This article was originally published in Charities Management and can be accessed here.
Charity incorporation: What’s the issue?
With the exception of a small number of charities created by Royal Charter or by Act of Parliament, it used to be the case that pretty much all charities were constituted either as trusts or as unincorporated associations. By and large this has seemed to work fine for most of them.
Ways were found to get round the fact that these structures cannot themselves own property, enter into contracts or be sued in their own name. Legal ownership of land and other assets can be registered in the names of individual trustees, and that works well so long as they remember to update things when there is a change of trustees. Land can also be held for a charity by the Official Custodian for Charities, and a range of assets can be held by nominees or custodians.
However, as the environment in which charities work has become more risky and litigious, trustees have quite understandably become less comfortable about another feature of being unincorporated, namely that they will be in the firing line for claims arising from the charity’s activities. Of course, trustees may look to their charity’s assets to settle any liabilities they have properly incurred, but if the charity has insufficient assets, there is no protection and the personal liability of trustees can be unlimited. In theory, trustees’ homes could be at risk.
If your charity is just making grants, the potential liabilities should be manageable and should never exceed its assets, but if you are employing staff, leasing premises, entering into contracts, arranging fundraising events, providing services to beneficiaries or borrowing money, think carefully about whether you need the protection of an incorporated structure.
How does a corporate structure help?
If a charity adopts a corporate structure, the risk of personal liability for trustees will be significantly reduced. The charity itself can hold property and enter into contracts in its own name, so the trustees are no longer in the firing line, even if the charity has insufficient funds to settle a claim.
Within the charity, there is still scope for trustees to be personally liable for losses resulting from breach of trust or breach of duties but that is a liability to the charity itself, not to the outside world.
There are some liabilities that will always stick with the trustees, for example in relation to environmental contamination, health and safety law, bribery and wrongful trading, but by and large any liability properly incurred by an incorporated charity rests with the charity and will not fall on innocent trustees.
What incorporated structures are available?
The principal forms used by charities are:
(a) a company limited by guarantee, answerable to Companies House as well as the Charity Commission, and subject to a range of obligations under company law; and
(b) a charitable incorporated organisation (CIO) which is a relatively new form introduced in 2013, based on many of the same concepts as a company, but answerable only to the Charity Commission.
Other forms are available but are unlikely to be the first choice for many charities.
(a) Incorporation of the trustees
There is a mechanism under the Charities Act 2011 for the Charity Commission to incorporate the trustee body of a charity, so that property can be held in its name. This has been widely used by charities associated with faith groups for convenience in the holding of property, but does not offer quite the same level of protection and reassurance as incorporation of the charity itself.
(b) Corporate trustee
It is also possible to appoint a corporation to act as a sole trustee of a charity. It may be necessary to amend the charity’s constitution to enable this to happen and, as it leaves the trust structure in place, it is only a partial remedy for the disadvantages of an unincorporated charity. Having said that, if an unincorporated charity has permanent endowment or special trust assets, the usual incorporation process outlined below will result in the new charity being appointed as the trustee of those assets.
What does incorporation involve?
In broad terms, you need to create the new corporate entity and then transfer everything that currently sits in the old charity into the new one.
Because there can be some serious obstacles along the way, you may want to start with a due diligence exercise to assess what can be transferred, and whose consent or assistance may be needed to enable things to be transferred.
Key areas to look out for include:
- If the charity rents its premises, will the landlord consent to the assignment of the lease to the new charity?
- If the charity is funded by grants, the trustees should talk to its funders about the incorporation process at an early stage.
- While some contracts can be assigned, a deed of novation may be needed in which the contractor releases the trustees from their obligations in return for the new charity’s agreement to be bound by the original contract.
- Your bank will need to know about the proposal.
- The rights of any employees to be consulted about the transfer of their employment to the new charity need to be respected.
- If there is a defined benefit pension scheme in the old charity, will the transfer trigger the crystallisation of any liability in the scheme?
- If the old charity has a wider membership than its trustees, it may be necessary (or politically advantageous) to secure their agreement to the transfer.
If the coast is clear, the next step is to create the new charity.
If you have chosen to use a company limited by guarantee, you will need to prepare a Memorandum and Articles of Association in a suitable form (with charitable purposes matching those of the old charity) and file these at Companies House, who will then issue a certificate of incorporation.
You must then apply to the Charity Commission for the registration of the company as a charity. It can take quite a while for the Commission staff to complete the registration process but, generally speaking, they deal quite quickly and efficiently with applications where the organisation is being set up to take over the operations of an existing registered charity.
If a CIO is your preferred structure, the formation and registration processes are combined into one application to the Commission, and it is the Commission that brings the CIO into existence by registering it.
Charity Commission consent
One consent that will almost always be needed is from the Charity Commission. The reason for this is a bit of a technicality but is worth considering. The trustees of the old charity will almost always (and quite reasonably) want to have the benefit of an indemnity from the new charity – after all, their existing right to look to their charity’s assets to settle their liabilities will be rendered worthless by the transfer of those assets to the new charity. However, because the trustees of the new charity will usually be the same people who have been running the old charity, giving this indemnity would amount to “self-dealing” by the trustees, which can only be done with the blessing of an order of the Commission. Fortunately, the Commission is generally willing to make these orders as a matter of course, but trustees should be aware that it can take the Commission a few months to provide the order.
Where the new charity is a company, the Commission’s order can also authorise the resolution that the members of the company are required to pass under the Companies Act rules on substantial property transactions.
There may be other regulators who need to be consulted; for example, if the charity operates in Scotland, it may be necessary to seek clearance from the Office of the Scottish Charity Regulator for the reorganisation process.
There is a mechanism in the Charities Act 2011 that enables trustees to make a vesting declaration, which has the effect of transferring the old charity’s assets to the new charity on a specified date. However, this has two key drawbacks:
(a) it can only be used where the old charity is to be wound up and removed from the register of charities, which you may not wish to do if you want to keep the old charity in existence as a “shell” to capture any legacies that might otherwise be lost; and
(b) it does not transfer the old charity’s liabilities. If you want the trustees of the old charity to know that they will not be responsible for settling any claims that come to light after the transfer to the new charity, it will probably make sense to have a more substantial deed to enable this, in which case the same deed may as well deal with the transfer of assets as well.
In most cases, therefore, the transfer will be effected by a transfer agreement or deed, which will look very much like a conventional asset purchase agreement.
If the old charity has any permanent endowment or other assets held on special trusts, the trustees will need to ensure that they will be held by the new charity on the same trusts, rather than being treated as part of the corporate property of the new charity.
Post transfer tasks
Once the transfer has taken effect, there will be several further matters to attend to:
- You may wish to add the transfer to the Commission’s register of mergers so that, if any legacy is left to the old charity it can (in most cases) be treated as a gift to the new charity.
- You may want to keep the old charity as an empty shell, for example if there are assets or contracts that cannot be transferred for any reason, or to capture those legacies that might not be caught by the registration of the transfer in the register of mergers.
- You will need to notify contractors, staff, service users, HMRC and relevant regulators that the transfer has happened.
- If land has been transferred, this will need to be registered with the Land Registry.
- The charity’s stationery and website will need to be updated to show the new charity’s details.