Legal and regulatory obligations
June 2009 Supplement
When it comes to finance, the duties of trustees and executives are grounded in a wide range of statutes, standards and guidance
When it comes to finance, the duties of trustees and executives are grounded in a wide range of statutes, standards and guidance.
Trustees of charities have a wide set of responsibilities, because every charity involves a relationship between three parties – donors, beneficiaries and those running the charity.
This guide sets out the core legal and financial regulation covering the financial responsibilities – both in terms of reporting and investment undertaken by trustees of charitable organisations. We have used the term trustees to encompass other terms, such as ‘directors’ or ‘management committee members’, which are sometimes used. On occasion care is needed to be clear about which individuals actually are the trustees. If there is any such doubt this should be clarified as soon as possible, and certainly before any significant decisions are taken.
The duty of care
Charity trustees have a duty to act at all times in what they reasonably consider to represent the best interests of their charitable objectives, which should be reflected in their operations.
In doing so, trustees must also exercise reasonable skill and care. Section 1 of the Trustee Act 2000 defines this general duty although strictly, the act does not apply to all charities but in practice functions as the statutory yardstick by which all charities are measured.
A trustee: ‘must exercise such care and skill as is reasonable in the circumstances, having regard in particular… to any special knowledge or experience that he has or holds himself out as having…’
When trustees act as professional trustees (generally when they are paid a fee) the same section of the Trustee Act contains an enhanced duty so that: ‘If he acts as trustee in the course of a business or profession regard must be had to any special knowledge or experience that it is reasonable to expect of a person acting in the course of that kind of business or profession.’
As with all trusts, the courts have a general jurisdiction to intervene in the running of a charity in order to enforce the trustees’ duties, although, in practice, most regulation of charities is carried out by the Charity Commission.
General powers
Charity trustees must act within the investment powers conferred on them by the law and their charity’s constitution. Trustees of unincorporated charities are given very wide investment powers by the Trustee Act 2000, which (subject to any restriction in their charity’s constitution) allows such trustees to make any type of investment that they would have been able to make if they themselves were the owners of the assets involved.
There is no equivalent statutory power for the trustees of charitable companies, but there is an equivalent broad fiduciary duty to invest prudently. Case law [1] also suggests that failure to invest surplus income may be a breach of trust.
The power of investment must be exercised in a prudent way but so as to yield the best return for the beneficiaries without undue exposure to risk. In judging the return from the investment both the prospects of income and capital appreciation have to be considered. Those using the power must set aside personal preferences and moral judgements [2].
In addition, the Charity Commission expects all charity trustees to comply with its own guidance set out in CC14.
The standard of care
Trustees have a duty to exercise care when exercising power of investment. The standard of care to be expected from them is that of the ‘ordinary prudent man of business‘ but remunerated trustees and trustees who possess special qualifications are expected to meet a higher standard of care than other trustees (CC14, para. 15).
Trustees must have regard to certain criteria (s.4 Trustee Act 2000). In exercising any power of investment a trustee must consider:
- the suitability of the type of investment to the charity (for example whether it is consistent with the charity’s ethos or any relevant requirements or policies it might have); and
- whether a particular type of investment is appropriate.
They must also consider the need for diversification of investments, in so far as it is appropriate to the charity. The Commission recommends that trustees should, ‘at both levels (described above), try to consider the whole range of investment options which are open to them; how far they should go here will, of course, depend on the amount of funds available for investment’ (CC14 para 15).
Advice
Unless the trustees consider it inappropriate or unnecessary to do so, a trustee must obtain and consider proper advice. ‘Proper advice’ is the advice of a person who the trustee reasonably believes to be qualified to give it by his ability in and practical experience of financial and other matters relating to the proposed investment (s.5 Trustee Act 2000).
Other duties
Related duties include the duty to
- assess risks;
- keep appropriate reserves;
- ensure grants awarded by trustees are properly spent; and
- the duty to keep investments under review.
In addition, specific duties may be imposed by the constitution of the charity and other agreements by which trustees choose to be bound, including agreements with donors which may, for example, specify how funds should
be spent.
Delegation
There are also limits to the extent to which trustees can delegate responsibility for financial, investment, accounting and reporting activities. While it is of course common practice for charities to delegate investment to (in particular) investment managers, charities doing so must:
- formally agree written terms of service;
- agree an investment policy (a ‘policy statement’) to set out what investments are permitted and what level of risk is acceptable; and
- regularly review the investmentperformance.
