The freezing of the payment of £10 million of grants by the Diana, Princess of Wales Memorial Fund could have been avoided if the fund had not been "fatefully misguided" by the Charity Commission, according to its chief executive.
Dr Andrew Purkis claims the decision to adopt unincorporated trust status on commission advice was a "pretty fatal mistake" as it leaves the trustees, who include Princess Diana's sister, personally liable for debts.
With the fund preparing for a potentially costly damages case brought by the US memorabilia manufacturer Franklin Mint, the trustees decided last week to halt grants rather than take a personal financial risk.
"We would not have any difficulties of the kind we face now if we weren't an unincorporated trust," said Purkis. "People's houses are on the line.
That's the source of all our problems."
The fund was established four days after the princess died in 1997, when millions of pounds of donations were pouring into Kensington Palace.
"The commission presented us with a standard model constitution," said Purkis. "In the extreme heat and emotion of the moment there wasn't time to sit down and look at its pros and cons, but with hindsight it's a shame we weren't set up as a charitable company limited by guarantee."
Charity Commission spokesman Anthony Robins denied the regulator issued any advice and said it was up to charities to consult lawyers. "We are a regulator," he said. "We do our best to help charities but we are not a governing body and we don't give grants."
Stephen Bubb, chief executive of ACEVO, accused the commission of fuelling the controversy by issuing a statement last week warning charities of the dangers of litigation. "The commission has made its regulatory role paramount when its advice and support is needed," he said.
Purkis added: "They were about as unhelpful as they could have been in our hour of need."
The fund started legal proceedings against Franklin Mint in 1998 to prevent it from selling Diana-branded memorabilia. It lost, and now faces a claim of malicious prosecution. Around 500 staff at 127 organisations, many heavily dependent on the Diana fund, face an uncertain future.
Had the latest grants been honoured, the trust would still have £46 million in reserve. But the prospect of US-style litigation prompted three of the 16 trustees to insist payments were halted.
The Community Fund is considering whether it can help those charities which are losing their grants.
See They Said It, p2.