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Insolvency

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If your organisation finds itself heading for financial difficulties you need to arm yourself with an understanding of what your (and/or your trustees’) duties and obligations are, so you are prepared for the worst.  Then look for some practical advice and tools to help you to negotiate your way through the options.

The Charity Commission provides useful general guidance in CC12: Managing a charity’s finances: planning, managing difficulties and insolvency 

If you think your organisation may be in trouble, take professional advice because it is possible to fall foul of the law while trying to do the right thing.  Getting advice early is more likely to lead to you being able to rescue the situation. 

NCVO and the Charity Finance Group have a helpline or you could ask your independent examiner or auditor if they could recommend someone locally.  Or you could look for a licensed insolvency practitioner.

The trustees are legally responsible for the organisation, so it is a good idea for them to meet more often and record any key decisions along with the reasons for them. If things become difficult, particularly where personal liability is involved, you need a reliable record to refer to.

What is insolvency?

There is no statutory definition of insolvency, but in practice there are two tests, either of which might indicate insolvency:

  • Going Concern test – an organisation is unable to pay its debts as they become due
  • Balance Sheet test – the value of an organisation’s assets is less than the value of its liabilities (ie overall, it owns less than it owes to other people) .
Restricted Funds – when you are looking at whether your organisation can pay its debts, you must remember that you can only use restricted funds for the purpose for which they were given, and not to pay off the general debts of your organisation.  Although, it is possible in certain circumstances to seek clearance from the Charity Commission or the original donor to vary the terms of the restriction.

The impact of insolvency for trustees depends on the legal status of your organisation.

  • For a company limited by guarantee or CIO, as long as they have acted responsibly, the trustees will not have personal liability, and the members will only be liable up to the amount of their guarantee
  • The trustees of a charitable trust or management committee of an unincorporated association can be held personally liable for the debts of an organisation if it has insufficient money to pay them.

How to recognise potential insolvency

You need to be familiar with your organisation’s financial position and what you expect to see in the regular management accounts so that you can spot whether issues are “one-off” or signs of impending problems.

The finances should mirror what you know (or what is reported) about the activities of the organisation and remember that it is lack of cash that most often causes an expanding organisation to falter.

Signs to look out for on the accounts are things like a pattern of:

  • reduction in cash balances
  • increases in amounts owing to suppliers, late payments to HMRC
  • increases in amounts owing from grant funders (or other debts)
  • increased costs compared with budget
  • decreased income compared with budget.

Any of which might be indications that you need to take some action. 

More guidance on recognising potential insolvency:

What are your obligations?

Any organisation should not take on a debt that it does not reasonably expect it will be able to pay.  It is that simple.

Even when you are doing valuable work with the best of intentions, you always need to be aware of your duty to suppliers and the other people your organisation owes money to. This can be difficult for charities where it might seem contrary to the interests of your beneficiaries, but, in a situation where there is a danger of insolvency, the law looks to protect the rights of your creditors, and to treat them fairly. There are strict rules about who you can make payments to once you have identified that you might not be able to pay everyone.

Wrongful trading and fraudulent trading

As a trustee, this is a situation where you might become personally liable. Wrongful trading is when you carried on taking on debts (eg employing staff) even when you knew, or ’ought to have known‘ that there was no reasonable prospect of being able to pay (‘avoiding insolvent liquidation‘). Even if you didn’t intend to defraud them, you can stumble into wrongful trading. 

Preferential transactions

Be aware that once you are in a situation where insolvency is on the cards, you have to be extremely careful about who you make payments to – because you have to preserve your money so it can be shared out fairly amongst everyone you end up owing money to, rather than you getting as much money out to your favourites before your assets are frozen.

It is very unsettling being in a situation where you are facing insolvency, so take advice from professionals who can calm your fears and give you some perspective.

What are your options?

  • Review and restructure
    • Discontinue some activities
    • Find new sources of income
  • Merge or collaborate 
  • Wind up the charity

How to wind up a charity

The process to wind up your organisation will be different depending on:

  • its legal status – there is detailed company law around winding up  
  • whether you can pay your existing bills – create a budget to see what you will have to spend to close down. There’s a useful example in the WYCAS good practice guide to closing down a solvent organisation.
  • the details of your constitution – check for any specific rules about distribution of funds, and requirements for members’ meetings.  

If you are able to pay your bills

This is a relatively straightforward process, though it is always sad to close an organisation that has done valuable work. The WYCAS good practice guide to closing down a solvent organisation takes you through the steps you need to go through.

If you are unable to pay your bills

WYCAS guide to financial difficulties and Insolvency is a straightforward guide to the process 

Page last edited Jul 19, 2018

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