UK: Getting Wound Up - Charities And Insolvency

Last Updated: 9 February 2012

Article by Alison Maclennan and David Blenkarn

The economic outlook for 2012 continues to be uncertain and this may lead to real issues for a number of charities. We look at the reasons for this and the possible courses of action open to trustees.

With continuing worries about the stability of the eurozone economies, high unemployment and the impact of the future reductions in Government expenditure still to be felt, a great deal of economic uncertainty persists. In that context, many charities will face financial challenges.

The funding sources and activities of charities are incredibly varied. Charities may also have different types of funds, such as restricted funds and permanent endowment, or different types of assets with differing degrees of liquidity. This diversity itself means that at any point in time – regardless of the economic environment – a proportion of charities will be struggling with financial uncertainty and be at risk of insolvency.

Added to this underlying core of usual activity for the sector are increasing numbers of publicly funded charities struggling to survive the effects of the comprehensive spending review. While the review has faded from the headlines, real reductions in Government spending are planned over the next three years, with departmental and administration budgets forecast to reduce from £378bn in 2010/11 to £369bn in 2014/15. This represents a reduction in real terms of over 10% in aggregate, but with spending on the NHS protected, some Government departments are facing harsh cuts, the cumulative impact of which will be felt over the coming years.

Trusts and foundations whose primary income stream is investment-based have not had a comfortable time, but their cautious approach to investment and foresight in dealing with volatility has paid off. Surprisingly, donation income has not suffered as much as had been expected but this may change if the current austere mood continues for a prolonged period and unemployment rises.

Recent reports highlight the concerns in the sector: many finance executives consider that their organisation's solvency is at risk because of the squeeze on funding and reduced donation income. The perception in the sector is that the Government has failed to comprehend what it is charities are being asked to do. The demand for charity services has increased simultaneously with the cuts in funding.

Statistical research by New Philanthropy Capital shows that almost a quarter of charities in the UK were funded directly by the Government to some extent and 13% received more than half their income from the state. A few charities were reliant on the Government for 90% of their income. Withdrawal of funding can result in a charity becoming insolvent very quickly – which has already happened to a number of charities. For example, the Immigration Advisory Service was the largest provider of publicly funded immigration and asylum legal advice. Government reforms removed immigration from the scope of legal aid which meant that the charity's liabilities could not be met from its much reduced income base. A solvent restructure could not be found and as a result the trustees decided that they had no option but to place the charity into administration.

Trustees of charities which are facing difficulties (or where there is uncertainty over the future) should take early advice and consider possible courses of action as follows.

  • Restructure operations, increase funding, cut back on costs. The key is to make operational changes as soon as the charity can foresee problems.
  • Look to merge the charity with another in the same sector to increase scale and resources. This has been the route to safety for several charities recently and underlines the fact that often bigger is better.
  • If a restructure or merger does not look like it will bring an answer, then taking specialist advice from an insolvency practitioner and a lawyer is vital. The trustees will need guidance to ensure that their actions cannot be criticised and that the requirements of the Charity Commission are met.

In considering any action, any legal restrictions on the use of funds or assets must be considered and timely advice is essential.

If a charity cannot pay its debts as they fall due for payment, or if the value of its liabilities exceeds the value of its assets, then the charity may be insolvent. Insolvency law aims to rescue or restructure an organisation and perhaps the sale of a business may be arranged with the proceeds going to the creditors. The difficulty with charities is that a 'sale' is inappropriate. This begs the question as to what is the solution for charities which might be facing insolvency. The common solutions involve restructuring, joint working or merger. Ultimately, a winding up or dissolution may be the only option. The charity trustees may prefer not to wind up the charity as there may be a desire to continue some of the charity's work, saving at least some jobs, expertise and possibly a brand.

Charity mergers are therefore usually born from need. For charities facing a situation where a merger is desirable there is still the task of finding a good merger partner. The need may not just be economic but can arise from a perception that the charity has gaps in its services or expertise. There should be some shared gains and often cost savings too. Finding the right partner can take some time and there are many factors to consider.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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