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  • Overview

    By its winding up order, made on 20 August 2015, the High Court laid upon the mortuary table the corpse of Keeping Kids Company.  The masked and gowned figures of the Official Receiver, Charity Commissioners and, who knows, other pathologists will now have assembled to dissect the body and determine the cause of death.  At first sight, the cause of death is obvious. Kids Company died of starvation - it ran out money. According to its published accounts for the year to 31 December 2013, Kids Company had no endowment and depended for its income entirely on government grants and substantial donations from companies and private individuals.  It seems that all of these different sources dried up and one question has to be "why"?  Was the apparent loss of confidence just the result of a malicious whispering campaign conducted by competitors envious of its success and politicians riled by its campaigns on behalf of disadvantaged children or were the allegations of financial mismanagement true?

    Regulators do not move with CSI like speed and it will be some time before we know the answer. Spare a thought then for the trustees of Kids Company – well intentioned people whose reputations, peace of mind and, possibly, financial position will depend on it.

    This last point may surprise.  Like many well advised charities which operate in high risk areas and incur significant liabilities to staff, suppliers and others, Kids Company was a company limited by guarantee. Why, then, should its trustees or the trustees of any other incorporated charity be at risk of personal liability, if the charity fails to pay its creditors?  What can charity trustees do to reduce the risk of being found liable?

    The answer lies mainly in the Insolvency Act and the law relating to directors’ duties (because trustees of an incorporated charity will almost inevitably be directors for the purposes of company law) which, between them, provide a liquidator with quite a wide choice of means for recovering money from directors whose company (whether charitable or not) has become insolvent.    There is space only to mention the main ones, but a liquidator is duty bound to consider whether or not it is in the creditors’ interest to make use of them and, in any event, to report to the  Department for Business Innovation & Skills on the conduct of the directors of the insolvent company.  Of course, nothing in this article should be regarded as a direct or implied reference of any kind to the integrity, character, competence or otherwise of any trustee or staff member of Kids Company.

    Liability for fraudulent trading arises if any business of a company which is being wound up has been carried on with intent to defraud creditors, or for any other fraudulent purpose. Anyone (not just a director) who was knowingly party – and you do have to be knowingly party - to the fraudulent business can be liable and there has to be "actual dishonesty, involving ... real moral blame". 

    A director can be liable for wrongful trading if: their company goes into insolvent liquidation at a time when its assets are not sufficient to pay its liabilities and the expenses of the winding up; and, at some time before that, the director knew or ought to have concluded that there was no reasonable prospect of the company avoiding this.  They will not be liable if they took every step with a view to minimising the potential loss to the company's creditors as they ought to have taken.  This usually, but not always, means following one of the insolvency procedures available.  Liability only arises if continuing to trade makes the company worse off.

    The standard against which the director is measured is the same as the standard, referred to below, which is applied in assessing whether or not a director is in breach of the duty to exercise reasonable care, skill and diligence.  Dishonesty does not have to be shown.

    Someone liable for fraudulent or wrongful trading can be ordered to make such contribution to the pool of assets available for the company’s creditors as the court thinks proper (the aim is to compensate the company, not punish), and can be disqualified from acting as a director of any other company (without the leave of the court) for between two and fifteen years.  Fraudulent trading is a criminal offence, but wrongful trading is not. 

    As far as directors’ duties are concerned, these were codified by the Companies Act 2006, which specifies seven, but I want to focus on just one of them - the duty to exercise the care, skill and diligence.  This says that a director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person who has, first, the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and, second, the general knowledge, skill and experience which that individual director actually has.

    So, a director take the care which someone with a reasonable level of knowledge, skill and experience would take (ignorance is no defence!) or, if they have specialist knowledge, a higher level (the professionally qualified should take note!).  In applying the test, regard is to be had to the functions of the particular director, including their specific responsibilities and the circumstances of the company.

    How does this apply to a trustee of a charitable company, who may be time poor and  assuming that it is enough to roll up to board meetings, having flipped through as much of the paperwork as they can, and, for the rest, to rely on the senior management team to implement controls, enforce them and comply with them themselves?  The short answer is that, in this day and age, this would be unwise.

    A longer answer is that a trustee will be in a much better position to ward off a liquidator if they can show that their charity complied with generally accepted principles of good governance and especially those about managing risk, having internal financial controls and monitoring compliance with them.  The Charity Commission guidance and even the UK Corporate Governance Code are good sources of ideas.  When it comes to monitoring compliance, an internal audit function is really useful and any charity of any size should consider having one.

    Trustees can reduce their risk in the area of wrongful trading by making sure that they always have up-to-date financial information (for most, monthly management accounts must be appropriate) and reacting quickly to anything in them, or any other signs, which suggest that financial problems are looming.  Once things start to slide, the pace of the descent can become alarmingly rapid and time to think, plan and take advice is in short supply.  If things are going wrong, take independent financial advice and make sure full board meetings are held as often as necessary, with decisions fully minuted. 

    If, as is not uncommon, there are one or two people who tend to dominate decision making and who may well have managed the charity into its uncomfortable position, this will be a time to act independently,  but resigning as a director will not guarantee that you will not be liable.  If you cannot persuade the rest of the board that action is needed, it may be enough to resign.  Ideally, before you do, take independent advice and write to the other directors about your concerns.

    A possible, but not foolproof, way of avoiding insolvency in the first place is to ensure that the charity has adequate reserves.  It is well understood that people to not give money to charities for it to be held dormant in bank accounts “just in case”, but, at the same time, it is perfectly reasonable to hold funds to deal with contingencies, foreseen or unforeseen, and it is very common for charities to do this.  If things turn sour, having reserves buys a bit of time for a charity to find a better solution than winding-up or, at least, enables a more orderly winding-up process to be followed.

    Finally, every trustee should ensure that they are protected by a sensible level of liability insurance. 

    This article was first published in Charities Management on 23 October 2015.

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