Caroline Armitage, a governance specialist and legal adviser to charities, explains why it is important for charities and not-for-profit organisations operating as unincorporated associations or trusts to review their legal structure.
The legal complexities arising from an informal structure
Many charities and other not-for-profit organisations operate as unincorporated associations or trusts. Trusts in particular may have been in existence for many years, and have changed substantially since their establishment. Or an unincorporated association may have been formed due to the low initial set up costs and the flexibility with which they can be run. However, the law applying to both trusts and unincorporated associations has become increasingly complex in recent years, and the personal risk to those who act as Trustees has also increased.
As these organisations grow, so do the complexities of having an informal structure. Key issues are:
- The difficulty of entering into contracts whether that is for services, for employment of staff or to hold land.
- The risk of personal liability.
As a trust or an unincorporated association, the members and trustees are required to take on personal risk for trading liabilities such as entering into commercial contracts, leases and other obligations on behalf of the organisation. By incorporating, the organisation will have its own legal personality allowing it to enter into trading liabilities in its own right.
What is the most appropriate legal structure?
The most appropriate legal structure will unquestionably depend on the current circumstances and future plans for the charity or other not-for-profit organisation. Typically, the most commonly adopted legal structures are either a Charitable Incorporated Organisation (CIO’s) or a charitable company (usually limited by guarantee). When deciding on the best structure, consideration should be given to several factors, including:
- Who is running the organisation and what is their level of involvement?
- Does the organisation enter into commercial contracts?
- Does the organisation hold land, or have interest in obtaining land?
- Is there a requirement for the organisation to have a wider membership?
- Is the organisation planning to expand? and/or
- Is there a requirement or need to obtain funding?
By separating the operational and commercial requirements into factors such as these, the charitable organisation can really hone in on not only their current requirements but also, and arguably more importantly, their future obligations and responsibilities.
Charitable Incorporated Organisations (CIO’s)
The CIO structure was introduced in early 2013 having been specifically designed for and available only to charities. The Cabinet Office originally assumed that the target market for CIO’s would be charities with incomes of between £10,000 and £500,000, and there is good reason for this. Smaller charities are likely to find the protection afforded by a limited liability entity, coupled with the reduction of red tape very enticing. CIO’s only need to register with the Charity Commission and comply with charity law, whereas a charitable company must also register with Companies House and comply with company law. If your charity is primarily a grant giving foundation, or is small and funded only through public donation the CIO may well be the ideal structure for you.
However, whilst the governance arrangements for a CIO can appear attractive and far less burdensome for members, this type of corporate vehicle may not be suitable for charities that require financial support from lenders. Although a CIO has the power under the Charities Act 2011, subject to anything specified in its constitution, ‘to do anything which is calculated to further its purposes or is conducive or incidental to doing so’ and the model constitutions for CIO’s provide specific power for a CIO to ‘borrow money and to charge the whole or any part of its property as security for the repayment of the money borrowed’, CIO legislation currently makes no provision for the maintenance of a publically accessible register of charges. This may make it more difficult for a CIO to borrow, as lenders could be discouraged by the fact their security will not be clearly registered, which if indeed the case, will likely result in stifled growth plans. That said, where a CIO grants security over land, this may well trigger a requirement to register with HM Land Registry (for registered land) or the Land Charges Department (for unregistered land).
Charitable Company Structure
Larger charities with more complex financial arrangements are largely better suited to a charitable company structure. Importantly, with this type of corporate vehicle funding is more readily accessible to a charitable company as lenders are able to obtain the protection that they require by registering a charge at Companies House against the company. Another significant distinction is that written member resolutions can be passed with a majority of more than 75%, whereas for a CIO, the resolution must be unanimous which can make decision making unnecessarily difficult.
That being said, both structures give the charity legal capacity to enter into commercial contracts, own or lease property and increase its membership in its own name. Not only will this limit member and trustee liability, but it will also lay the foundations for the charity’s future with a smoother process on trustee retirement or handover.
Foundation or Association Model?
Another area to consider is around ‘membership’. Your organisation may have been set up with a group of like minded people and have a membership structure. Membership charities typically look to raise funds from their members by annual subscription, and look to members for public support. An example of a membership charity would be the National Trust. Such a charity allows and expects its members to have some influence on its future direction, and the members appoint (and can remove) the trustees.
If your charity’s activities are primarily providing charitable services however, such as in health and care, while you will have supporters you will probably be looking for most of your income to come through contracts, for example with individuals (say a school) or the public sector (a care home). In these circumstances members are unlikely to have the technical knowledge to be able to help guide the direction of the charity. Or you may be a charity whose main activities are to raise philanthropic funds and give grants. In both these cases it is really the trustees who need to set the direction and be in control. Such a charity normally operates with its trustees and members being one and the same, which is known as the Foundation Model.
Sometimes charities which originally started with a wide membership have changed over time to become more suited to the Foundation Model, and so need to look at consulting with their supporters to change their constitution.
What do I do next?
If you care considering changes to your organisation’s structure, care must be taken to consult all your stakeholders and bring them on the journey with you. Governance changes are complex, but properly implemented can lead to a more streamlined operation, enabling you to focus fully on those you are set up to benefit.
If you are considering incorporating your charity or changing its constitution, please do not hesitate to contact Charity Law and governance expert, Caroline Armitage with any questions or queries you might have.