Liability – charitable companies and unincorporated organisations
Limited companies
In the case of a limited company the liability of the trustees is restricted to the assets of the charity, unless there is:
- a breach of trust;
- a specific contractual commitment; or
- a statutory obligation, such as in some aspects of health and safety.
These exceptions include: criminal negligence, corporate manslaughter and other negligence (in tort).
The trustees of charities that are structured as companies are subject to the statutory duties imposed by company law, in particular (s. 171 to 177 of the Companies Act 2006). These duties broadly reflect the common law and fiduciary duties that apply to all charity trustees. Trustees must:
- act in accordance with, and within the powers conferred by, the charity’s constitution;
- act in a way which they consider in good faith, will be most likely to promote the achievement of the charity’s purposes;
- exercise independent judgment;
- exercise reasonable care, skill anddiligence;
- avoid conflicts of interest;
- not accept benefits from third parties which may be conferred by reason of their being (or acting as) trustees; and
- declare their personal interest (if they have any) in any proposed transaction or arrangement.
Unincorporated organisations
Unincorporated trusts and unincorporated associations do not have a separate legal existence and the trustees end up owning property themselves and entering into contracts. They can also be personally liable if the charity is sued or incurs liability.
Risk of insolvency
Under the auditing standards (ISA 570+) directors need to consider whether the entity is likely to be able to continue trading for a year from the date of signing the accounts. If the charity is being audited, the auditor needs to form a view on the reasonableness of the conclusion reached. Should the conclusion be that there is significant doubt, or even a fundamental uncertainty, then comment will need to be made in the audit report?
The process is more complex for a charity than for a normal commercial company, and involves:
- understanding the balance sheet to make a proper assessment; and
- identifying and separating out restricted funds.
The auditor may also see the use of designated funds for purposes other than those that the funds were designated for as a warning sign. Under SORP accounts ‘borrowing’ from restricted or endowment funds is more apparent. There is a duty to explain the strategy to correct any shortfalls in these funds.
CC12: Managing Financial Difficulties and Insolvency in charities states that restricted funds are not part of a company’s own property. ‘The company holds these assets as trustee for individual charity trustees. In the event of insolvency it could be a breach of trust (for which the directors, or liquidator, would be personally liable) if restricted assets were realised to pay a dividend to the creditors.’ In effect each fund is a separate charity.
Whilst it is not common for charity trustees to be prosecuted or sued under insolvency law it is not unknown, and the potential penalties are severe. The legal framework needs to take account of charity law, and complex and changing insolvency case law, and statute. The relevant statutes are the Insolvency Act 1986, and the Enterprise Act 2002. The law differs for trusts and unincorporated associations – where there is potential personal liability.
Should the trustees consider that insolvent winding-up is a real risk they should:
- seek professional advice;
- not treat some creditors better thanothers – i.e. not create a ‘preference’;
- consider the risk of wrongful trading and if so, act in the interests of creditors;
- document decision-making; and
- bear in mind that any legal judgement is made in hindsight.
However, many organisations have been insolvent (in the technical sense of the word) at one time or another – and have been able to resolve the issues.
Charity Commission guidance
CC14 and CC15
The Charity Commission provides guidance on investment in CC14: Investment of Charitable Funds, Basic Principles and on reporting and accounting in CC15: Charity Reporting and Accounting: The Essentials.
As with all Charity Commission guidance, there is a distinction to be made between what charities are obliged to do by law (indicated as ‘must’) on the one hand and recommendations and statements of best practice on the other hand (indicated as ‘should’).
In most cases, the Charity Commission’s guidance makes this distinction accurately, but in some cases the ‘should’/‘must’ usage does not, or cannot, reflect the true subtleties of the legal position. One example is where (at para. 5, CC15) the guidance states that ‘trustees must know their investment powers’. Knowledge of investment powers is indeed a practical requirement of trustees (otherwise, how else could they fulfil their duties?). However, there is no specific legal requirement for them to do so.
The Charities SORP
Section 8(5) of the Charities (Accounts and Reports) Regulations 2008 states that: ‘The statement of accounts must be prepared in accordance with the methods and principles set out in the SORP.’ The SORP is the Statement of Recommended Practice 2005, updated June 2008 and is issued by the Charity Commission which has been recognised by the Accounting Standards Board (ASB) as the appropriate regulator to issue a specific code of practice for charity accounting in accordance with its own general fundamental points of principle. It is developed by the Charities SORP committee, an advisory committee made up of charity finance directors, charity auditors, academics, charity advisors and charity regulators, and incorporates research, input and feedback provided by the sector.
