Insolvency professionals advising cathedrals and other charities

Frettens’ resident Insolvency Guru, Malcolm Niekirk, delivered one of his popular monthly coffee break briefings on Monday 8^th March.

He spoke about insolvent charities with another large group of insolvency practitioners from all over the country.

Below, we have provided a summary of what was included. You can also download the slides and a recording of the presentation.

Insolvent charities - quick links

This is a complex area of insolvency law and this is a lengthy article. We’ve included some handy links below to take you to relevant sections, and have included some corresponding timings for the presentation recording.

• ​What is the third sector of the economy?
• How is the third sector different from the rest of the economy?
• How is a charity different from other third sector organisations?
• Defining charitable purposes
• Pros and cons of becoming a charity
• Different types of constitutional entities for charities
• The anatomy of a charity; the beneficial ownership of it's assets
• How new legislation is intended to prevent insolvency from forcing the sale of cathedral buildings
• Advising insolvent charities - conclusion

Please don’t hesitate to get in touch if you are an insolvency practitioner and have any questions relating to issues raised here.

What is the third sector of the economy?

An overview of 'non-for-profit' organisations.

Before we talk about the third sector, we need to define what the other two sectors are:

• The State sector; organisations that are part of the government (national, or local), or largely directed by governments (national, local or international).  Their objective is the furtherance of government policy.
• The Private sector; organisations that are privately owned and directed by individuals promoting the interests of their owners.  Their objective is normally private profit.

The Third Sector comprises organisations that are outside those categories.  Examples of third sector organisations include:

• Co-operatives,
• Social enterprises,
• Voluntary groups, and, of course,
• Charities.

How is the third sector different from the rest of the economy?

What sets the third sector apart from the rest of the economy is that it is:

• Independent of government.  However:
  • Third sector organisations can be very dependent on grant funding from national or local government (and previously the EU).
  • Third sector organisations can deliver government policy.  For example, housing associations, are important providers of social housing.
• Not for personal profit.  However:
  • Third sector organisations – like any other – will become insolvent if they do operate at a deficit for excessive periods. 
  • Many people are gainfully employed in the third sector
• Values driven.
  • The mission, the service they deliver, is the end in itself, not a means to an end.

How is a charity different from a non-charitable ‘third sector’ organisation?

There are two tests for a charitable organisation, both are about its objectives.

The first is whether its purposes are charitable in nature. The organisation cannot be a charity unless it exits to carry out a charitable objective.

The second is about who benefits from its activities. The organisation cannot be a charity if it is run for private benefit. 

The private benefit might be because it is a commercial organisation, which needs to provide a return on capital for its shareholders. Or it might be because the class of people who are intended to benefit from its activities is too narrow.

So, for example, a private hospital, open to the public, is likely to be carrying out charitable objectives (healthcare).  If it is funded by shareholders, who need a return on investment, it will not be a charity.  But, if it is funded by philanthropists, on non-commercial terms, it probably will be.

Defining charitable purposes

Charitable purposes are defined in law. There’s a list in the Charities Act 2011:

Broadly speaking, they are:

• The relief of poverty.
• Education.
• Religion.
• Health.
• Communities and citizenship.
• Art, culture, heritage and science.
• Amateur sport.
• Human rights and tolerance.
• Environmental causes.
• Aiding people who are at a disadvantage.
• Animal welfare.
• Support for the members of the uniformed services.

There is also a ‘sweeping up’ category, to allow many other purposes to be charitable, if they are within the spirit of those, or recognised as charitable under the previous law.

Remember, in each case, it can be charitable only if there is also public benefit from the organisation’s activities.

Pros and cons of becoming a charity

An organisation that sets up as a charity can benefit from doing so. Examples of the benefits might include:

Advantages

• Recognition
  • People are familiar with the idea of a charity.  Being able to describe itself in that way may open doors to the charity.
• Fund raising
  • There are grant funds available to third sector organisations.  Charities probably have more opportunities to win grants than do non-charitable not-for-profit organisations.
  • Charities can claim gift aid on donations (and higher rate tax payers can get tax relief on their donations too).
• Tax benefits
  • Charities are not expected to pay income tax or corporation taxes on their surpluses.
  • Charities have exemptions from stamp duty.
  • Charities can claim relief from VAT on goods and services they buy.
  • Legacies to charities can reduce the inheritance tax paid on an estate.
  • Charities can pay very much less in business rates on the premises they use.

There are disadvantages to operating as a charity too.  For example:

Disadvantages

• Limited permitted activities.
  • The charity has to operate within the fairly narrow range of activities set by its constitution (and falling into the range of permitted objects for charities). 
  • It can be difficult to redirect or diversify those activities.
• Raising capital.
  • Charities cannot pay a return to investors, so cannot raise equity capital.
  • Funds received as gifts or grants can have restrictions on how they can be used.
• Regulation.
  • Most charities are regulated by the Charity Commission, and, of course, have to comply with charity law.
  • Those that are exempt, or exempted from registration with the Charity Commission still have to comply with charity law, and are likely to be regulated by another body.

How does the type of constitutional body affect insolvency procedure?

Charities can be set up with many different types of constitution. That can limit the choice of insolvency procedure.

Charities may be incorporated, or unincorporated. The trustees and managers of charities are better protected from personal liability in incorporated charities.

They are likely to be personally liable for the debts of the charity in unincorporated charities.

