How can the Corporate Insolvency and Governance Act help charities in financial distress?


How can the Corporate Insolvency and Governance Act help charities in financial distress?

09 November 2020

CIGA came into force on 26 June 2020 with the aim of promoting a stronger rescue culture in the UK. The provisions create a new suite of restructuring tools and protections to help businesses and organisations, including charities, recover from financial distress without entering a terminal insolvency proceeding. We welcome these changes and the powerful new measures to improve the potential for distressed companies and organisations to survive, stabilise and prosper.

What does it mean for the Charity sector?

The Act applies to all charities incorporated as companies, their subsidiaries and Charitable Incorporated Organisations (CIOs) registered in England and Wales (with technical modifications).

Scottish CIOs have their own specific insolvency framework, which will continue to apply.

There are both permanent and temporary changes to current law, as well as two new, permanent innovations which demonstrate a significant evolution of the UK’s approach to business restructuring. Charity trustees in particular will want to ensure they understand the impact of these changes and new rules on their charity and governance duties. To help, we look at the changes, below, starting with the two evolutionary developments.

Significant evolutionary innovation

1.Moratorium – time to plan

The introduction of a moratorium period provides charities in distress with simple access to extensive and potentially lengthy legal protection from creditors, including landlords, while a plan for rescue is devised.

This protection applies to ‘pre-moratorium debts’, allowing payment to these historic creditors, including HMRC, to be suspended. ‘Moratorium debts’ (debts for goods and services received or used in the moratorium period, e.g. an apportionment of rent) and any ‘financial obligations’ (e.g. lending from banks, such as loans) must still be paid. Grant commitments, common in charities, will need to be carefully considered to see how they should be treated.

There is a degree of complexity in this, but the intention of the legislation is clear: the moratorium puts the charity trustee in control of the process, with the insolvency practitioner’s role restricted to that of ‘Monitor’, overseeing compliance within the statutory terms of the moratorium.

The moratorium lasts at least an initial 20 business days, but can be extended by a further 20 business days by the trustees themselves, and up to a maximum of one year with creditor consent and potentially longer with Court consent.

The detail of ‘a plan’ is not statutorily defined. It could be an operational reorganisation to support a new strategy, a breathing space to agree terms for a refinancing, or a fundamental restructuring including the reshaping of estates, workforce and financial structure.  It could support a formal Restructuring Plan (see below), merger solution, collaborative partnering, a Company Voluntary Arrangement (CVA) or a negotiation with landlords. The only requirement is that it rescues the charity, so formal merger (if that is the solution for a charity) may need to be considered as a step within the plan.

2.Restructuring Plan

Importantly for the sector, the Restructuring Plan (the RP) is not an ‘insolvency’ procedure under the Insolvency Act, instead it comes under the Companies Act 2006. It is available to charities meeting two conditions:

  1. The charity is likely to encounter financial difficulties that will or may affect its ability to carry on business as a Going Concern.
  2. A compromise is proposed between the charity and its creditors (or members for subsidiaries), or any ‘class’ of them. The purpose of the compromise (or arrangement) is to eliminate, reduce or prevent, or mitigate the effect of that financial ‘difficulty’. 

This wide scope implied by the terminology suggests a deliberately wide level of applicability. The RP allows for creditors to be categorised into ‘classes’ and for the decision of classes of creditors with a genuine financial interest in the outcome to be binding on all other creditors by Court Order. The Court may also sanction an RP over the objection of one or more classes, provided at least one class consents and certain other requirements are met. This is called a ‘cram-down’. The RP may  be used in combination with the Moratorium, but the processes are independent of one another.

The changes

Ipso Facto termination clauses in supply contracts are now void for most

A permanent change introduced by the CIGA is the limitation of ‘Ipso-facto’ termination clauses in long-term supply contracts, which terminate, or permit a supplier to terminate, supply because the customer is subject to an insolvency procedure. These clauses are often enacted by suppliers and can inhibit attempts to rescue entities. The Act not only voids the ‘Ipso-facto’ clause, but also prevents changes in terms of supply. It has retrospective effect, so applies to contracts already entered into, and the provisions take effect across all insolvency procedures, including the Moratorium as well as the Restructuring Plan.

