As many charities are faced with increased costs and reduced income, trustees must be vigilant in ensuring that their organisation is in a sound financial position to achieve its goals. If this is not the case, there are steps that should be taken to minimise damage to all interested parties.
Assess the organisation’s financial position
There are two bases on which to consider whether an organisation is insolvent or not - the ‘asset test’ and the ‘cash flow test.’ An organisation is insolvent when its assets are insufficient to cover its liabilities. From a cash flow perspective, insolvency is when an organisation cannot pay its expenses as and when they fall due.
Often the trustees might not be involved with the day-to-day management of the organisation but it is essential you receive timely financial information. Having up-to-date accounting information is vital so that trustees can look at alternatives at an early stage before problems escalate. You can then assess whether the financial difficulties are temporary, and can be overcome, or whether they are too serious, and steps must be taken to close the charity.
In limited circumstances, there may be the opportunity to merge with another charity with similar goals. This can give scope to the reduction of operating costs, ensuring the continuance of the charity’s aims. But what if this cannot be achieved?
A further restriction on your charity’s cash might be the extent to which funds are for restricted use. Assessing the organisation’s solvency, trustees must therefore consider whether they have sufficient unrestricted funds to meet their liabilities as and when they fall due.
The cost of closure
Financial accounts will show what liabilities need to be paid. However, there may be other costs that are not so obvious, such as liabilities under leases. Another potential issue that can tip a charity into insolvency is staff redundancy payments, particularly if staff have long service histories.
Legal structure
Who you need to engage with can vary depending on the legal structure of your organisation and its governing document. For example in an LLP with charity status, it is normally the members of the LLP who decide to appoint an administrator. Alternatively, if there is no prospect of saving any aspect of the charity then it may be more appropriate to put the organisation into liquidation. The members can also be the trustees, who are responsible for the day-to-day running of the organisation. However, particularly in larger organisations, the members can be a separate body, in order to give independent control over the running of the charity.
Whatever the organisation’s constitution there are basic principles that all trustees should adhere to. Firstly you must ensure that you are sufficiently informed and act in good faith and only in the interests of the charity.
However, once it is identified that the organisation is insolvent, the duties of the trustees will also need to factor in responsibilities to creditors of the organisation.
If the trustees have formed the view that the organisation is insolvent, it is key that you seek early advice so that the right insolvency process is identified and also the possibility of a return to creditors is maximised.
Before administration or liquidation
A common question asked by trustees is ‘whether the charity can continue to operate when insolvent?’ The answer is ‘yes’ but great care is required. All decisions need to be fully documented. For example, charities may resort to short-term financing whilst they await an expected influx of cash such as the payment of a grant. Ultimately the decision to continue must be seen to be of benefit to the organisation's estate. Trustees also need to ensure that all creditors are treated equally in the period that they continue to operate prior to a formal insolvency process.
Charity Commission involvement
Trustees have a duty to report any serious incidents, such as financial difficulties to the Charity Commission. Where there is suspicion of serious misconduct or mismanagement in the administration of a charity or risk to property held for charitable purposes, the Commission may open an inquiry under section 46 of the Charities Act.
Seek advice early!
If you are a trustee of a charity or not-for-profit organisation and have any concerns about your financial position and the challenges you are facing, seeking advice early will ensure the best possible outcome is achieved, whether that is to minimise the impact of the insolvency or to identify issues and help improve your organisation's performance.
Please call 0808 144 5575 or email help@armstrongwatson.co.uk for further information and support.
