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Financial difficulty and insolvency

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This page provides a brief overview of some of the areas you will need to think about in relation to serious financial difficulties and insolvency. There are also links to practical advice and guidance to help you to find your way through the common options.

If your charity finds itself heading for serious financial difficulties, then having a clear understanding of your duties and obligations is essential, as it allows you to think about recovery plans and prepare for closure or merger. This is especially true for the trustees of a charity as they are legally responsible for the organisation and have obligations in relation to its solvency.

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

Professional advice

If you think your organisation is facing serious financial difficulties then, wherever possible, you should take professional advice. This is because it is possible to break the law even while trying to do the right thing. Getting advice early means you are more likely to develop an effective recovery plan or managed closure.

NCVO cannot offer advice on insolvency as we are not lawyers or insolvency experts. The Charity Finance Group (CFG) is a charity who specialise in advising charities on financial management knowledge and skills.

These specialist providers offer professional advice on a fee-paying basis:

  • Crowe provide a range of financial advisory services to charities and have produced free guidance on insolvency.
  • Lucas Johnson are an independent firm specialising in business recovery and insolvency, and which offers free consultations.
  • The Insolvency Practitioners Association can help you search for accredited providers.

You may also wish to seek legal advice to make sure you are meeting your obligations.

Bates Wells, the charity and non-profit specialist legal firm, has launched its new Decision Tool for voluntary organisations facing financial difficulty, for organisations who are unsure of their next steps. 

What is insolvency?

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

  • The cashflow test: An organisation is unable to pay its debts as they become due
  • Balance sheet test: the value of an organisations assets is less than the value of its liabilities (ie overall, it owns less than it owes to other people).

Recognising potential insolvency

When assessing the two tests set out above it is essential that you get accurate and timely financial management information. You will need to be familiar with this information and be able to spot whether issues are ‘one-off’ or signs of impending problems or tends. The finances should mirror what you know and what is reported about the activities of the organisation.

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

  • reduction in cash on balance sheet
  • increase in amounts owing to suppliers, late payments to HMRC
  • increase in amounts owing to 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.

Developing a cashflow forecast

It is a lack of immediate cash to pay debts that most often causes expanding organisations to falter. Developing a cash flow forecast will help you see when you may have a shortfall and how to handle this. A cash flow forecast can be developed by mapping out:

1. the payments the charity will have to make over a defined timeframe including all costs eg the next weeks and months

2. the cash which is currently available to the charity to cover those payments

3. the income the charity expects to receive over the same timeframe together with an assessment of how likely and secure the income is.

Assessing your assets and funds

The nature of the net-assets and funds held by a charity will require careful consideration when assessing your financial position and mapping your cashflow forecast. You need to think about the funds according to the restrictions on their use:

  • Unrestricted funds: These funds are available for general use and can be allocated against any potential liabilities.
  • Restricted f unds : Restricted funds can only be used 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.
  • Restricted capital funds: These funds are not for direct application. In the case of a permanent endowment, trustees will have no power to apply the fund as income. If it is an expendable endowment, trustees can use it if necessary but it should be treated as capital until the right to use it is exercised. You can seek permission from the Charity Commission to use endowments in certain circumstances.

Assessing your options

Once you have assessed your financial position you will be presented with one of the options below. Even if you pursue one of these options its helpful to understand at what point you may need to look at the alternatives.

  • Review and restructure your organisation
  • Stop some activities
  • Find new sources of income
  • Merge or collaborate 
  • Close the charity

The Charity Commission have guidance on how to close a charity . The process to wind up your organisation will be different depending on:

  • its legal status : There are specific steps which different types of organistion need to take
  • whether you can pay your existing bills: If you are able to pay existing bills, WYCAS good practice guide to closing down a solvent organisation takes you through the process . If you can’t pay your bills, have a look at the guidance on insolvency below
  • The details of your constitution: You should check for any specific rules about distribution of funds, and requirements for members’ meetings

Insolvency guidance

You can find further guidance on assessing your charity’s financial position against the insolvency tests here:

Trustee and director obligations

No organisation should take on a debt that it does not reasonably expect it can pay.  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. For incorporated organisations there are strict rules about who you can make payments to once you have identified, or reasonably ought to have known, that you might not be able to pay everyone.

For this reason, as as a trustee, you must consider whether or not your organisation is a ‘going concern.’ This means that there is an underlying assumption that the organisation will continue in operational existence for the foreseeable future, and that it has neither the intention nor the need to liquidate or materially reduce the scale of its operations.

Trustee liability

The obligations and implications of insolvency for trustees depends in part on the legal status of your organisation .

  • Unincorporated charities (eg charitable trusts and unincorporated associations): Trustees can be held personally liable for properly incurred debts of the charity if the charity has insufficient funds.
  • Incorporated charities (eg charitable incorporated organisations or companies limited by guarantee): Offers more protection to trustees but this protection is still ‘limited’ and does not remove all liability for trustees particularly in the case of insolvency.

Boards concerned about the potential for insolvency, or financial difficulties, should meet regularly to manage the situation and record all key decisions along with the reasons for them. A reliable record of decisions is essential in these cases.

Below are some of the main areas of responsibility trustees need to be aware of because they can occur in insolvency and expose board members to personal liability. More detail can be found in Crowe’s guidance note on Charity and Insolvency .

Wrongful trading and fraudulent trading

Wrongful trading is when an incorporated entity has 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. 

Fraudulent trading is similar but occurs when a director allows the incorporated entity to carry on, with the intention of defrauding creditors. It is much stronger than wrongful trading, therefore it carries stronger penalties.

Preferential transactions

If you are an incorporated entity then once you are in a situation where insolvency is on the cards, you must be extremely careful about who you make payments to. This is because you must preserve the organisation’s money so it can be shared out fairly among everyone you end up owing money to. This includes cases where paying out money might advance your charitable purpose.

Breach of trust

All trustees, regardless of legal form, can also always incur personal liability for what is called a ‘breach of trust’. This includes activity such as operating outside the charity’s objectives, using funds for non-charitable purposes, or unauthorised payments to trustees. It is essential that trustees follow the governing document and take steps to safeguard the charity’s funds.

Page last edited Aug 26, 2020

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