Blog post written by Ian Oakley Smith, former Head of Charities at PwC and specialist in insolvency.
The guidance below applies to charities that are constituted as limited companies. Charities which are unincorporated, or which have another legal form, such as CIOs, should take advice on any specific differences in law, but the behavioural and decision-making aspects of this blog should apply.
In the current context of the coronavirus pandemic, many charities are increasingly anxious about the future; whether they can remain solvent and continue to provide a valuable service for their beneficiaries and how they should respond.
Many trustees and Chairs will be asking themselves whether their charity is presently insolvent; if not, whether it will become insolvent in the future and how will they recognise when this is the case.
What do we mean by insolvency?
Charities can be insolvent either on a cash flow basis (if they are unable to pay their debts as and when they fall due) or a balance sheet basis (if they have liabilities exceeding their assets).
How do we know when our charity might be insolvent?
First, good information is vital – regular, reliable and insightful information makes a significant difference. Such information should include an up-to-date balance sheet, forecast income/expenditure and cash flow, including scenarios with clear assumptions, and information on a legal entity basis, i.e. not on a group basis.
Judgements may need to be made – for example, valuing liabilities to pension schemes, grant clawback provisions, other contractual obligations such as leases and restricted funds may all be an imprecise science. Trustees may need to consider “best” and “worst” case scenarios to understand the range of likely outcomes and determine the risk of a charity being insolvent.
Independent advice may be useful – Chairs should consider how they become comfortable that the information they are looking at is robust. Advice may be needed from insolvency experts but also perhaps from pensions or legal experts.
If in doubt, it may be best to behave as if a charity were insolvent: in practice, this means putting the interests of creditors at the front of decision-making.
What should Chairs do if their charity is insolvent?
The main change in mindset is that trustees will need to put the interests of the charity’s creditors (i.e. those owed money by the charity) at the forefront of their minds. In doing this, boards need to consider whether they have a “reasonable prospect” of returning to a solvent position. Boards will, therefore, need to think about both the “can we?” question (ie will we run out of money?) as well as the “should we?” question (ie should we make the position worse for creditors in the hope it will then improve?)
Charities should also actively consider the worst-case scenario of a cessation, as doing so will prove informative and may well improve the position for beneficiaries if a cessation of the charity becomes necessary. Such detailed planning for the best possible outcome in a cessation is often referred to as a “living will”.
What are the top priorities as a board navigates through a time of insolvency?
- Keep a detailed record of decision making and ensure a clear separation between the board and the executive leadership team.
- Have difficult conversations at board level early, when there is more time to navigate and address different opinions.
- Plan for the worst – a so-called “living will” (see above) can be very helpful in illuminating the practicality of contingency plans.
- Consider staff retention – concrete plans may be needed to retain key members of the team in a period of uncertainty.
- Take advice – don’t be afraid to take professional advice, even if it requires the use of some scarce funds.
For more information on insolvency
The Charity Commission’s guidance, CC12 Managing a Charity’s Finances, addresses the issues around insolvency for trustees.
If the charity is insolvent, or highly likely to be insolvent within the next 12 months you need to make a serious incident report to the Charity Commission.
There is more detailed information on what Chairs need to know about insolvency in our Members’ Area.