Insolvency is sometimes the best option for a charity

Charity trustees must examine their options, not bury their heads in the sand, says Peter Gotham of Gotham Erskine

Peter Gotham, partner, Gotham Erskine
Peter Gotham, partner, Gotham Erskine

There are circumstances when the best way for a charity to serve its objects is to close down. As with most potential crises, early action increases the chance of salvaging some, if not all, of the organisation's activities, and maybe even staff jobs.A delay increases the chance of personal liability for trustees, of funds being lost and of a stressful situation becoming close to intolerable. In this case, I often see staff going off sick while the buck stops with a few individuals.

Under the Insolvency Act 1986, there is a possibility that the board of trustees could be held personally liable if courts deem it has been "trading wrongfully". This means an organisation should not continue to trade if the directors know that there is no way it could pay its debts.

Accepting that an organisation is heading for failure and moving on can free up the time and energy of trustees to work on new projects. While it can be difficult to let go of an organisation, it can also be positive to move on.

When facing financial difficulty, the most human reaction is to bury your head in the sand. However, if the case of Lehman Brothers has taught us nothing else, it is that the refusal to acknowledge a problem can have catastrophic consequences.

To minimise personal liability, the board should take the following steps. First, it should draw up a strategy for eliminating any accumulated deficit and build up an appropriate level of reserves to avoid a recurrence of the insolvency in future. If it's not possible to prepare an appropriate strategy, seek professional advice.

Second, every board meeting should include a review of the financial position to ensure it has not worsened.

Third, the trustees should receive a report of income and expenditure against budget to ensure results are at least as good as budgeted, and to take appropriate action if this is not the case.

Taking these steps would minimise the risk of a loss to creditors - a key Insolvency Act concern.

The general misconception is that an insolvent position automatically leads to closure. It doesn't. One of our clients is a community centre in London that ran for 10 years despite the fact that it was technically insolvent for that whole period. It came out of its insolvent position a few years ago and completed a number of substantial building projects.

No trustee wishes to be looking at insolvent liquidation, but in some instances this is the best option. Whatever the final decision, it is crucial that it is managed properly, that the process is based on timely and accurate financial information and that decision-taking is carefully minuted.

- Peter Gotham is a partner at Gotham Erskine

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