Charities and insolvency

Charities and insolvency

Pesh Framjee, Partner, Global Head of Non Profits
03/04/2020
 Charities and insolvency
The charity sector is going through, and will continue to face, a period of real challenge and change.

On 28 March 2020 the government announced changes to the insolvency regime aimed to provide companies breathing space and keep trading through the COVID-19 pandemic. There will be a temporary suspension of wrongful trading provisions to remove the threat of personal liability during the pandemic, applied retrospectively from 1 March 2020.

In addition, there will be a temporary moratorium for companies undergoing a restructuring process so that they cannot be put into administration by creditors and will continue to be able to pay suppliers and staff.

The detail and the underpinning legislation is yet to follow. However, it has been clarified that these measures do not impact the existing laws relating to matters such as fraudulent trading, transactions defrauding creditors, misfeasance.

  • There are normally two tests of insolvency – the balance sheet test (positive net assets) and the cashflow test.
  • The key issue is can the organisation pay its debts as they fall due.
  • Careful consideration is required of many factors such as what values can be realised in time to meet debts and what assets can be used to meet liabilities.
  • Understanding is needed of the implications of the different restricted and endowed funds held by the charity.
  • The position for trustees of an unincorporated charity is different and the risks are usually higher.
  • Directors and shadow directors can be guilty of wrongful trading if they continue to trade and incur liabilities they knew or ought to have known that there was no reasonable prospect of avoiding insolvent liquidation.
  • Fraudulent trading is also a risk.
  • The charity should avoid entering into preferential transactions which put another party in a better position to the detriment of other creditors.
  • The court will recognise mitigating circumstances. For example, if the directors took proper steps to minimise the potential loss to the company’s creditors.
  • The Companies Act requires that the accounts are prepared on a going concern basis unless there is a reason to believe that this is not appropriate. Therefore, Directors must consider whether the entity is a ‘Going Concern’.
  • ‘Cash is king’. Organisations should ensure that they focus on careful cash management and recognise that some funds are not available for general use or to pay creditors.
  • Good management information is vital and it is important to reassess how the charity identifies what matters, recording and reporting on what matters.
  • Knee jerk reactions are risky and careful consideration of reserves and how they can be used coupled with cost optimisation and a real focus on income can help manage the situation.
  • It is important to look beyond the obvious and to recognise that the impact on income generation may be delayed but reduction in income can be sudden with little warning and therefore good communication and careful evaluation and forecasting are needed.
  • There should be action plans for different scenarios and monitoring of trigger points and trend analyses to enable the charity to decide when it needs to put the plans into place.
  • All decisions must be carefully made and the deliberations should be properly recorded.
  • The frequency of Board meetings and briefings from management may need to increase and it is vital to show that the Board received proper and up to date information to really evaluate the financial position. 

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Pesh Framjee
Pesh Framjee
Partner, Global Head of Non Profits
London