Types of incorporated charities

Common forms of incorporated charities include:

• Charities limited by guarantee.  (Registered at Companies House and the Charity Commission)
• Charitable incorporated organisations.  (Registered only at the Charity Commission, and not at Companies House.)
• Registered societies. (These used to be called industrial and provident societies.  They are registered in the register of mutual societies administered by the FCA.)

There are other forms of incorporated charities. (You may encounter a charitable friendly society. Friendly societies are not the same as registered societies, although they are registered in the register of mutual societies. Some friendly societies are bodies corporate, others are unincorporated, depending on the legislation under which they were first registered.)

The constitutions of Anglican cathedrals

Cathedrals (under the present law, which is due to change soon) exist as bodies corporate with perpetual succession. The body corporate is composed of the members of the cathedral’s council, its chapter and its college of cardinals. 

When the new law takes effect, the cathedral will still be a body corporate, but consisting only of the chapter.

Corporate insolvency procedures

Not all types of charity organisation can take advantage of the full range of insolvency procedures available to companies under the Insolvency Act 1986. It may be possible to convert a body corporate into a different type of corporation to use a particular insolvency procedure.

Insolvency professionals advising charities

When advising a charity or its trustees, it is good practice to identify early on what type of body it is, to assess what procedures are available.

Unincorporated charities may be described as trusts, foundations, societies or associations (or in other ways). 

There is perhaps even more diversity in non-charitable third sector organisations. Those can can be registered as companies limited by share, or community interest companies. Charities cannot be set up in that way.

Credit unions, and trade unions can probably also be considered as non-charitable third sector organisations.

Larger charities can have a more complex structure, more like a group structure. There may be trading companies (companies limited by share) that are owned by the charity, or closely associated with it, to carry out activities to generate income for the charity.

There may be registered societies closely linked to the charity, to engage in supportive (but non-charitable) activities.

Importance of regulatory bodies

Although most charities are registered at the Charity Commission, some are not. You can expect the trustees of the charity to tell you that it is a charity when you first start talking to them. They are also likely to tell you if it is an exempt charity or exempted from registration. 

In that case, you will probably ask for verification from their professional advisors as you will not be able to get information about them from the Charity Commission. And you should find out what body regulates them (there may not be one if they are a registered society that is not a housing association).

The beneficial ownership of charity assets

The assets held by a charity cannot necessarily be used to pay its debts, even when it is insolvent.

The essence of a charity is that it holds its assets on trust.  But a charitable trust is different from other trusts.  Other trusts have beneficiaries; identified persons for whom the trust property is held.

The assets in a charitable trust are beneficially owned for the charitable purposes of the charity. 

The important issue for an insolvency professional, is that the assets owned by the charity might have to be treated as beneficially owned by another. They may not be available to pay the costs of winding up the charity, or the debts it owes to its creditors.

The different types of charity funds

There may be different categories of ‘funds’ in the charity’s accounts.  For example there may be some of these:

• Unrestricted use funds.
• Restricted use funds.
• Land and buildings.
• Expendable endowment.
• Permanent endowment.
• Held on another charitable trust.

These can affect the extent to which the charity is able to use its funds to pay for the costs of winding up, or to pay its creditors.

For example, the proposed constitution for cathedrals under the new law is intended to protect the cathedral building from insolvency.  It will do that by placing the land and buildings (and other items of significant value) in a separate charitable trust. 

How new legislation is intended to prevent insolvency from forcing the sale of cathedral buildings

The cathedral’s liabilities, and operational responsibilities will be in the body corporate comprised of the chapter.  That incorporated cathedral will have use of the land and buildings, but not ownership of them. 

So, although under the cathedral corporation, the land and buildings will be beyond the reach of its liquidator.

Can cathedrals go into CVA?

Looking at new legislation regulating cathedrals, as charities, highlights many of the issues that can affect insolvent charities of many different types.

There is another aspect of dealing with insolvent charities that is brought into focus by looking at cathedrals.  It is the range of insolvency procedures that may be available. 

For example, although Bradford Cathedral went into a CVA in 2004 (following the failure of an associated multi-faith project ‘Life Force’), the law has since changed. 

Presently it is not possible for a cathedral to go into CVA.  The intention is for that to change when the law changes, but the arrangements for that are not yet apparent.

Malcolm has provided further insight into the new regulations, which you can read here.

Typical issues with distressed charities

Charities, in common with all Third Sector organisations are driven by their values, more than financial value. The continuity of their work and objectives is likely to be a factor important to the trustees and managers.

The risk of personal liability will be an issue of real concern for the trustees, perhaps more so than in commercial organisations (where that risk may be more balanced by the prospect of personal gain).

Advisors should expect to spend more time on this issue than might be needed when advising the directors of commercial organisations.

The corporate governance of charities is often formal, and subject to checks and balances between the trustees and the operational management.  As a result, decision making can be be more considered – and take longer – than might be the case in a commercial organisation. 

The full range of corporate insolvency procedures may not be available.  That will depend on the type of organisation that constitutes the charity.  Advisors should make an early check on this point.  It may be possible to convert the organisation into one of a different type that offers different options.

Similarly, advisors should check the categorisation of assets held by the charity, to identify those available for use during a formal insolvency, and those which have to be ring-fenced.

Insolvency Law: Coffee Break Briefings

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We hope you found the briefing useful. If you are an insolvency practitioner who would like to discuss the content of this article, please do not hesitate to get in touch.