A recent and growing trend in the independent school sector is one of schools exploring the possibility of mergers with other schools. The reasons for this are many and varied but may include the following:
- Operating margins are low, so pupil numbers are critical. Fixed costs are escalating and to counteract this, schools are increasing their fees. If the fees remain above inflation levels for any sustained period, this in turn could threaten pupil numbers, especially in the strained economic times in which we find ourselves. A merger should achieve higher pupil numbers and reduce costs ratios.
- School premises are always in need of renovation, maintenance and improvement and are a constant drain on resources. Although the Charities Act 2006 relaxed the rules slightly relating to the spending of permanent endowment (of unincorporated charities), it may still be preferable to realise the asset value of one school's property and use part of the proceeds to modernise and extend the premises and facilities in another school.
- The combined brand and resources of two well-known schools may be more attractive to future parents than one, and consequently will assist in the marketing.
However, the governing bodies of schools contemplating a merger will need to consider the possible negatives as well as the positives when coming to a decision. Obstacles and difficulties associated with school mergers are varied and include:
- The possibility of disruption, as management time required on the project can interfere with the running of both schools, and ultimately therefore, the education and welfare of the pupils.
- The anxiety which a merger can bring about. Pupils and parents may lose confidence in the prospects for the merged school and may consider moving to another school.
- The damage a merger can bring to a brand, especially if the merger does not go ahead.
- Incompatibility of the specific charitable objects of each school.
- The possibility of a culture clash between the two schools in question and the difficulty in dovetailing the different ways in which the schools are run, and the parents to whom they appeal.
- The almost certain need to reduce staff levels as a result of the merger.
- Objections of third parties (other than the immediate stakeholders, being pupils, parents and staff).
- Professional and other costs.
There are various reasons for choosing a particular method to implement a merger but it is usually driven by the structure of the two entities involved (ie whether or not they are incorporated) and whether any liabilities may arise as a consequence of the merger. The merger will usually be achieved by one of the following methods and which one will be the most appropriate will largely depend on the factors mentioned above:
- school A transferring its undertaking (ie the business of running the school), assets and liabilities to school B, or vice versa; or
- school A and school B both transferring their undertaking, assets and liabilities to a newly established charitable company ("Newco"). (This is sometimes regarded as preferable to the first option, as a means to avoid the perception that one school is taking over the other); or
- school A being appointed as trustee (or sole corporate member) of school B or vice versa.
As you may be aware, the Charities Act 2006 introduced a new legal entity, the charitable incorporated organisation ("CIO") which may become increasingly relevant in mergers. A CIO will have a legal personality of its own, like a company, but will only need to be registered with the Charity Commission (and not Companies House). However, secondary legislation is required before CIOs will be available. After a consultation on the draft secondary legislation took place in 2009, the Office for Civil Society has had to revisit and substantially revise its proposed first draft. At the time of writing this guide the final form of the legislation has not yet been published and is not now expected before the end of 2012.
It is widely believed that the CIO structure will be a watered down version of the original vision and at least initially won't be a suitable form for larger more complex charities. It is also believed that conversion to a CIO from an existing charitable entity will not be initially possible, as this will require further secondary legislation in the future. The first to use the CIO structure are likely to be the guinea pigs, and may pay for being the pioneers of the new structure in time and expense until the inevitable teething problems associated with the new structure have been overcome.
Below are some key issues which the governing bodies of each school contemplating a merger should bear in mind at the very outset.
Governing bodies have overriding duties under charity and/or company law and to fulfil these, a fundamental question they should be asking themselves is whether it is genuinely in the best interests of their school, and the achievement of its charitable objects, to proceed with the merger, or are there other options?
The decision-making process will involve, amongst other things, the consideration of legal, financial, and reputational issues.
It will be necessary to ensure that the specific objects of the merging schools are compatible. For example, if the objects of school A specifically include a restriction that it shall only educate boys but school B is a co-educational school, then it will be necessary for the former to apply to the Charity Commission for a cy-près scheme pursuant to section 62 of the Charities Act 2011 to lift the restriction in its objects so that it can merge with a co-educational school. This should be put in train and the Charity Commission approached at the earliest opportunity.
Power to Merge
Initial consideration will have to be given as to whether the constitutions of both schools contain a power to merge, and in the manner proposed. If the existing powers are unclear or are prohibitive, then legal advice must be sought, as the relevant documents may need amending in order to proceed and this may require the prior consent of the Charity Commission.
Equality Act 2010 Considerations
It may be necessary to obtain a transitional exemption order from the Equality and Human Rights Commission if one or both schools will, upon the merger, change from a single sex to a co-educational school. We recommend that specialist legal advice is obtained at the earliest opportunity.
