4 Mins
We have given insolvency advice to some unincorporated charitable entities recently that although have significant property assets and a low level of liabilities are struggling with cash flow to make payment of their debts as and when they fall due. We thought we would summarise some of the key issues. There are other types of entities that a charity be such as a company limited by guarantee or a SCIO and different processes and issues apply. One consistent factor to consider whatever the entity type is that Trustees may have good intentions when delaying a decision to wind up, but this can ultimately lead to an unexpected insolvency event that can have a more severe impact on employees, service users, and the broader community.
The insolvency process
Insolvency occurs when an entity is no longer able to pay its debts as they fall due, or its liabilities exceed its assets. A surplus of assets over liabilities does not matter when the entity is unable to pay its debts as they fall due. As an unincorporated entity, the relevant insolvency process would be a bankruptcy, sometimes referred to as sequestration.
A formal insolvency process would happen in one of two ways:
- Creditors take legal action to place the charity into bankruptcy. Following non-payment of debt, a creditor would seek to raise a statutory demand for the amount owed and on expiry of that would be able to present a petition to court to place the charity into bankruptcy. The court would then appoint an insolvency practitioner as Trustee in Bankruptcy of the entity.
- The Trustees can take steps to place the entity into bankruptcy themselves. The Trustees would need to pass a resolution. An insolvency practitioner would need to be consulted who would confirm that the charity is insolvent. An application is made to the Accountant in Bankruptcy who would then appoint the Insolvency Practitioner as Trustee in Bankruptcy. Consent from OSCR would be required prior to the application being made.
The effect of the appointment is the same in either scenario:
- The powers of the Trustees cease, but they are required to cooperate with the Bankruptcy Trustee.
- All the property of the charity would vest in the Bankruptcy Trustee who then has the power to sell.
- The Trustee would seek to realise all the assets of the charity for the benefit of the creditors.
- It is likely that all staff would be made redundant immediately and they would receive their full employee entitlements from the government (redundancy, notice and holiday pay) and the government would rank in the insolvency as a creditor for the amount paid.
- Any subsidiary shares and investments held would be sold.
- The Trustees can seek to guide the Bankruptcy Trustee on how to realise the assets but they do not control.
- Any surplus would be available to be passed to another charity with all or any of the same objects as the charity. It would be the Trustees that would determine this by resolution.
Duties of charity trustees and implication of insolvency
Charity trustees have a legal duty to act in the best interests of their charity and its beneficiaries. They are responsible for making important decisions about how a charity is run and ensuring that the charity’s finances are managed effectively. They need to ensure that it operates in compliance with relevant laws and regulations.
It is essential to ensure that restricted charitable funds are used only for the specific purposes for which they were donated. Designated and Restricted funds should not be used to cover general costs or expenses that are not directly related to the restricted purpose without the consent of the donor/grantor or OSCR. If the Trustees are currently in breach of this OSCR should be informed.
Unincorporated entities do not benefit from any limited liability which means that creditors can pursue the Trustees personally for any liability of the entity. This means that at they may be required to contribute from their own personal funds. The Trustees ultimately have a right of recourse to the funds of the charity, but only if there are funds remaining.
There can be reputational damage which could impact a Trustee’s future. However, there should be no impact on a Trustee’s credit rating, or ability to act as a director of a limited company or hold positions of public office. A Trustee will be able to hold Trustee positions with other charities. This is unless they have acted in a certain way such as carrying out fraudulent acts, breaching a fiduciary duty or benefitted personally from charitable assets.
A Bankruptcy Trustee will be able to pursue a Trustee of a charity personally in these circumstances and is required to notify OSCR if they have identified any breach of a trustee’s charitable duties or obligations.
For further advice get in touch.
