As charities consider their reserves position and forecasts in the current situation, it will be important for trustees to understand their options. A new Government proposal may increase their choices.
In response to COVID-19, the Government has proposed temporary and long-term reforms to the UK insolvency framework. The apparent objective is to give companies and their directors’ time to implement changes to their businesses free from the fear of statutory risk; the basis of which has fundamentally changed.
There is no specific insolvency legislation for charities. Instead charities which are set up as companies are treated in insolvency law as any other company: that means that the terms ‘director’ and ‘trustee’ are synonymous.
Because the changes set out below apply to limited companies, they therefore automatically cover charities that are set up as companies. The situation for unincorporated charities, such as trusts, remains unchanged. It is not clear to what extent these changes will affect charities that are incorporated, but not as limited companies. These include charter bodies, charities incorporated under legislation, community benefit societies and associations: at present they follow the processes set out in the Insolvency Act, so it is assumed that the same will apply here.
We outline below some of the proposals and then set how these new rules may apply to different types of charity, not just those set up as companies.
There are two main sets of proposals, one short term and one longer term.
Short term proposals – to lessen the threat of personal liability
The first proposals are designed to lessen the threat of personal liability during the pandemic and comprise a temporary suspension of the wrongful trading provisions for company directors. This will be applied retrospectively from 1 March 2020 initially for a period of 3 months, but there is a recognition that this may need extending.
Many companies may be finding it difficult to work out whether or not they are solvent, with the amount of uncertainty introduced by current circumstances. When a company becomes insolvent (on a cash flow or balance sheet basis) the directors’ duties shift from acting in the company’s best interest, to a duty to act in the interest of its creditors as a whole
The current legislation (section 214 Insolvency Act 1986 (Wrongful Trading)) says that where directors continue to trade when they knew, or ought to have known, that there was no reasonable prospect that the company would avoid insolvent liquidation, they may be liable for wrongful trading and risk being ordered to contribute to the company’s assets if such trading increased the net deficiency to creditors. There is no requirement that a director acted dishonestly, but directors must use reasonable skill and care when fulfilling their duties.
Longer term proposals – to help companies avoid insolvency
The Government has said that “relaxation of these rules will reassure directors that the difficult decisions they have to make about the future viability of their business will not have to be unduly influenced by the exceptional circumstances which are entirely beyond their control.” The final details have yet to be worked out and set out in legislation.
The longer-term proposals help companies going through a rescue or restructure process to continue operating, giving them greater breathing space that could help them avoid insolvency. This may include allowing companies to continue buying critical supplies, such as energy, raw materials or broadband, while attempting a rescue. The detail has not yet been settled, but may include:
- a moratorium supervised by an insolvency practitioner but where the company continues to be controlled by the directors. Currently the moratorium created by administration restricts creditor rights to enforce security, forfeit leases and terminate HP contracts without permission of the Court, but is controlled by the administrators, not the directors. Under the new proposals, it is probable that the company will need to demonstrate that it has sufficient cash to keep trading through the extended moratorium period, but the exact details are not yet settled;
- limiting contractual rights that allow a supplier to withhold supplies because the company is entering an insolvency process. This may well build on the ‘utilities supply’ provisions of s.133 IA 1986, which ensures that essential supplies, including electronic communications, are not cut-off from the business when it enters into an insolvency process; and
- a new restructuring plan, binding creditors to that plan.
All of these proposals will include key safeguards for creditors and suppliers to ensure they are paid while a solution is sought.
Charity Sector Guidance
There is no comment or updated guidance yet from the Charity Regulators. The existing guidance is aimed squarely at limited company charities and trusts. Charitable Incorporated Organisations are subject to the Insolvency Act 1986, with relevant technical modifications, and the changes discussed above can be expected to flow through to CIO’s and Scottish Charitable Organisations.
There is therefore no change in the position as relates to trustees of unincorporated charities – usually simply referred to as ‘Trusts’. As before, a trust cannot technically be insolvent as it has no legal identity separate to its trustees. This means that the liability of the charity is the liability of its trustees. In these situations, trustees may be indemnified out of the charity’s assets, but that is unlikely to be of much comfort.
If a trust does not have sufficient assets to meet its liabilities, trustees are likely to have to meet the shortfall personally with the liability being shared between trustees. In the absence of any relevant insurance, or prior agreement with the creditor, in the event of a shortfall, they will have to meet these liabilities out of their own pockets.
Whilst the new proposals are a welcome development, until they are in force trustees should not rely on them but continue to behave in accordance with existing legislation. Trustees should also ensure that they know their own legal structures and governing document in order to understand the implications of the charity’s financial position and these proposals.
Now, more than ever, trustees and directors should monitor their unrestricted cash flows and reserves carefully in the coming months. This may mean changing a course of action, re-examining fund structures, or seeking closer working relationships with other charities. Trustees also need to be ready to take action and/or professional advice as soon as they foresee a potential problem.
View our COVID-19 Hub