Overview
The guidance provides a useful reminder of some of the operating differences between mainstream charities & RPs with charitable objects.
Despite those differences, charitable RPs should have regard to the guidance & consider whether to carry out a compliance review of their governance framework to make sure they comply or be able to justify any departure from what the Commission regards as best practice.
Introduction
In February, the Charity Commission published, in draft, guidance for charities that have a close relationship with connected non-charitable entities or organisations.
The draft guidance comprises:
- detailed guidance;
- an at a glance summary; and
- a checklist that charities can use.
The guidance is aimed at trustees of registered charities that have a long-term close relationship with a connected non-charitable organisation, such as a social enterprise or trading subsidiary.
The guidance has been produced to help trustees understand the risks and challenges that these relationships can bring and to set out what the Commission expects trustees to do to deal with them. The guidance points out that the principles it sets out are not new. They are reflected in other Commission guidance.
The deadline for comments on the draft guidance is 15 May 2018.
Why should board members of RPs review it?
The consultation should be required reading for trustees of all charitable entities. That includes exempt charities. Although exempt charities are not subject to direct regulatory scrutiny by the Charity Commission they are, however, still bound by charity law and the Commission’s guidance is influential. If an exempt charity acts contrary to the Charity Commission’s guidance, its officers may run the risk of being held to have acted improperly.
The draft guidance raises a number of issues for RP groups – for example, in managing conflicts of loyalty, the independence of charitable entities and the provision of services. The guidance, therefore, provides a useful framework for reviewing existing intra group arrangements for RP groups with one or more charitable entity. We comment on these issues further below:
Relevant issues
- Key duties and principles that apply to all relationships
This section summarises the current legal position under 8 headings, namely:
- Compliance with your trustee duties
- Keeping the charity separate – don’t blur the boundaries
- Make independent decisions
- Avoid conflicts of interest and conflicts of loyalty
- Personal benefits: avoid or authorise
- Use written agreements
- Be open and accountable
- Manage the risks, review the relationship.
We comment below on one or two of these sections:
- Compliance with your trustee duties
The guidance makes the point, at some length, that in its arrangements with third parties the charity’s trustees must ensure that the arrangement “only” furthers the charity’s purpose. This, arguably, runs contrary to the concept of programme related investment or social investment discussed later in the guidance. Moreover, the Charity Commission recognises in its investment guidance that there will be circumstances in which some private benefit is derived from the charity’s participation; but that benefit should be no greater than is necessary. In our view, therefore, this section of the guidance would benefit from being softened slightly.
- Keep the charity separate – don’t blur the boundaries
In this section the Charity Commission makes a number of points:
– Shared staff/resources: The trustees must properly decide what to charge the non-charitable organisation when sharing resources such as premises and staff.
– Shared or similar names/branding: There needs to be a clear distinction as far as a third party is concerned as to who it is dealing with (consider, for example, email templates).
– Decision making: The Commission’s paper stresses that trustees must be “able to evidence that their governance, management and decision making are fully independent, made and always made, in the charity’s sole interests”.
- The need for boards of each group entity to make independent decisions
If a trading entity wants to use a charity’s logo (for example to market a development) the trustees of the charity will need to consider not only the risk, say, of confusion but also whether a fee is appropriate (which may entail obtaining third party advice).
The guidance correctly highlights the principles of trustee decision making. That said, it does not explain the issues very clearly. We prefer an approach similar to that adopted by the Department for Business Enterprise and Regulatory Reform which has issued the following high-level guidance as to how directors should act to ensure compliance with their duties:
– “Act in the [entity’s] best interests, taking everything you think relevant into account;
– Obey the [entity’s] constitution and decisions taken under it;
– Be honest, and remember that the [entity’s] property belongs to it and not to you or to its shareholders;
– Be diligent, careful and well informed about the [entity’s] affairs. If you have any special skills or experience, use them;
– Make sure records are kept of your decisions;
– Remember that you remain responsible for the work you give others;
– Avoid situations where your interests conflict with those of the [entity]. When in doubt disclose potential conflicts quickly;
– Seek external advice where necessary, particularly if the [entity] is in financial difficulty.”
In our view, the most effective means of complying with the legal duties imposed upon board members is the application of basic principles of proper commercial behaviour, supplemented by a recognition of the higher duty of care that apply to charitable trustees.
The type of behaviour that the boards of each member of a group collectively, and each board member of a group board, individually, should have regard to are:
- trying to identify problem situations before they arise;
- being methodical in the way they make decisions. In particular, each board member should ask a series of questions:
– what are my duties?
– whose interests do I need to consider? For example, if there is a perceived conflict that should be disclosed.
– what should I do?
- recording the reasons why a decision was taken at the time it was taken and why it was in the best interests of that entity. This will typically be done in the minutes;
- taking advice in cases of doubt, and recording the advice given;
- supervising and maintaining effective reporting structures and systems; and
being open and frank with fellow board members; encourage collective responsibility and decision-making on all important issues (for example do not withhold information that may affect their decisions).
- Avoid conflicts of interest and conflicts of loyalty – the relationship with other group members
The economic benefits of being part of an RP group are derived largely from the ability of its members to act collectively and to give each other commercial and financial support. This collective approach can sometimes appear, conceptually, to be at odds with the basic legal concept that each member of the group is a separate entity and the board members of each entity owe duties to the individual entity (a point made in the guidance); an action or decision of the board members of an individual entity, taken to further a sensible and honest group purpose could, nonetheless, be seen by the Courts as a breach of their duty to the individual entity unless it is clear that the decision has furthered the charity’s purposes.
