Insights
Insights 25.9.20 Author: Jonathan Reason

Practical Steps and Options for Trustees of a Distressed Charity

Insights 25.09.2020 Author: Jonathan Reason

Introduction

Our first article focused on the personal risks for Trustees where a charity is in financial distress and highlighted measures which could be taken to limit their personal liability exposure. This article covers some of the measures that trustees could take to preserve or enhance the charity’s reserves in times of distress and the options available where a restructuring or insolvency becomes necessary.

What immediate actions can Trustees take where a charity is stressed?

Where a charity is stressed, Trustees will have to focus on turnaround and preserving the charity’s assets. Cash is king and, as the post-coronavirus environment begins to look clearer, charities should be preserving their reserves, contingency planning and ensuring they have adequate flexibility for any future adverse events, such as another lockdown.

Trustees need to review the charity’s business plan and decide how this needs to be adapted for the current situation.  For instance, certain longer-term expenses (e.g. capital expenditure) should be postponed. The buy-in of the entire team to focus on the short term should also be prioritised.

Some of the measures to be considered are set out below:

1. Improve income and conserve reserve

Engage with regular donors/funders – harities usually have a close connection with their regular donors and, in our experience, there is sometimes a reluctance to make an approach to explain the situation and seek assistance. As donors typically have a strong affiliation with the charity and its mission, this can result in some positive outcomes in terms of cash generation.

Look at finding alternative sources of funding – Charities need to undertake their own fundraising diligence to ensure they are not missing out on short term support packages that could make the difference between survival and insolvency.  At the time of writing, there are still many coronavirus support schemes in operation, which can be found on the Charities Aid Foundation (CAF) website at: https://www.cafonline.org/covid-19-support/help-for-charities#tab1.

Consider launching an emergency appeal – The launching of an emergency appeal is not something to be done lightly as if executed badly it can harm longer term funding and brand reputation. The most successful emergency fundraising requires planning and a clear understanding of aims and objectives. Where relevant, Trustees should ensure that donors are informed that new funds raised may be used to meet the charity’s debts.

Conversion of designated funds to unrestricted funds – Designated funds are unrestricted and available for the general purposes of the charity, but which the Trustees have chosen to assign for a particular purpose (e.g. capital expenditure). In times of stress, designated funds could be ‘undesignated’ by the management committee for general charitable use, but this should always be done at a formal meeting and be properly minuted.

Transfers from restricted to unrestricted funds – This should not be undertaken except in extreme circumstances and even then, should only be done with great care and legal advice as the funds are held on trust. That said, it is possible for the charity to make a request to the donor of restricted funds for their consent to convert funds to ‘unrestricted’.  In the first instance, it is the donor’s right to have these amounts repaid.

In some situations where a charity is wound down and left with only restricted funds, it is possible for the charity to seek approval from the Charity Commission to ‘make a scheme’ (i.e. an amendment of the special trust), which will allow them to borrow the funds for general purposes. Again, this should only be explored with legal advice.

2. Cost minimisation

To reduce or manage costs, Trustees could consider:

  • Identifying and stopping non-essential outgoings – A careful review of all costs should be undertaken and those which are not core to the operation of the charity should be stopped. The most common example which we see is travel expenditure.  Staff credit card limits should be reduced or stopped entirely so that costs can be controlled.
  • Refinancing existing borrowing or loan facilities – There may be scope to obtain a better finance offering on the market. The refinance of certain loans can reduce monthly repayments to enhance cash flow but the associated costs (e.g. interest and arrangement/early-termination fees) will need careful consideration, particularly where funds are being secured against the charitable assets.  Where new borrowing is being sought, Trustees will need to check their borrowing powers in the charity’s governing documents.
  • Negotiate with creditors – Even where contractual agreements exist there could be scope for renegotiation. Being open and transparent with creditors at the earliest opportunity is key if forbearance is to be requested.  Professional advisors can sometimes act as a conduit between the charity and the creditors, particularly where managing a tight cash flow or a creditor is cantankerous.  This assistance is particularly desirable where there is a defined benefit pension scheme with a funding deficit.
  • Discontinue some of the Charity’s activities – Those activities or departments which are lossmaking and/or not core to the charity’s mission should be carefully reviewed for cost savings and where necessary, discontinued.
  • Terminate certain supplier contracts – It may be possible to obtain more flexible payment terms outside of a contract so that cash flow can be better managed.
  • Making redundancies – Legal advice should be sought to adhere to the complex rules surrounding consultation (where making 20 or more redundancies) to avoid incurring further liabilities for wrongful or unfair dismissal. Clearly, this measure is likely to have an impact on employee morale so an open and transparent policy is recommended.

What if charity cannot continue to operate?

1. Merger & Acquisition

Working with professional advisers and/or corporate finance specialists, a merger with another charity of the same or similar charitable objectives should be explored. However, in the backdrop of the coronavirus, such opportunities may not be readily available where other charities are also struggling. A key factor in mergers and acquisitions outside of insolvency is that the charity’s liabilities would also be acquired with the merging party. Accrued employee liabilities, which are unlikely to be presented in the Charity’s management information (and which transfer in an insolvent sale), can present a significant stumbling block and legal advice should be sought to establish the Transfer of Undertakings (Protection of Employment) Regulations 2006 liability for the acquirer and how to mitigate it.

2. Managed wind down

Where a charity concludes that it cannot continue but has sufficient reserves to pay all its debts (actual and contingent), a managed solvent wind down can be undertaken with any surplus assets to be distributed in accordance with the charitable objectives. This typically ends with a formal solvent liquidation of the charity or a voluntary strike off.

Our previous article highlighted certain costs which can arise that may not ordinarily be included within the cash flow forecast of a going concern entity such as dilapidation claims for leased property, contractual termination charges and redundancy costs. Professional advice should be sought where a managed wind down is to be undertaken to avoid the pitfalls of Trustees suffering personal liability exposure.

3. Formal insolvency options

If the charity’s financial situation means that it is insolvent, immediate guidance from a licensed insolvency practitioner (IP) should be sought. The IP will advise of the charity’s best options for a rescue or whether a voluntary liquidation process is necessary:

  • Company/charity Voluntary Arrangement (CVA)A CVA is a legally-binding payment plan negotiated between a struggling but viable charity, and its creditors. It is relatively uncommon in practice but it enables Trustees to retain control of the charity to operate it out of difficulty using the additional working capital released from reduced monthly debt repayments.  The only claim which can be brought against Trustees in a CVA is for fraud.
  • Administration – When a charity enters administration, it receives valuable protection from further creditor action through a moratorium. The appointed administrator will formulate a plan for rescuing the charity as a going concern.
  • Pre pack administration – This process involves a period of marketing prior to the administration with a sale of the Charity’s business and assets agreed, typically to a charity with the same or similar objectives and with Charity Commission consent. Immediately following the appointment of an administrator, the sale completes and the charity continues in its current form without the burden of historic unsecured debts. This process is heavily regulated and the IP must justify that it is the best financial outcome for creditors.
  • Creditors’ Voluntary Liquidation (CVL)A CVL is often the most appropriate solution when a turnaround of the charity’s financial situation is not possible. The role of the liquidator is to realise charitable assets and close down the charity once a distribution to creditors (if funds permit) has taken place.

What next?

If you have any questions or would like to discuss your individual requirements, please contact Jonathan Reason.