All charities, regardless of mission or size, face financial pressure at some point in their existence. Recent economic trends have seen these pressures intensify and impact all facets of life. Charitable organisations are not immune to this downturn. In fact, they may be more susceptible as it becomes increasingly difficult to establish, operate and sustain charitable organisations as viable entities.

Lester Aldridge’s specialist Charity and Restructuring & Insolvency lawyers have seen an increase in charity insolvency matters, with a “triple-threat” trend emerging of increased running costs, reduced income and a greater demand for services.

Legal challenges and governance duties

The “triple-threat” is a vicious cycle with each element flowing onto the next. The financial strain felt by charitable organisations has been exacerbated by a sharp rise in operational costs that has been felt across the world. Inflation and the soaring cost of living have driven up expenses, something felt keenly by a sector relying heavily on volunteers. In turn, as these pressures continue to rise, the first thing to be cut is often public spending, which feeds into growing social need. Charitable organisations that operate on a “hand-to-mouth” model can quickly become exposed to financial distress and governance risks. The workforces of charities are finding themselves stretched beyond capacity, whilst Central and Local Government funding is significantly reduced or restricted. Donations from individuals and corporate sponsors begin to dry up due to wider economic speculation and uncertainty. The difficult decisions that need to be made and concerns about complying with their legal duties can place immense pressure on boards.

Charities face a unique combination of financial, legal, and operational challenges. While they must meet many of the same regulatory and financial obligations as ‘for-profit’ businesses, they are further constrained by their voluntary nature, benefiting as they do from public money, not to mention regulatory expectations from the Charity Commission. While public benefit bodies get charitable tax relief, we are still seeing more instructions in relation to charitable organisations with concerns for their solvency.

Advising charitable organisations in distress

As situations increase, we are called upon to advise charitable organisations on the options available to them. These options often hinge on that specific organisation’s structure, and we regularly advise on charity restructuring strategies ranging from charitable trusts, companies and unincorporated associations to Royal Charter and Statutory Corporations. However, one solution that tends to apply across the board to navigate financial distress is a merger.

Charity mergers: how to merge charities in financial distress

In a recent matter, we acted for a charity that provided services in relation to residential nursing care facilities and care activities for people with learning and mental health needs. The charity was facing significant financial and cash flow pressures and sought to address its sustainability issues through a merger. Charities are only able to merge with other charities sharing similar objects or purposes. There are generally assets that can be passed across to another charity to continue to be used for those purposes, such as property, the goodwill of local beneficiaries and supporters, know-how or experienced personnel; charities rarely wither and die. In this instance, the charity client transferred its assets, liabilities, employees, operations and activities to its merger partner as a going concern. The result was a multimillion-pound merger that ensured the retention of over 1000 employees and increased the service delivery area of the expanding charity to the entire south coast and while at the same time preserving the benefit to the charity’s beneficiaries.

When assessing a potential merger partner, charities must first ensure that their objects are consistent. If the objects cannot be carried out, or one charity’s objects are adjusted as necessary with the consent of the Charity Commission, then the merger risks being a non-starter. We are often called in to help trustees conduct a preliminary assessment of the viability of proposed mergers.

Early intervention and legal support

We have also acted for a charity that had begun to suffer from ‘mission creep’, its services leaking into areas that were peripheral to its charitable objects, causing it to lose focus and suffer financial strain. It also became apparent that there were other charitable organisations offering similar services in the same area. However, the charity, whilst still holding a respectable level of reserves, was able to identify that solvency would become an issue in the not-too-distant future.

A merger partner was identified as one of those competing charities in the area. How better to reduce duplication and funding shortfalls than by merging with a direct charitable competitor? We were pleased to be able to assist and advise on the ultimately successful merger, which strengthened the pool of resources, expertise and employees for the provision of those charitable services in the area, while divesting the charity of ‘non-core’ services. Notably, it was the early assessment of financial difficulties on the horizon that allowed for the highest chance of success.

This touches on two important considerations when assessing the options for a charitable organisation beleaguered by the threat of insolvency. First, when times are tough, it is important to focus on the core, unique selling proposition of that charity. Divesting a charity of service streams, which do not align with its primary mission could be key to survival. Second, as with any entity, it is important to be aware of the charity’s longer-term financial position. If there is a foreseeable period when the organisation’s ability to pay its debts when they fall due is in doubt, it is vital to reach out to experienced charity insolvency practitioners at the earliest stage possible. Then, planning and preparation, such as identifying key records and registers, and liaising early with lenders and funders, can have a large impact on the success of a merger.

Conclusion

As public sector funding declines and social needs rise, it is likely that the threat of insolvency will continue to grow for charitable organisations. Trustees will also be mindful at this time of the upcoming Budget and what changes the Chancellor is likely to consider to help her plug the inevitable gaps in the public purse. The Charities & Non-Profit and Restructuring & Insolvency teams at Lester Aldridge are dedicated experts in advising insolvency professionals, boards and CEOs, as well as other stakeholders, who are exposed to and affected by these difficult decisions and challenges on the horizon. If you are faced with similar circumstances or require legal advice for insolvent charities, charity restructuring, or merger support, do not hesitate to get in touch to discuss how we may be able to help.

FAQs

What are the biggest threats faced by charities today?

The biggest threats facing charities today include rising operational costs, inflation, increased living expenses, reductions in public funding, dependence on volunteers, and declining corporate and individual donations.

Can charities merge to avoid insolvency?

Yes — charities can merge, and in some cases, merging can be an effective way to avoid insolvency. However, the decision to merge must be made carefully and always in line with charities respective objects.

What is the role of the Charity Commission in mergers?

When considering a potential merger, charities must first confirm that their charitable objects are compatible. If one charity’s objects need to be amended to achieve alignment, it will require approval from the Charity Commission.

What is charity mission creep?

Mission creep for charities refers to a gradual shift or expansion of a charity’s activities beyond its original charitable objects. In other words, it happens when a charity starts doing work that, while perhaps well-intentioned or related, doesn’t directly support the specific aims it was established to pursue.