Consent from the Department for Education
The Education Act 2002 requires all independent schools to be registered with the Department for Education ("DfE"). Certain changes to a registered school require the prior approval of the Secretary of State for Education. The changes requiring such approval are:
- a change of proprietor;
- a change of school address;
- a change in the age range of pupils;
- a change in the maximum number of pupils;
- a change to admit boys only or girls only or become co-educational;
- a change to provide boarding accommodation; and
- a change to permit pupils with special educational needs.
It is likely that a school merger will trigger at least one of these changes and that one or both schools will need to obtain the prior approval of the Secretary of State, so the DfE should be approached at the earliest opportunity.
Steering Committee and Heads of Terms
The appointment of a steering committee, which should include key representatives of the two schools, is helpful to manage the project. The committee can negotiate and agree initial heads of terms (subject always to final approval of each governing body). In our experience these should be fairly broad as if the parties seek to make them too detailed from the outset this can hinder progress. Any conditions need to be clearly set out, including the time by when they must be fulfilled or waived. The steering committee can also remain in place throughout the process in order to implement the agreed terms and, if necessary, be given further powers by the governing bodies to discuss and resolve any issues which arise along the way.
Consideration should be given to whether any provisions in the heads of terms should be legally binding (such as confidentiality or those relating to costs), which could be particularly relevant if the merger talks fail.
Consideration will have to be given as how best to manage the expectations of both the stakeholders (particularly parents, pupils and employees) and the public. The schools may decide that they wish to keep the proposed merger away from the public domain until the documentation putting it into effect is signed. One advantage of keeping the negotiations confidential is that there is less involvement and input from third parties, making the transaction more manageable, and minimising anxiety and uncertainty. The disadvantage is that it is likely to be even more of a shock when the formal announcement is made, and that might have more of a negative impact than if interested parties had been consulted beforehand. The steering committee will want to agree the content of reactive and pro-active announcements.
Each school will want to carry out legal, financial and academic due diligence on the other, in order to ensure that the merger is in the best interests of the school and its pupils. This involves the onerous, but necessary, procedure of assembling and assessing all the relevant information and documentation relating to each school. Due diligence will take on particular importance for the transferee school, but a transferor school will still want to be reassured that the transferee is an appropriate beneficiary of its assets and undertaking. A report from each school's advisers (ie legal and accountancy) will be vital in determining which assets and liabilities are to be transferred, the areas and level of risk and any other issues which might affect the viability of the merger.
Consents are likely to be required from parties to contracts which the transferring entities have entered into. It is important that material contracts are identified at an early stage. However, if the merger is to remain confidential, thought will have to be given as to when to approach these third parties in order to obtain approval. In some circumstances it might be appropriate to ask third parties to sign a confidentiality agreement but legal advice should be sought beforehand.
Each of the schools will have to consider their financial circumstances and, in particular, whether or not they will be transferring any debt to the other school or the Newco. If not, how is it envisaged that the debt will be repaid? If debt is to be transferred, then the relevant documentation will need to be reviewed to assess which consents are needed and whether or not the lenders have, or will have, the unilateral ability to change the terms of the loans or even terminate their financial support altogether. This is especially important if there is to be a split exchange and completion, as both schools will want to continue to operate as normally as possible during the interim (please see the paragraph headed "Timing" on page 7). Furthermore, it is likely that lenders will have secured any substantial loans taken out on the property and assets of the schools. If the debt is not to be redeemed, separate consents will need to be obtained relating to the transfer of this security. The lenders will want to carry out their own due diligence to ensure that they are prepared to accept the transferee entity (or Newco) as the new borrower and mortgagor, and may ask for third party or personal guarantees of the obligations of the new borrower.
On a more general note, other day to day debts will also be owed by and to each school. Agreement will need to be reached well in advance of the signing of the documentation as to how these debts are to be dealt with at completion. In most cases, all the debts of the transferor school will be passed to the transferee on completion but there may be circumstances where this is not appropriate. It will be important to ensure that school fees paid in advance under those parent contracts which are taken on by the merged school continue to be held as a separate fund to be applied in payment of fees at the appropriate time.
Schools' land and buildings are usually their most valuable assets and therefore significant in any proposed merger. If a school is transferring property and it is a registered charity, the relevant provisions of the Charities Act 2011 must be complied with. If either or both schools are transferring leasehold land, landlord approval will probably be required and an extension to the term of a particular lease may be necessary. Planning consents could also be fundamental to the transaction and therefore form part of the conditions to the merger (as discussed above). For example, consents may be required for the development of the site of the transferor school and if more buildings are to be constructed as part of an improvement to the facilities of the transferee school. As real property and environmental issues often go hand in hand, it may in some circumstances be advisable to commission an independent environmental audit as part of the due diligence exercise, but these can be very costly.
