When is a charity considered insolvent?
Firstly, all charities should have a trustee body that puts in place a long-term strategy. This strategy should cover objectives including (but not limited to) finance, operations and governance. Regular trustee meetings covering financial reports, budgets, accounts and projection should identify any potential risks or signs of insolvency. However, indicators that would suggest your charity may be heading to insolvency would be:
- Charity cannot pay debts as they fall due
- The value of the charity liabilities exceed the value of assets
There are basic tests that will enable you to check whether your charity finances indicate potential danger. The cash flow test looks at whether the charity has accessible and sufficient resources to meet liabilities. In simple terms, is the charity able to make payments when they are due?
The balance sheet test looks at the overall finances and position, specifically, whether the charity has enough assets (fixed or current) to meet its liabilities. This test is normally conducted in conjunction with the cash flow test. You can find more information on insolvency tests here.
What steps can a charity take when facing insolvency?
Effective financial management may help prevent the early stages of insolvency, or help foresee the threat. If identified, however, trustees should take immediate action to rectify the position. The Charity Commission recommends professional advice is taken at the earliest possible stage, to prevent the issuing of a winding up petition and, subsequently, compulsory liquidation. The steps and procedures to deal with the issues will depend on the nature of your charity, and the reasons for the difficulties with your charity finances.
Alternative sources of funding
Alternative sources of funding, or launching an emergency appeal, may bring in additional revenue to help avoid charity insolvency. However, you must ensure the additional funds raised are unrestricted to recoup losses for creditors. You could also:
- Discuss the charity finances with the bank, particularly if secured loans are held against the charity’s property
- Review existing borrowing or loan facilities
- Potentially seek new facilities
Are there any activities that the charity undertakes that could be discontinued to reduce costs? Is there an an opportunity to merge some or all activities with any other charities of similar purposes? Are there any fixed assets and investments that could be realised to provide additional funds? If you are considering restructuring the charity’s operations, seek advice and support from industry peers as well as insolvency experts.
Administration can be used to give the organisation breathing space. In effect, it can be considered a business rescue process. The procedure is managed by an administrator, appointed to act in the interests of the creditors. Administration can aid in helping a company to survive, in whole or as a part.
Under the terms of the Insolvency Act, charitable companies may be able to enter a company voluntary arrangement (CVA). The contractual agreement sets out payment installments – agreed to by the creditors – that you can afford, based on the charity cash flow. If a CVA is agreed, it also suspends legal action, should a creditor attempt to issue a winding up petition.
Unincorporated associations may be able to obtain an informal arrangement with creditors, outside of the remit of the Insolvency Act. The arrangement would detail repayments that you can afford. However, it’s important to note that this is not legally-binding, an affords less protection than that of a CVA.
Liquidation process for charities
As mentioned above, the liquidation process for the charities can differ depending on the structure.
Charitable company limited by guarantee
The process of liquidation for a charitable company limited by guarantee is the most similar to that of a limited company. A charitable company limited by guarantee is registered at Companies House, and members determine financial objectives, aims and fundraising. However, unlike a limited company, the charity profits are destined for the purpose of the organisation, rather than distributed to those members.
If a charitable company limited by guarantee becomes insolvent, there are two liquidation processes that can be used. Both creditors voluntary liquidation and compulsory liquidation are options, using the same procedures as that of a limited company. In both cases, an insolvency practitioner (IP) will oversee the process, realise assets and recoup losses for creditors. Staff may also be made redundant and the organisation will be removed from the charity register at Companies House. A recent example of a charity facing compulsory liquidation is that of Kids Company.
Charitable incorporated associations
This incorporated charity structure is not registered at Companies House. The above liquidation processes are options, with some minor modifications. Almost all cases result in members protected from personal liability for the company debts, as the IP attempts to recoup sufficient funds for creditors.
Unlike the above organisations, charitable trusts are unincorporated entities. As such, the trustees overseeing the objectives and charity finances are responsible for the debts, should the body face insolvency. Typically, the trust deeds will include the procedure for a winding up petition.
Due to the nature of unincorporated associations, the organisation is not treated as a separate legal entity to its members. Therefore, if this type of organisation becomes insolvent, the members are not protected and could be held personally liable for company debts. Formal liquidation procedures are also not available for unincorporated associations.
Can a charity still operate when insolvent?
Charities can continue to operate, but only when great care is exercised. It’s possible that an organisation can continue as a going concern, avoiding the process of winding up. In the short term, charities may have to resort to financing or operate over credit terms. However, directors have a duty to ensure they are not continuing trade if there is no hope of recovery. This is regarded as wrongful trading, and more information on the subject can be found here.
As mentioned earlier, the Charity Commission states you must seek advice immediately if facing the signs of charity insolvency. Doing so may just prevent the worst possible scenario, and allow you to come to an arrangement with creditors. Our business rescue experts can discuss your options and provide a relevant solution.