Reporting and accounting duties
The Charity Commission’s objectives, functions and duties are set out in the (amended) Section 1 of the Charities
Act 1993:
- The commission’s ‘accountability objective’ (s.1B), sets out to enhance the accountability of charities to donors, beneficiaries and the general public.
- Its Functions (s.1C) include the facilitation of better administration.
- One of its Duties (s.1D) is to have regard to best regulatory practice.
- Although the Commission does not itself ‘make law’, its Powers (s.1E) allow it to do ‘anything which is calculated to facilitate or is conducive or incidental to the performance of any of its functions or general duties.’ Furthermore, its guidance has the force of law where legislation so provides (for example, the SORP, which is given statutory force under the Charities (Accounts and Reports) Regulations 2008).
Duty to keep accounts
All charities must prepare accounts and make them available on request (ss. 41 and 42 Charities Act 1993). The duty to file accounts with the Charity Commission applies to all registered charities whose annual income or expenditure exceeds £25,000 (following the changes to the thresholds which apply to accounting periods ending on or after 1 April 2009). All charities which are established as companies must also file annual accounts with Companies House.
Changes to financial thresholds
Receipts and payments accounts (the R&P basis)
Non-company charities with a gross income of £250,000 or less for the year may produce ‘receipts and payments accounts’ (Charities Act 1993).
These are simpler than ‘accruals accounts’ (see below) and consist of an account of all money received and spent in each year, and a statement of assets and liabilities at the end of the year. There are no rules as to what should be disclosed, or how this should be reflected.
Accruals accounts
Unincorporated charities with gross income of over £250,000 during the year, and all charitable companies, must prepare ‘accruals accounts’ in accordance with the SORP. Accruals accounts consist of various statutory disclosures on governance, a trustee report, a balance sheet, a statement of financial activities and explanatory notes.
External scrutiny: audit or independent examination (s43 Charities Act 1993)
The thresholds that now apply to charities took effect for accounting periods ending on or after 1 April 2009. If gross income exceeds £500,000, or if gross income exceeds £250,000 and assets exceed £3.26m, the accounts must be audited. If the income is less than these thresholds, but greater than £25,000, an independent examination is required, but charities may still opt for an audit. Below £25,000, charities do not need an audit or an independent examination. More guidance is available in CC15a.
Both the charity’s constitution and specific donations to the charity may also contain provisions about external scrutiny. The charity must follow the higher standard of scrutiny, defined by the threshold or elsewhere, as appropriate.
Auditors’ and examiners’ duties to report (s.393 Companies Act 2006)
Auditors must have regard to the directors’ duty not to sign accounts unless satisfied they give a ‘true and fair’ view of its assets, liabilities and financial position.
They must also comply with any directions given by their regulatory body as to the information to be contained in the report, the manner in which the information is to be presented or the methods and principles according to which the report is prepared. Reporting standards include SSAPs (Statements of Standard Accounting Practice) and FRSs (Financial Reporting Standards).
Auditors and independent examiners have a ‘whistleblowing’ duty to report to the Charity Commission material matters likely to be relevant to the Commission’s functions (ss. 44A and 68A Charities Act 1993). Such matters might include a breach of the Money Laundering Regulations 2007.
Annual reports and annual returns (s. 45 Charities Act 1993)
The duty to file an annual report with the Charity Commission applies to registered charities whose annual income exceeds £25,000 (The Charities (Accounts and Reports) Regulations 2005). CC15 sets out the accounting framework and a useful template is set out in Section H, referencing relevant paragraphs of the SORP.
The duty to file an annual return applies to all registered charities whose annual income exceeds £10,000.
[1] RC v Helen Slater Charitable Trust Ltd (1981)
[2] Cowan v Scargill (1985)
Author: Clarissa Dann
Clarissa Dann was the editor of Caritas as well as an HR and management online service,he People Bulletin until July 2011.
She is now the editor of the specialist trade finance magazine, Trade and Forfaiting Review which can be viewed at www.tfreview.com but does write on charity finance and investment from time to time.
Clarissa has a background in legal and professional publishing, as well as business journalism and holds an MBA from Cass Business School. She has been one of the judges for the non-profit category of the Chartered Institute of Marketing's Excellence in Marketing Awards for the second year running.
She has also acted as clerk to the trustees of a small almshouses charity and as a member nominated trustee to a pension scheme of a multinational publishing company.
Click here for other articles written by Clarissa Dann
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