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Weathering the storm - what are the legal risks for third sector board members? | Burness Paull

The coronavirus pandemic has already had a significant impact on third sector organisations and – notwithstanding the various schemes and concessions which the UK and Scottish Governments have announced, and the launch of the Third Sector Resilience Fund – there will be many third sector boards across Scotland who now have serious concerns about the ability of their organisations to weather the storm.

In circumstances like these, the priority in many cases will be to identify how the organisation can continue with its activities, if only at a reduced level or via different ways of working; and that can be particularly critical where there are vulnerable people who depend on the organisation for support. There will also be a sense of responsibility in relation to staff, with an understandable reluctance to take any steps that could place staff members and their families in financial hardship. And of course board members will be conscious of the hard work and dedication involved in building up the organisation over the years to its current level; and keen to do everything they can to avoid the organisation having to close down or shed major parts of its operations.

Third sector boards are driven by a sense of mission, and that is one of their key strengths; it comes as no surprise, therefore, that the current pressures represent a source of major stress for board members. It is understandable – and as a general principle, something to be encouraged – if boards take the view that the organisation should soldier on; but it is important that board members take account of the legal principles which apply in circumstances of this kind. Specifically, there is the potential for board members to attract criticism from regulators or funders, suffer reputational damage through reports in the media – and, in an extreme case, incur personal liability - if they fail to comply with their legal duties… or (in the case of an organisation with charitable status) fail to live up to OSCR’s expectations regarding good practice.

The issues are complex - and much will depend on the particular factors that apply in a given situation - but the following key points may be helpful to bear in mind:

  • For an organisation with charitable status, the key point of reference is the legal duty of charity trustees (i.e. the board members) to take decisions in the best interests of the charity. Brutal as this may seem, that duty needs to take priority over protecting the interests of staff - though of course there may be an argument in certain circumstances that protecting key staff is necessary to ensure the survival of the charity, hence no conflict between the two. Similarly, there may be circumstances where continuing to provide a full service to those receiving support from the charity would put the charity in an insolvent position, and again it is the interests of the charity which need to be seen as paramount when boards are taking these difficult decisions. If it becomes clear that the financial position is irretrievable, it is very likely (though the legal position on this is not entirely clear), that the duty to protect the interests of creditors would become paramount.
  • For a company, the implications of the “wrongful trading” provisions of the Insolvency Act need to be borne in mind, given the risk of personal liability for board members. In summary, the wrongful trading provisions allow a court – in a case where a company has gone into insolvent liquidation – to order any director to make a contribution (out of his/her own personal finances) towards the company’s debts if (a) at some point before the liquidation commenced, he/she knew (or ought to have concluded) that there was “no reasonable prospect” that the company would avoid liquidation and (b) as from that point, he/she failed to take all necessary steps to minimise the loss to creditors.
  • For an unincorporated association, there is a risk of personal liability falling upon the members of the management committee if the organisation becomes insolvent and there are debts or liabilities outstanding. This is an area of obvious concern, and was one of the key drivers for the development of the SCIO model as a relatively simple route for gaining the benefit of limited liability status in cases where charitable status would be available. Unfortunately, if an unincorporated association is already in serious financial difficulties, it is likely to be difficult (if not impossible) to address the issue of personal liability for existing debts/liabilities through a change in legal form. Those who have acted as signatories to leases, commercial contracts etc may be exposed to particular risk, depending on the wording used in the document. Having said all that, the legal principles in this area are not particularly clear or consistent, and the legal costs associated with more complex litigation (and/or other practical considerations) can sometimes deter those with outstanding debts or claims from pursuing court proceedings against management committee members personally.
  • For all third sector organisations, it is critically important that the board should actively engage in addressing the challenges; and that the basis on which they reached particular decisions is carefully recorded in the board minutes. The board will be expected to take proactive steps to establish the extent of the financial and other challenges, fully explore what routes may be available to mitigate the challenges and risks (current and anticipated), give clear direction to staff teams, and keep the position under close review. Notwithstanding that virtual meetings will now be the norm (we are issuing a separate blog on that topic), it is vital that proper minutes are kept, and that these provide sufficient detail to demonstrate that board members have complied with their legal duties.
  • For organisations with charitable status, steps should be taken to comply with the OSCR notifiable events regime. The responsibility for notifying OSCR of any notifiable event (and major challenges for a charity arising from COVID-19 undoubtedly fall within that category) lies with the board members. Having said that, OSCR has indicated in its COVID-19 guidance that the key focus should be on addressing the challenges, and that it acknowledges that reporting to OSCR under the notifiable events regime may be a secondary issue.

As a matter of practice, the wrongful trading provisions only result in personal liability for directors in a tiny proportion of company liquidations. Nevertheless, the impact of the wrongful trading provisions in discouraging company boards from weathering the current storm, is recognised – and indeed there was an announcement by the Business Secretary, Alok Sharma, at the weekend that there would be a temporary relaxation of the wrongful trading provisions, to address this very issue. A separate blog on the relaxation of the wrongful trading provisions will be issued shortly by our Restructuring and Insolvency Team – watch this space!

For completeness, it should be noted that the recommendations issued by the SCIO Dissolution Working Group (as published on 10 March 2020) included a statement that the Working Group were “keen to ensure provisions akin to wrongful trading be put in place for SCIOs”. My personal view is that that would be a serious mistake - in firstly adding to the level of concern which already exists among those serving on charity boards regarding legal duties and liabilities, and OSCR expectations; and secondly in increasing the likelihood that the board of a SCIO facing financial difficulties will simply close down the charity, rather than take the risk of personal liability in finding a way through. It remains to be seen how far the recommendations of the Working Group will be taken up – but I would like to think that this particular recommendation will be reconsidered from a wider policy perspective, particularly in light of what is currently happening across the third sector.

As always, the Third Sector team in Burness Paull are keen to share experience and principles of best practice; as well as providing one-to-one support as required. In addition we have a very strong Restructuring and Insolvency team who are able to provide leading-edge specialist advice. Please do contact us if we can be of any assistance.