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Commercial Question

Insolvency in the charity sector: a pensions problem

updated on 01 July 2014

Question

Are the number of insolvencies in the charity sector increasing and, if so, what is causing them and what can be done about it?

Answer

According to the survey, 'Managing in the new normal', produced jointly by PricewaterhouseCoopers, the Institute of Fundraising and the Charity Finance Group, 94% of fundraisers expect the economic climate to get worse for their charities over the next 12 months; 63% said they had been negatively affected by the government’s spending policies and one in five are considering a merger to increase their chances of successfully overcoming economic difficulties.

While the charity sector is a notoriously resilient sector, these statistics make for grim reading and it is inevitable that, unless significant changes are made, we are likely to see an upsurge in the number of charities entering into some form of insolvency process, some of which are likely to end in a winding up of the struggling charity. This risk is accentuated by the anticipated rise in the interest rate and the increased demand for charities’ services, stretching their resources to sometimes untenable levels.

The state of the law

While there is no specific test for the insolvency of charitable institutions in the Charities Act 2011 or elsewhere, the test for the insolvency of a company is a two-armed test prescribed by the Insolvency Act 1986. A company, whether limited by shares or by guarantee, is termed "insolvent" if it cannot pay its debts as they fall due and/or where the value of its assets is less than the amount of its liabilities, taking into account prospective and contingent liabilities.

A Charitable Incorporate Organisation (CIO) will be deemed insolvent if it has not paid, secured or compounded a claim for a sum exceeding £750 due to its creditor within three weeks of having been served with a written demand for payment. Although the Insolvency Act 1986 specifically refers to companies and not all charities are set up as companies, in the past we have seen liquidators appointed over unincorporated associations, an example of which is discussed below. Charities, like companies whose objects are to make profit, can enter into administration, liquidation or receivership, and these processes can be initiated not only by the trustees, but also by the charity’s creditors.

Pensions deficit

A major concern for many charities and one that cannot be ignored is the level of their pensions deficit.

Employees of many charities, like many civil servants, are members of 'defined benefit' pension schemes where the benefits payable upon the employee’s retirement are pre-determined. They are calculated using the employee’s age, history of earnings and length of employment, rather than being determined by returns on investments. Over the last decade, partly as a result of an aging population, onerous government regulations and, of course, the economic downturn, the cost of providing defined benefit schemes has been steadily on the rise, in contrast to the return on investment of the charity’s assets that underlie those pensions, which have generally either been flat or in decline.

According to the Charities Commission, the current pensions deficit of all 180,000 charities registered in the United Kingdom combined is approximately £3.4 billion. It is a problem which can and does affect some of the largest and most well-known charities. In 2013 the RSPCA reported a deficit of £54 million in its defined benefit pension scheme, which had rapidly increased from £22 million in 2009. Following discussions with the pension scheme trustees, an arrangement was agreed whereby the RSPCA made a lump-sum payment of £10 million to reduce the deficit and is in the process of making yearly overpayments of £1.5 million. The RSPCA no longer offers such defined benefit pension schemes; it has revised its investment strategy and it is in the process of resolving its problems, but other charities have not been so lucky.

In November 2012 People Can, a charity supporting communities and individuals that have experienced homelessness and domestic abuse, went into administration as a result of its staggering pensions deficit of approximately £17 million. At the point of its administration, People Can employed around 300 people and operated in various cities across the United Kingdom.

Another charity to come to a sad end was the Spirit of Enniskillen Trust, a peace charity set up in Northern Ireland following the death of 11 people in an IRA bombing in County Fermanagh. Its aim was to promote an atmosphere of forgiveness by encouraging young people to travel outside of Northern Ireland and use those experiences to encourage peace back home. While the charity’s assets valued approximately £150,000, as a result of the charity’s pensions deficit of £250,000, it was felt that it would not be able to recover. The charity therefore resolved to wind itself up in 2013.

The role of charity trustees

The Spirit of Enniskillen Trust story is a sobering one for charity trustees. The charity was run as an unincorporated association, which meant the trustees automatically became personally liable for £100,000 of its debts, despite them by all accounts appearing to act responsibly and using their best endeavours to act in the charity’s interests. Had the charity been set up as a limited company or as a CIO, as was the case for People Can, the trustees would not have become personally liable for the charity’s debts as incorporated entities benefit from what is termed 'separate legal personality', meaning creditors could only pursue the assets of the incorporated entity, rather than those of the trustees.

However, regardless of how a charity is set up, it is the trustees who are responsible for the charity’s solvency and they must act reasonably and prudently in running the financial affairs of the charity. Failure to do so can result in the trustees being pursued personally by a liquidator or administrator for the debts of the charity, even if the charity is an incorporated entity.

If a charity begins to encounter financial difficulties to the point where it may become insolvent, trustees must prioritise the impact of its continued trading on creditors. They are strongly advised to take professional advice to ensure that the best possible result is achieved for creditors and for the charity, and, of course, to avoid any personal risk. While at times it may become necessary to cease trading, often charities can resolve the situation by coming to an informal arrangement with creditors or by entering into a Company Voluntary Arrangement (CVA), which may result in creditors agreeing to write off some of the debt or accept a longer timeframe for payment. Alternatively, the charity may wish to look into a merger with another charity or organisation via a formal insolvency process or otherwise. If the trustees are keen to pursue this course of action, early communication with the Charity Commission is heavily encouraged.

The future for charities

The issue of defined benefit pension schemes is one that many charities have taken steps to resolve. Many have stopped new employees from entering into the schemes and many have stopped employees who are members of the scheme from accruing further rights under it. However, exiting the scheme is not always the answer as it can, at times, trigger further liabilities for the charity. One hopes that the government will make changes to the current system, which is clearly not in a satisfactory state, but in the meantime, it is essential that trustees take early advice and do not ignore the problem for the benefit of the charities, the charities’ beneficiaries and themselves.

James Hillman is a second-year trainee in the corporate and commercial department at Irwin Mitchell.