Charities are, unfortunately, continuing to experience situations in which their finances are being tested. It is clear, that, particularly in circumstances of doubtful solvency, trustees will need to keep on top of financial data and cashflow projections of the charity in order to best assess the options which are available to the charity and, where possible, try to remedy the situation and rescue the charity.
In this article we provide some guidance as to how trustees how trustees should be dealing with different types of assets that a charity may have access to, such as restricted funds and reserves, in a situation of potential insolvency.
As we have reported in previous articles, trustees have a duty to act in the interests of the charity and its beneficiaries, they have a duty to protect and safeguard the assets of the charity and they have a duty to act with reasonable care and skill. However, in a situation a charity's financial position is precarious, or where there is doubtful solvency or impending insolvency those trustees' duties change to include a duty to act on the interest of the charity's creditors. In order to minimize the risk of personal liability, trustees must ensure that the duty to act in the interests of the charity's creditors must be the primary duty that trustees seek to achieve if the insolvency of the charity is inevitable and cannot be avoided.
It is therefore vital for trustees to have an awareness of a charity's up to date finances and financial information in order to be able to assess when a situation of doubtful solvency may arise, as well as to identify the point in time at which insolvency is inevitable. In order to assess insolvency, trustees will need to assess if the charity has failed or is at risk of failing either the Cashflow Insolvency Test (i.e. when a charity is unable to pay its debts as they fall due) or the Balance Sheet Insolvency Test (i.e. whether the charity's assets are less than its liabilities).
Equally important, in addressing both of those tests is the way in which a charity may account for, and hold their assets. We explore some practical implications of this below:
Charities will often be given assets to be used for specific purposes, in line with a charity's objectives, or be given gifts, or hold assets on terms which restrict how the asset can be used. In general, these types of assets can only be used to met expenses incurred in relation to the assets themselves and cannot be used to met general liabilities.
Accordingly, when applying the Cashflow Insolvency Test, or Balance Sheet Insolvency Test, trustees need to consider unrestricted assets separately from restricted assets. It is important for trustees to be able to accurately determine and record which assets of the charity are unrestricted, and which assets may be restricted, designated for specific purposes or be a permanent endowment (taking care, where necessary, to differentiate between the capital value of an asset, and any income it generates).
As well as taking into account the way in which an asset is held when calculating the Cashflow or Balance Sheet tests, trustees should, of course, be aware of the characteristics of an asset when actually discharging any expenses or meeting liabilities, particularly in a situation of financial distress. Trustees should be careful so that restricted funds are not used to discharge general debts.
As charity accounting provisions can be complex, it is advisable that trustees instruct accountants who specialise in charity accounts to asset them in preparing the financial information in relation to the company.
It is important for trustees to understand how different categories of income may be treated in the charity's accounts (eg is future grant income included as a 'debtor' or as a separate category in its own right) as understanding this will enable trustees to better assess what future cashflow in the charity may look like and to help recognise the parameters under which that future income may be withdrawn.
In assessing the charity's financial information, trustees should consider whether values attributed to assets are current up to date market values or book values/cost values dating back to when the asset in question was acquired. Trustees should consider whether it would be sensible to obtain more updated valuations.
We often come across situations where a charity is part of a group, together with other charities and or non-charitable trading subsidiaries, where unfortunately the financial management or record keeping has not been accurate or whether there are consolidated accounts for the entire group where it is difficult to extract the assets and liabilities attributable to one entity from the group itself.
This can lead to confusing and inaccurate information, which may suggest that an entire group is at financial risk when it may be that only one entity within it has a problem.
A situation of conflict of interest may also arise in these situations, particularly if different entities within the group have different trustees/directors.
We would suggest that, where possible, the accounts of each charity are kept accurately and separated as needed to enable each charity's specific position to be assessed by its trustees.
The sooner that trustees are able to spot signs of impending distress the sooner they are able to mitigate the risks of personal liability by taking appropriate specialist advice and adopting preventative measures.
Whilst accurate up to date financial information and awareness of a charity's assets is key to the trustee's ability to do so, we would also suggest that the following warning signs are heeded, and extra support and advice sought of any of these are present:
There are often ways in which charities can be rescued from the brink of insolvency, whether by way of a merger with a like-minded cause allowing a benefit of economies of scale, whether a standalone asset can be released for value, or whether cost saving measures can be implemented.
We can, together with other specialist distress advisors, support charities and their trustees through the process.
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