Property held on trust/as permanent endowment
Even if a school is incorporated, it will frequently be the case that some of the property used for the purposes of the school is held on trust rather than as the school's own property. That being so, careful consideration will need to be given to the terms of the particular trusts, and whether the trusteeship can be changed or how the property can otherwise be transferred. If the trustees of the trust are different from the school's governing body, discussions will need to be initiated with them at the earliest opportunity. Many schools will have permanent endowment, i.e. property held on trust, the capital of which cannot be spent as if it were income, and the use of which may be restricted to a particular purpose. Although the Charities Act 2006 to a degree relaxed the rules on the spending of permanent endowment, restrictions remain. Consequently, an application may still need to be made to the Charity Commission for a Scheme or an Order pursuant to the relevant provisions of the Charities Act 2011 to resolve these issues (by, for example, appointing the transferee as the trustee of the transferor's permanently endowed property), and this can take time. The trustees of the permanently endowed property will have to make any such application and, again, if they are different from the schools' governing body, their co-operation will be essential.
Employment and Pensions
Employment and pensions are potentially difficult and emotive areas and so will need to be addressed at an early stage. 'TUPE' Regulations give employees of transferring businesses rights to enjoy the same terms and conditions of employment with the acquiring party that they enjoyed prior to the transfer. Both schools will be required to inform and consult with their employees within specific time frames. As it is unlikely that all staff will be required after the merger, employment law principles and procedures under which redundancies and other dismissals are carried out will also need to be strictly adhered to.
The parties will also need to review the pension arrangements in place for the staff of each school prior to the merger and assess potential liabilities which may arise postmerger. The considerations will depend on the type of pension arrangements each school has in place prior to the merger (for example: an occupational pension scheme or personal pensions; a defined benefit (final salary) scheme or a defined contribution (money purchase) scheme). Problems are particularly likely to arise where one or both of the schools sponsor(s) an underfunded defined benefit scheme and, as with employment, there are consultation requirements where changes to members' pension arrangements are proposed.
Name and Branding
The steering committee should discuss and agree at an early stage what the name of the merged school is to be and how it is to be branded. For example, should the name and brand stay the same as that of the school which is, in effect, 'taking over' the other, should it be a combination of both (to preserve the identity of both existing schools), or should it be a completely new name and brand (to reflect the new future)? Marketing, publicity and goodwill are obviously significant areas of concern here and it may make sense to engage a PR firm for this purpose. However, legal advice will also be needed as to whether any proposed new name and branding will infringe any third party intellectual property rights and also, if applicable, whether the new name will be acceptable or obtainable under company and/or charity law. The Companies Act 2006 provides for a 'names adjudicator' to consider any new company names which are too similar to one currently used by another individual or entity, and any person or entity is able to lodge an objection to a new name on the basis that he, she or it already has goodwill in that name.
It could be that there is a gap between the signing of a binding agreement and the date on which the merger legally takes effect, i.e. a 'split exchange and completion'. Whether this is necessary will depend on a number of factors, some legal (such as certain consents needing to be obtained) and others logistical (such as preparing the schools for the merger or coinciding the effective legal transfer date with school terms or academic years). To reflect this, conditions (which have to be fulfilled by one party or waived by the other) will often form part of the contract, so that if they are not met or waived within a certain period, completion of the merger does not take place.
The Commission now keeps a register of charity mergers which are notified. The register distinguishes between two types of merger: (i) where a charity transfers all its assets to another and then ceases to exist; and (ii) where two or more charities transfer their assets to a newly created charity and then cease to exist. The register of mergers was introduced by the Charities Act 2006 and at that time, it was thought that this register would alleviate the need to keep a transferor school in existence (but dormant) on the Charity Commission register after a merger took place solely for the purposes of safeguarding future legacies. However, it has transpired that some legacies (depending on the wording used in the will) may still fail if the transferor school has ceased to exist. The current advice therefore remains that the transferor charity should be retained on the Charity Commission register as an empty shell for the purpose of collecting legacies and transferring them to the transferee charity.
The non-legal and logistical issues are just as important as the legal issues. Who will teach whom? What subjects will be taught? Will the schools remain 'separate' in all but name and ownership? If years are to be assimilated, how will this be carried out? Where will extra staff and/or pupils be housed and accommodated?
School mergers are often perceived as school closures (and are therefore usually sensitive) and because they often result in complicated issues, the importance of planning well in advance and obtaining professional advice at an early stage cannot be too strongly emphasised. It is imperative that the merger is managed efficiently to a manageable timetable and with due care in order to minimise any perceived or actual negatives.
On the other hand, mergers may constitute an ideal opportunity for schools to maximise their capabilities and resources, and for the governing bodies to provide the best possible education and infrastructure for their pupils, setting the foundations for all-round success in the future.
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.