Sector Briefing – Charities (June 2021)
Charities have been hit hard by the pandemic. In some cases, income has been decimated with reductions in donations, grants and the all-important gala dinner. In addition, the operational side of the business has been hit hard with many staff put on furlough or being made redundant.
Certain types of charities have been hit the most. The arts in particular have been badly hit as there are limited live performances and restrictions on capacity in venues even as social distancing restrictions continue to be lifted.
However, it is important to bear in mind that many charities are also corporate entities that are monitored by the charity commission and have reporting requirements and legal responsibilities. The trustees (and the CEO) may well be directors and therefore have legal duties if they have any doubt as to the solvency of the entity.
Financial planning & forecasting in charities
In my experience charities are generally pretty good at planning and forecasting. Many trustee boards will include volunteers experienced in accounting, law and other professions however we are currently in such an unusual situation as a result of the lockdown that trustees need to keep one eye on the solvency of the charity at all board meetings. It is therefore essential that meaningful and up to date accounts / key performance indicators are provided to the trustees on a regular basis so the board can consider these and the level of current and predicted reserves.
The financial situation becomes more complicated for charities with many employees who have been working at the charity for significant lengths of time as the redundancy costs (and any legal costs associated with this) can eat into reserves. It’s important to consider all contingent liabilities in these circumstances which would also include the termination of any leases (property and other) and returning payments received on account of services which have not yet been provided.
In the context of reserves and accounts it’s important to understand certain sections under the Insolvency Act 1986, the first being the definition of insolvency which is either the inability of the entity to pay its debts as they fall due or that the value of its assets are less than its liabilities, importantly taking into account contingent liabilities.
The effect of trading whilst insolvent is called wrongful trading and is defined in the Insolvency Act 1986 being where that person (i.e., director or trustee) knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation. Where there is uncertainty whether the entity is solvent, the trustees should be careful not to sell off assets at undervalue or to prefer one creditor in advance of another especially if they are connected in any way.
Charity accounting is more complex and has nuances such as restricted and unrestricted funds. It’s important for these funding pots to be kept separate although there may be a temptation when funds are tight to delve into the restricted funds. Practically, given the current turmoil, it is possible that a donor may agree for restricted funds to be used to support the charity although authorisation should be obtained in writing before spending these funds.
So what are the trustees obligations in these uncertain times? In the normal course of events at the start of any financial year, board meeting dates are circulated to trustees so they can keep the dates free. During the pandemic, in many cases, it will be necessary to hold additional board meetings to consider the effect of the lockdown. As usual these meetings should be minuted and where there are any doubts as to solvency, the trustees should protect themselves from criticism or worse by obtaining professional advice. It is important to bear in mind that trustees with professional qualifications (such as lawyers or accountants) should be wary at providing binding advice directly especially in areas that may be at the periphery of their expertise. Instead protection from any subsequent action can be obtained by using qualified professionals to evaluate the figures provided and to present options available to the board.
Of course, trustees have overriding objectives in relation to charities to ensure that spending is in accordance with the objectives of the charity. However, should the charity be financially unable to continue to supply their service then most well drafted memorandum and articles of association will have provision for the distribution of surplus funds to charities with similar objectives or the merging of charities in cases where cost savings will ensure the continuity of service supply.
Is important for trustees to understand their risks in uncertain times. Their position can be considered an unenviable one because whilst they’re not being paid for their tireless contribution to the charity , they could be made personally liable in relation to decisions made in the context of a subsequent insolvency. Taking out Trustee Indemnity Insurance can provide a level of support but that’s only in particular circumstances so it is key for trustees to take timely professional advice which will ultimately benefit both the charity and trustees.
Charity case studies
David Birne, Partner at Opus has worked with a number of charities in his role of an IP. Below are some summary case studies of his work.
Case study 1
The trustees and chief exec came to see me as they had become aware that they were looking at a funding shortfall the following month. Having reviewed the financial position the figures appeared correct and due to the longevity of staff the restructuring costs through redundancy were unaffordable.
The discussion turned around how to either bridge the funding gap, merge with another organisation with similar objectives or restructuring. Merging was debated but the trustees had already considered this and couldn’t find other interested parties although even if they did, taking into account contingent liabilities (staff redundancy costs and the premises lease) the charity was still unable to pay its debts as they fell due.
At the meeting the trustees stated that they were passionate about the charity objectives and so were looking at taking a loan out from the bank. Whilst this may have worked in the short term, the bank wanted personal guarantees from the trustees. They evidently felt regretful about the situation so wanted to plug the funding gap. This shows great devotion to the cause but the simple fact remains that the trustees have no financial interest in the charity so to take on a personal guarantee for the loan doesn’t really satisfy the risk/reward calculation.
The trustees thought long and hard about providing the guarantees but in the end took the view to liquidate the charity to ensure that the employees received their statutory entitlements from the Redundancy Payments Service and without the pressures of taking on personal guarantees.
I know that the trustees found it hard to close down a charity that they had worked so hard to keep going but there are situations where it is best to take that step so avoiding potential personal liability and very real possibility of having to either extend the guarantees or a close down in the future. As well as the payment of staff by the government there was also a dividend to the creditors.
Take away: Having an unconnected professional review the charity plans can be enlightening and add a perspective in uncertain situations.
Case study 2
Case study 1 is unusual. In most cases I find that charities are very conservative with their forecasts and budget many months in advance so leaving them with a clear picture of the financial position in the future. In the second case study I was called in to a trustees board meeting at short notice and the situation was presented.
The charity provided care to the community but the take up for a new service line was significantly lower than expected due to delayed government funding and they were forecasting a shortfall in around 6 months’ time. Without an increase in demand for the service the charity couldn’t continue as it had pumped considerable resources into the project.
At the first meeting the trustees agreed to work with the exec team to provide forecasts that were flexed for differing scenarios together with evidence of support for the project from proposed users and funders. The information was reviewed when received and in a further trustee meeting the evidence and financials presented showed that the charity had both the resources and support to continue but that the trustees should continue to review the position at regular intervals to ascertain whether the new project was providing the income required.
The situation was further complicated as the funding for the project was considered restricted funding meaning the charity had to ensure that these funds were only to be used on the project. The charity was therefore able to continue but with a watchful eye on the project.
Take away: To take professional advice when there is uncertainty. This advice gives the trustees confidence to move forward with current plans or restructuring.
This briefing was written by David Birne, Partner at Opus. If you would like to contact David about his work in the charity sector or if you are a charity with current challenges you would like to discuss, please email David at email@example.com or call him on +44 (0) 20 3326 6454.