has resulted in a trustee making a profit, the Commission cannot use the statutory power in question to relieve that trustee from liability to repay the money.

Following discussions with the Commission, the remaining trustees recovered the unauthorised payments.
The Commission was satisfied that the proposed share sale was in the charity's best interests, so authorised it.

Why is a trustee who receives payments from a subsidiary deemed to have received a benefit from the charity?

Neither the report nor the Commission's current consultation spells this out and (to the author's knowledge, none of the Commission's materials on this subject explain it). After all, the decision to remunerate will have been taken by the board of the subsidiary company, which is – or at least should be – independent from the board of the charity.

One scenario where this is an issue is where the charity has financially invested in the subsidiary. Where this is the case, there is a relatively clear link between the money received by the remunerated trustees and the charity. However, even where a charity has no financial stake in its subsidiary, it is owned by the charity, so any trustee who receives money from the subsidiary is deriving a material benefit from the charity's "property".

Either way, where a subsidiary wants to pay a trustee of the parent charity (whether the payment is director’s or consultancy fees or payments for goods or services), the trustees of the parent charity will need to authorise this. If neither statutory powers nor the governing document permit such payments, then the trustees will need Charity Commission authorisation. If the governing document permits the payments, when authorising them, the charity's trustees will still need to manage the conflicts of interest this decision entails. If the governing document is silent, the statutory power of remuneration for services and goods supplied in connection with such services may apply (see section 4 of the Charity Commission's guidance on trustee expenses and payments, linked in the final section of this article) but, again, conflicts will need to be managed. 

Managing conflicts of interest

The Commission found that the trustees of the grant making charity had neither identified nor managed the conflicts of interest surrounding the payment of trustees. Given that they didn't realise the charity needed to authorise the payments, this is hardly surprising. The conflicts issue was exacerbated in this instance by the fact that the charity's trustees were also directors of the trading subsidiary.

By contrast, in relation to the intended share sale, the trustees had identified the conflict and managed it: the conflicted trustees were removed from the decision-making process and a new independent trustee was appointed. Furthermore, the trustees had taken professional advice on the proposal, to ensure that the deal was in the best interests of the charity and negotiate better terms where necessary.

In many of the Commission's inquiry reports, problems have arisen because the trustees of the charities under investigation failed to recognise and manage conflicts. As this inquiry report states: “Where trustees have a conflict of interest…they should identify it, follow any provisions in their governing document about how to manage it, prevent it from affecting decisions and record how it was dealt with. If a trustee stands to benefit directly or indirectly, they should withdraw from discussion and any decision making process”. It goes on to note that trustees need to manage conflicts not only where they (or someone connected to them) stand to benefit financially, but where “your duty to your charity competes with a duty or loyalty you have to another organisation or person”. In the context of a grant making charity, this could happen where one of its trustees sits on the board of a charity that the grant maker is thinking of funding.

Keeping records

Because the trustees of the parent charity did not realise they needed to authorise the payments, they kept no records of discussions about them. Again, this contrasted with the proposed sale of shares: the trustees were able to provide the Commission with minutes of meetings showing how the conflicts of interest in relation to that issue had been managed.

Most modern governing documents will require trustees to keep a written record of their decisions, but in any event there are obvious reasons why it is a good idea to keep a paper trail of what the trustees have decided (and why), even if the Charity Commission isn't likely to come knocking.

Further guidance

If your charity has a subsidiary that wishes to pay (or is already paying) trustees and you have any concerns, you may want to read the Charity Commission's guidance on paying trustees and on managing conflicts of interest. The inquiry report also refers to its guidance on making decisions, which you may find helpful.

If you require further information please contact Rachel Holmes, 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, June 2018