Your guide to handling charity insolvency
Being able to make a real and lasting difference in someone’s life, give them the opportunity to be more self-sufficient, or restore some functionality or normality to their lives would be tremendous.
Charities are one of the sectors that hold society together by meeting demands that the public and private sector can’t or aren’t set up to meet.
But they have to function according to the same rules as other businesses or organisations which means that they must pay their debts when they come due and are just as liable for the consequences as any other organisation if they can’t.
There are options for them depending on their situation which they can take advantage of to rescue or restructure the charity to keep going.
Alternatively, if the situation can’t be reasonably salvaged then there are efficient and effective options to close down and possibly reform without debt.
Regular businesses have management structures or a board of directors in place to oversee their day to day affairs and monitor medium and long term strategy.
In the case of charities, a trustee body will assume this essential duty and look after operations and governance as well as finance.
It might seem boring compared to the more fulfilling and exciting aspects of charity service provision but carefully monitoring the budgets, accounts, projections and financial reports of the enterprise will give important indicators on the overall financial health of the enterprise.
They will be the first warnings of potential insolvency through two key indicators:
- The charity is having trouble or cannot pay debts as and when they fall due
- The assets of the charity are worth less than current liabilities
There are other practical assessments the trustees can make including a cash flow test and balance sheet test but any of these should indicate potential trouble.
Steps to take
The first thing trustees should do is get professional advice from an insolvency practitioner. Even if they aren’t being threatened with winding up by creditors immediately, they will be able to offer support and ideas on what to do to prevent these threats coming to pass if possible.
If there is an immediate shortfall, the first thing that can be done is an immediate audit to see what costs can be reduced at short notice.
It will take longer but some assets and investments could be realised to provide additional funds or ultimately there could be some reduction of staffing or service provision if it means the charity as a whole can survive.
Further borrowing options could be explored through extending current lending facilities or considering new ones if the situation is considered mainly temporary.
If the situation is more serious and creditors are beginning to demand repayment with legal recourse then the picture is clearer and requires immediate action.
They can consider an administration procedure which automatically gives the charity an insolvency moratorium which halts all action against it – giving valuable breathing space for trustees to work out their next steps.
In an administration, an insolvency practitioner (the administrator) takes over the running of the charity temporarily to see if it can be restructured appropriately and other changes made that will allow it to resume its activities.
Another alternative can be entering into a company voluntary arrangement (CVA) with the charity’s creditors.
This would see a proportion of outstanding debt written off with the remainder paid to creditors in a series of regular monthly payments based on the expected cash flow coming into the charity.
Payments must be kept up with to avoid further action but this is an equitable solution to debt problems that could otherwise lead to closure.
If the problems are more manifest and there is no realistic way of returning the organisation back to profitability then the only realistic option would be closing down through liquidation but the method will differ depending on the charity’s structure.
- Charitable company limited by guarantee
This process is very similar to that of liquidating any other limited company.
Charitable companies limited by guarantee are registered at Companies House and their members determine their aims, objectives and fundraising.
The difference between them and regular limited companies is that any profits are invested in their mission, not distributed among shareholders as dividends.
They can become insolvent like any other business and if they do and have to close then they will either choose to undergo voluntary liquidation or in the worst case scenario, will face compulsory liquidation.
A creditors voluntary liquidation gives trustees more control over the process although a licensed insolvency practitioner will have to oversee the process in either scenario.
Their job is always to protect the interests of creditors by selling off any assets to recoup as much money back as they can. Once this process is completed then the organisation is removed from the charity register at Companies House and it will cease to exist.
- Charitable incorporated associations
Voluntary liquidation and compulsory liquidation are still options for charitable incorporated associations with some minor modifications although this incorporated charity structure isn’t registered at Companies House.
An important point to underline is that members of charitable incorporated associations are usually protected from personal liability for the organisation’s debts.
- Charitable trusts
Unlike other charitable organisations charitable trusts are classed as unincorporated entities.
This means that the trustees overseeing the objectives and charity finances are personally responsible for any debts incurred by the organisation.
In the event of closure, the trust deeds will usually include a procedure for instigating a winding up petition as the most efficient and effective method.
- Unincorporated associations
An unincorporated association, by its nature, is not treated as a separate legal entity to its members.
Because of this, if this type of charity becomes insolvent then the members are not protected and could be held personally liable for any outstanding debts incurred.
Also, unincorporated associations cannot make use of any formal liquidation procedures but directors can still get advice and should if they’re in this situation.
Can charities operate if they’re insolvent?
The short answer is yes with an important but.
It might be possible for them to operate as a going concern in the short term and avoid a winding up process but the onus is on directors & trustees to ensure that new financing is being sourced or other measures being taken to achieve solvency.
Directors have a duty to ensure any business does not continue to trade if there’s no reasonable hope of recovery – Otherwise the charity could be regarded as wrongful trading with consequences for those directors if proven.
Running a charity might be even harder than managing a similar sized business.
They have to raise sufficient funds to make a profit and pay all their suppliers, staff and creditors on time. Charities have to do this as well as using the funds to run services their users find essential.
So if a charity runs into financial difficulties, and the past 18 months will have affected giving and donations as much as any other sector, it will feel doubly difficult and that users are being let down. Customers can go to other providers but for the users of many charities, this isn’t an option.
The Charity Commission says that in the event of potential charity insolvency, directors and trustees should get immediate advice.
We’ll get a better idea of what your situation is and be able to let you know your options in plain english.
Depending on your charity’s model, we can let you know what you can do and if there are any special circumstances or accommodations that you have to make.
We can then help you implement your decisions quickly and effectively to help you get on with doing the great work your charity has always done.