This is a positive step for those entities requiring support in an insolvency process, however, the new provision could potentially have a significant impact on charities and trading subsidiaries in the supply chain. While charities supplying goods or services should be paid for services post insolvency, they will not be able to make it condition of supply that historical invoices are paid.

There is an exemption for ‘small businesses’, who can enact ‘Ipso-facto’ clauses until 30 March 2021, or if the suppling charity can prove to the Court that continuing to supply will cause it financial hardship.

If a charity is supplying goods or services to a customer who subsequently goes into an insolvency related event, the charity is still liable to continue supply. Charities should therefore review the terms of their contracts with customers and consider what other protections can be put in place. Focused due diligence on customers’ financial position and contract management should help to manage potential risks.

Temporary suspension or modification of insolvency processes

CIGA also makes a number of temporary changes to existing insolvency law. While the wrongful trading changes have ceased, some of the changes are still applicable to the end of 2020.  

Statutory demands and winding-up petitions - suspended to the end of 2020

The serving of statutory demands and the presentation of winding-up petitions is suspended to the end of the 2020 and applies to all creditors (including landlords). If the petitioning creditor can satisfy the court that it has reasonable grounds for believing that COVID-19 has not had a financial effect on the organisation, or the situation would have arisen had COVID-19 not happened, the suspension does not apply.

On a related point, the Coronavirus Act 2020 provides a moratorium on a landlord's right to forfeit a lease for rent arrears. This is also in place through to the end of the year and once the legislation has lapsed, landlords will be able to claim for forfeiture for both payments that became due during the moratorium period and for any becoming due after it ends. Consequently, if a charity has withheld payment of rent or requires revised terms with its landlords, it would be well advised to open an early dialogue with them before a claim is made.

Wrongful trading provisions – no personal liability if attributable to COVID-19

CIGA also provided a temporary protection to ‘office holders’, e.g. charity trustees, relating to personal liability. If the charity went into insolvency, so long as the debts were attributable to the pandemic, the personal liability was removed. This temporary protection ceased at the end of September 2020 however, the below is a reminder to trustees of their duty in order to avoid being personally liable.  

Under the wrongful trading provisions, trustees are obligated to exercise reasonable skill and care when fulfilling their duties. If a charity becomes insolvent (on a cash flow or balance sheet basis) the Trustees’ duties shift from acting in the charity’s best interest, to acting in the interest of its creditors as a whole. 

Section 214 Insolvency Act 1986 (Wrongful Trading) states that where directors continue when they knew, or ought to have known, that there was no reasonable prospect that the charity would avoid insolvent liquidation, they may be liable for wrongful trading and risk being ordered to contribute to the entity’s assets if such trading increased the net deficiency to creditors.

Whilst the temporary protection under CIGA did not relieve trustees of their other duties under charity or insolvency law, nor did it provide a resolution for struggling charities, it did support an important ‘but for the pandemic’ consideration and approach which should have given trustees comfort that there was time for careful, considered decision-making.

Trustees should be mindful of the impact of this protection not being extended and care should be taken when monitoring the solvency of an charity to ensure appropriate decisions are being made. 

Supporting distressed organisations in their search for a new reality

Taken together, the temporary and permanent changes greatly advance ‘rescue’ culture at a time of greatest need. As with all new legislation, it is largely untested and its legal impact will be subject to differing interpretation.

But most importantly, the legislation supports the concept that ultimately viable organisations should have a statutory mechanism for restructuring that is led by the officeholders (directors / trustees), simple to access, flexible in its application and effective in its protections. This should promote the preparation of detailed and, where needed, bold plans to make and implement change.

The standard expectations for entities in distress of appropriate financial and operational solutions are now supported by a legal framework that places those with the knowledge, i.e. the trustees, at the centre of the solution. CIGA is not a defence against poor monitoring of reserves or failing to develop contingency plans and scenario models, but it is a clear indication that legislators wish to strongly support viable entities in their search for the new reality.  

If you would like to discuss any aspect of the new legislation in more detail and how it will affect the service you provide please contact Katie Cooper or your usual BDO charity adviser.

To find out BDO’s view on CIGA with more specific detail, please go to our Corporate Insolvency and Governance Act 2020 web page.