The recent Keeping Kids Company decision, where proceedings were unsuccessful and no disqualification orders were made against any of the Defendants, was good news for the many charity trustees across the land who often, like the Kids Company trustees, volunteer their time and do not see any remuneration for their services – a point that was heavily played in the press by the Kids Company trustees.
However, the decision identified many issues that trustees of charities in financial difficulty need to be aware of, and the purpose of this article is to look at the lessons that can be learnt to mitigate the risk of personal liability against a charity trustee where finances are tight.
Trustees of a charity in financial distress need to be aware of certain key legal principles in both charity law and the insolvency legislation. In summary, these are as follows.
Although day-to-day management of a charity can be delegated to a senior management team (or teams), the charity trustees continue to have ultimate responsibility for its management.
They have a duty to act in the interests of their charity and its beneficiaries, protect and safeguard the assets of their charity, and act with reasonable care and skill. Understanding and managing the charity’s financial health is therefore crucial to complying with these duties.
The Charity Commission has published guidance on what trustees need to consider when facing financial difficulties or an “insolvency” scenario (this term is used loosely, and the Commission uses it to refer to all charities, regardless of legal structure). The guidance should be read in full by the trustees of any charity facing financial difficulties.
Where a charity has to close, the Commission’s guidance makes clear that it expects charity trustees to have planned for an orderly shutdown.
The guidance also sets out the role of the trustees, including:
In an insolvency situation, payments to creditors are the trustees’ primary responsibility and should be scheduled in accordance with their priority. Every step necessary to minimise the potential loss to the charity’s creditors should be taken. This may involve cutting back or stopping some or all of the charity’s activities.
Paying professional fees for advice obtained is justifiable if incurred with a view to ensuring the best outcome for the charity’s creditors.
In the case of Kids Company, the charity was an incorporated company limited by guarantee, which meant that the Companies and Insolvency legislation applied, in addition to the Company Directors Disqualification Act 1986 (“CDDA”).
And in the case of Charitable Incorporated Organisations, the Insolvency legislation is largely implemented in the same way as for a company.
However, certain types of unincorporated charities – including those incorporated by Royal Charter or Act of Parliament, and unincorporated associations, but excepting charitable trusts – could still be wound up as an “unregistered company” under the Insolvency Act 1986 (the “Act”).
If this was to happen, then the provisions of the Act and the CDDA would apply and our advice and recommendation to charities in financial distress is therefore that the trustees proceed as if the Act applies and as if their charity were incorporated as a company.
In these circumstances, the main provisions of the Act that the Trustees need to bear in mind are:
Neither a charitable trust nor a charitable association has a legal personality, and so the trustees themselves enter into contracts on behalf of their charity, and are personally liable for the liabilities of their charity.
While the charity has assets, the trustees are entitled to be indemnified out of those assets for all liabilities and debts properly incurred in the performance of their trustee duties.
When the charity has insufficient assets, the trustees have potentially unlimited liability for any of the charity’s liabilities that remain unpaid, and can face personal insolvency.
For this reason, even if the same Company and Insolvency legislation cannot apply to charitable trusts as it might for an unincorporated charitable association, it would still be prudent for trustees of charitable trusts to be alert to signs of their charity being in financial difficulty, follow the Commission guidance, and take into consideration the points made in the remainder of this article!
One of the areas that the judgment in the Kids Company decision focused on was that charity’s management structure.
Executive power and decisions rested with the trustees but, like many charities, the charity employed a CEO and a management team to run the charity day-to-day.
The issue was highlighted in the judgment because the Official Receiver bringing the proceedings alleged that the CEO was a “de facto” director (someone who was not an actual director, but acted as if they were).
Under the Companies and Insolvency legislation, de facto directors and “shadow” directors (those who direct the directors how to act even though they are not themselves directors) are dealt with in the same way as actual directors and can be personally liable for their actions and the actions of the other directors, even though they are not directors themselves.
In the Kids Company decision, the Official Receiver argued that the CEO was, in effect, a director and could therefore be disqualified as if she were an actual director. The Judge disagreed, on the facts of the case, and refused to find that the CEO was a director.
However, the fact that the argument was pursued to trial demonstrates how important it is for charities to have a clear management structure and for everyone to know and understand their role and their liability, particularly if a charity gets into financial difficulty and ends up in an insolvency process, as Kids Company did.
In a non-charitable corporate, those with executive power in the company would normally be directors and the company may employ, depending on its size, people to run the day-to-day operations. However, those people would usually report to the directors, who would make the executive decisions on the most important issues.
In times of financial distress, we advise and encourage directors to have an even more detailed view of the day to day operations of the company and to take decisions on all aspects as it is not known which decision could give rise to personal liability if the company fails.
With charities, we often find the inverse is happening – the management team are making the executive decisions about the running of the charity and simply asking the trustees, who sometimes consider themselves to be “non-executive”, to approve what the management team propose.
However, should the charity get into financial difficulty and ultimately fail, you could have a situation where:
That is the essence of many of the allegations made against the trustees in the Kids Company decision. So how is it avoided?
Ways to avoid confusion over roles and liability
Many charities are not companies, but if they get into financial difficulty, regardless of their size, the Kids Company decision has shown the importance of taking a “corporate” approach to structure and governance.
This should best mitigate against the personal liability that can visit on charity trustees, whether paid or unpaid, if their charities get into financial difficulty and eventually go into an insolvency process.
Very few do so, but if a charity trustee is unlucky enough to be involved in such a situation, they should be doing all they can not only to protect the charity but also to mitigate their own personal liability, particularly when they are not remunerated for what they do. Forewarned is forearmed.
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