All charities have been impacted in some way by the pandemic. With many fundraising events beings cancelled and further public sector cuts, charities are left with large holes to fill without the luxury of time to do so. It is no surprise that our phones are starting to ring as trustees seek professional advice in these difficult times.

Tests for charity insolvency

There are two tests which apply to charity insolvency:

  • A balance sheet test where the charity’s liabilities exceed its assets, taking into account future and contingent liabilities. 
  • A cashflow test. A charity will be considered insolvent if it is unable to pay its debts as and when they fall due. A typical test for cashflow insolvency is the failure to deal with a statutory demand. Late HMRC payments, County Court Judgements (CCJs), increasing overdraft and credit terms are all further warning signs that a charity may potentially be in trouble.

The impact of insolvency on trustees

Charity trustees have to fulfil a number of responsibilities. So how does insolvency affect the trustees of the charity? Trustees of incorporated charities are treated in a similar way to company directors. They will generally not be liable for the debts incurred by the charity. Charitable companies are normally limited by guarantee and the members will only have to pay up to their guarantee.

A word of warning, however. A trustee still has a fiduciary duty to act prudently and reasonably in administering the financial affairs of the charity. When a charity continues to trade knowing that it cannot avoid insolvency, trustees can, in some circumstances, be held liable for misfeasance and wrongful trading claims. If the trustee is a professional, such as an accountant or lawyer, their knowledge and skill will also be taken into account.

Trustees of unincorporated charities are at much greater risk of personal liability. Trustees will have contracted in their own personal name and so do not benefit from the protection offered to trustees of incorporated charities. How the liability is shared between the trustees is typically down to the terms of the agreement, but a creditor will be able to sue any one of the trustees for the whole debt.

Reducing the risk

To mitigate the personal risk to trustees, there should be reliable financial information available together with regular cashflow forecasts, which are later compared with actual figures. Trustees should also look for alternative income sources. How long can the charity continue if a major income source suddenly stops. Is there a plan B in place? Unincorporated charities may also want to look at converting into an incorporated entity. Is there another charity which it might be suitable to merge with?

If all the options have been exhausted, the trustees should seek specialist advice from a licenced insolvency practitioner. It might be possible to save the charity, depending on sources of income, future profits or restructuring assets.

Restructuring can be done informally or, where the need arises, a formal Company Voluntary Arrangement may be required. Alternatively, the charity may be left with the only option of winding up through liquidation. It should be noted that these options are only available for incorporated charities. For unincorporated charities, the liabilities will fall upon the trustees personally and they will have to consider how to deal with the resulting liabilities in their personal capacity.

Getting expert financial advice at the earliest opportunity is the best way to help your charity deal with any challenges you face.

By Jon Mitchell, Partner and Head of BRI