Charities merger a strong restructuring option

WITH SO MANY different funding sources and activities, regardless of the economic environment, some charities are likely to be struggling with financial uncertainty and facing potential insolvency.

If you throw in the effects of the comprehensive spending review, increasing numbers of publicly funded charities are struggling to survive.

Trusts and foundations for which primary income streams are investment-based have not had a comfortable time, yet their cautious approach to investment and foresight in dealing with volatility has paid off and many are not exposed to insolvency risk.

Surprisingly, donation income has not suffered as much as had been expected but this might change if the current austere mood continues for a prolonged period and unemployment rises.

Facing a rising tide of gloomy economic indicators, regulation and operating models, what are the restructuring options open to charities?

Charity options

If a charity cannot pay its debts as they fall due for payment, or if the value of its liabilities exceeds the value of its assets, then the charity could be insolvent. Insolvency law aims to rescue or restructure organisations and perhaps the sale of a business might be arranged with the proceeds going to the creditors; the difficulty with charities is that a “sale” is inappropriate.

This begs the question as to what is the solution for charities that might be facing insolvency. The common solutions involve restructuring, joint working or merger; ultimately however, a winding up or dissolution could be the only options.

The charity trustees might prefer not to wind up the charity because there might be a desire to continue some of the charity’s work as well as save at least some jobs, expertise and possibly a brand. As many charities are unincorporated, winding up is not an option. In Panter v Rowellian Football Social Club, decided on 20 May 2011, it was held that the club was not a company for the purposes of the Insolvency Act 1986, so there was no jurisdiction to appoint an administrator.

Charity mergers are therefore usually born from need. For charities facing a situation in which a merger is desired, there is still the task of finding a good merger partner. The need might not just be economic but can arise from a perception that the charity has gaps in its services or expertise. There should be some shared gains and often cost savings too. Finding the right partner can take  time and there are many factors to consider.

Pause for pensions

One potential bar to a successful merger could be any outstanding pension liability of the charity: FRS17 requires a charity to measure surpluses or deficits. A significant pension deficit that has not been addressed might raise an issue over the solvency of the charity as a going concern; trustees will need to consider how funding a deficit may impact on budgets in the future.

Whether or not a deficit is disclosed on or off the balance sheet, the impact of contributions on cash flow is normally considered as part of the future plans for a merged charity. Funding such a deficit might also have an impact on existing borrowing, compliance with loan covenants and the charity’s ability to raise funding in the future.

A merger could also trigger the need to assess the debt owed to a pension fund under (s)75 of the Pensions Act 2004; the amount of the debt under this section is assessed on a buy-out basis. The debt should include not only present liabilities but also the whole or part of any such debt that might become due in the future.

A merger could require an annuity to be purchased from a regulated insurance company to secure the scheme’s liabilities in the future and, at a time when the charity is under sufficient financial pressure to mean that merger is an option, this requirement could be enough to scupper plans to merge.

If this is the case then winding up might be the only option. This could potentially lead to the trustees being held personally liable for the debts of the charity. The Charity Finance Directors Group has produced some excellent work in its publication, The Charity Pension Maze, which highlights the particular problems of charities and pension deficits.

Funding squeeze a quick killer

Recent reports, such as that from FRP Advisory, conclude that of all finance executives questioned, over one-fifth said that their organisation’s solvency is at risk because of the squeeze on funding and reduced donation incomes. The perception in the sector is that the government has failed to comprehend what it is that charities are being asked to do: the demand for charity services has increased simultaneously with the cuts in funding.

Statistical research by New Philanthropy Capital shows that almost one-quarter of charities in the UK were funded directly by government to some extent and 13% received more than half of their incomes from the state. A few charities were reliant on the government for 90% of their incomes. Withdrawal of funding can result in a charity becoming insolvent very quickly, for example in the case of the Immigration Advisory Service.

The Immigration Advisory Service was placed in administration and administrators were appointed on 8 July 2011. This was the largest provider of publically funded immigration and asylum legal advice.

Government reforms removed immigration from the scope of legal aid. The legal aid cuts meant that the charity’s liabilities could not be met from a much-reduced income base and solvent restructure could not be found.

Alison Maclennan is a partner and head of charities at Stevens & Bolton LLP