PM: The Acevo governance commission, of which I am a member, published its report Realising the Potential of Governance, saying that the Charity Commission should re-examine its guidance on the governance of charities' trading subsidiaries. The guidance, CC35, is inadequate when dealing with the Companies Act 2006 and duties of trustees, and fails to address conflicts of interest that arise. The act outlines the duties of directors to ensure the long-term viability of the company, having regard to all its stakeholders. The duty of trustees, on the other hand, is to safeguard assets and support beneficiaries. Trustees and directors are therefore in conflict over matters such as long-term investment, short-term cash flow, employee rights, external investors and shareholder distribution.
RM: The points in the Acevo report are interesting. However, you say that conflicts of interest need to be managed between the charity and the trading subsidiary. For the most part, I don't see this as a huge problem. Under the Companies Act, a company director must promote the success of the company for the benefit of its members as a whole. Usually, the sole member of the trading subsidiary is the charity, so the directors should be acting to promote the success of the charity. I'm not so sure that the failure lies with CC35. Is it not because of a lack of training? I also wonder if there are cultural difficulties caused by subsidiary directors from commercial backgrounds. They can be more ambitious about generating income, but often fail to understand charity law and tax issues.
PM: The Acevo commission felt that the Companies Act was clear that the members are the charity. However, the act also says that the responsibility of directors is to all stakeholders, not just members. It's true that directors from a commercial background can fail to understand that it is a wholly owned subsidiary of the charity and the trustees are unpaid.
RM: Apart from insolvency, a director of a wholly owned trading subsidiary must act in the way most likely to promote the purposes of the charity. The duties of trustees and directors are essentially the same. Nonetheless, investment, cash flow, employee rights and external investors might be issues between the charity and the subsidiary. Charities often think they can fund a subsidiary but fail to realise that any injection of cash counts as an investment of charitable funds. This means that trustees will be expected to give proper consideration to any investment.
The subsidiary should not be engaging in activity or seeking external investment outside the charity's broad strategy. The directors need to understand that the charity calls the shots and can remove trustees.
Some trading subsidiary directors feel frustrated that the charity is not prepared to contemplate investing in new opportunities. I have often found that joint training between the trustees and company directors is a good way of dealing with these issues.
PM: The Acevo commission found that these issues - such as investment, pay or recruitment - can become real battles, and the lack of Charity Commission guidance is worrying.
The problem comes down to what a proper strategy for the trading subsidiary should be. Any arm's-length commercial investor will look for growth in value over the long term, but trustees look for short-term cash. The other issue is that the subsidiary is an asset of the charity. No asset manager would advise trustees to invest in only one small business - yet this is exactly what trustees do routinely. They would be better off selling the subsidiary and passing the cash to an asset manager.
RM: I know that pay can be an issue, particularly where the subsidiary wants to incentivise its commercial staff. This can cause tensions, but the argument is that without it the subsidiary cannot recruit the right staff.
I agree that trustees should not put all their eggs in one basket by investing only in the subsidiary. Any investment must be justified on an arm's-length commercial basis. If charities are investing all their funds in a risky business, I would be concerned that this could be non-charitable expenditure and it could end up losing tax relief.
Patrick McHugh is the founding chair of the City Centre for Charity Effectiveness Trust
Rosamund McCarthy is a partner in the law firm Bates Wells Braithwaite and a charity law specialist