The guidance notes that as trustees, board members have a legal duty to act only in the best interests of the charity. Board members must avoid putting themselves in a position where their duty to the charity conflicts with their personal interests or loyalty to any other person or body. The guidance sets out a number of examples, including:
– a trustee is also a director of the charity’s subsidiary trading company; and
– directors or employees of the non-charitable organisation are also trustees of the charity.
The Commission points out that a senior charity employee making recommendations to the trustees board could also face a conflict of interest or loyalty in the same way as trustees. This might include an employee where an element of their remuneration is linked to the outcome of a particular transaction.
For RP groups, common areas of sensitivity include:
– Composite group banking facilities
From the point of view of the group, it may be inefficient to deal with the liquidity needs of each group member separately at the level of the individual group member. The use of group treasury vehicles have become a common way to use the collective resources of members of a group for their common benefit. That said, a board member must be satisfied, before committing his/her charity to these arrangements, that the arrangements will further the charity’s interests, and, to the extent that it benefits other entities that do not have similar objects, that benefit is no more than is necessary to enable the arrangements to be put in place.
There may also be a tension as to the terms upon which trading subsidiaries can borrow funds from the charitable parent unless it is clear that the loan is arm’s length and an investment made by (and for the benefit of) the charity.
– intra-group trading and shared projects
The opportunity for trade between group companies can benefit all of the companies involved. For example, one company may provide management or development services to other members of the group or a non-charitable entity may contract with the charitable entity to develop mixed tenure schemes.
– making gift aid payments
Boards may need to be satisfied that they can properly authorise a gift aid payment to another member of the group.
It is possible for the board of a non charitable entity to ask its shareholder to approve (or subsequently ratify) a particular matter, for example a gift aid payment.
The board paper proposing a gift aid payment should set out the advantages and disadvantages of making the payment. The paper could be expected to cover:
– the adequacy of the entity’s long term cash flow;
– the tax implications of not making the payment and the effect on the group’s and the cost of funds if the payment is not made;
– the effect on any relevant banking covenants;
– the long term benefits of continuing to be part of the group.
– Common boards
The guidance also states:
“The Commission expects the charity to have enough independent trustees on the trustee board (taking into account personal interests and loyalties) so that a quorum can be formed and valid decisions can be made when conflicted trustees have to be excluded from certain decisions.”
In the RP sector we have seen a greater number of common boards between different RPs – although it is uncommon as between an RP and its trading subsidiary. Given the guidance above and the fallout from “Carillion” members of common boards need to understand their role & responsibility and ensure that they have a robust procedure to address any conflicts that might arise, particularly where the common board structure straddles both charitable and non-charitable entities.
- Manage the risks, review the relationship
We believe that now would be a good time for RPs to audit their intra group arrangements in the light of the guidance, particularly where there:
– is joint working on major projects;
– are grants being made to other group members;
– is sharing of the charity’s name, logo and branding;
– is data sharing;
– is sharing staff;
– is sharing premises; and
– is the provision of specialist services such as IT, building services, HR accounting.
The guidance highlights that where the arrangements are straightforward a letter agreement will be adequate. However, the terms to be covered would include:
– an exit arrangement;
– no automatic renewal – so there may need to be some form of informal (albeit documented) benchmarking to ensure VFM; and
– a mechanism that ensures that the charity is paying its “just and equitable” share of the cost of the services (which may require advice from the auditors) and provisions for a reconciliation if it is not. Ideally, a simple form of benchmarking could be inserted to ensure that the price paid is in line with the market.
While the form of legal agreement for the provision of shared services is reasonably straightforward,the basis for determining the charge may be more complex.
Ultimately, however, the key consideration for charitable RPs to note is that the Commission expects charities to regularly assess whether the relationship with any connected non-charity continues to be in the best interests of the charity. Therefore, we would recommend that review periods are built in.
Sharing staff – particular issues – The guidance on sharing staff should be taken into account when drawing up new intra group service agreements. For example, the guidance sets out several factors. These are:
– Will officers at the charity be able to assess whether the staff are suitable for the role? Does the relevant charity have a choice in the selection of staff?
– Will officers at the charity be able to say whether they are meeting the job description or the job objectives? This is often dealt with via joint employment or secondment agreements.
– Where appropriate, obtain independent advice or information to agree rates of pay.
– Do you have processes to ensure there is accurate recording of the time spent on the charity’s work?
– Will you be able to draw up formal agreements to cover the arrangements?
It may also be helpful to review group arrangements for the sharing of premises. Here the guidance identifies the following factors:
– Is it suitable for the charity and what are the charity’s reasons for needing premises?
– If the charity is paying rent, is it paying more than the market rent? Or, in the case of a trading subsidiary using space owned by the charity, is it paying the charity a market rent? This, however, is an example of where, in our view, the Commission may be being too prescriptive; if the charity wholly owns the trading subsidiary, the profits generated by that entity will be capable of being exclusively enjoyed by the charity.
– Does the agreement or contract protect the charity and its interest? Have you used independent advice? For example, liabilities for repair, maintenance, and wear and tear; and security of tenure so that the charity can confidently deliver its services.
– The charity should not be required to pay for liabilities relating to any non-charitable use, for example breach of lease covenants.
- Investments
Helpfully the guidance reiterates the ways in which a charity can invest its funds:
– to make the best return for the level of risk that a charity can support (a pure investment);
– the further the charity’s purpose with the possibility of receiving a financial return (the programme related investment); and
– in a way that will, in part, further the charity’s purposes and achieve a financial return (the social investment).
It would be helpful if the guidance would clarify that a charity can make a pure investment and a programme related investment at the same time into a trading subsidiary. This may be relevant where a mix of private sale and social housing was being developed on a site owned by the subsidiary.
Devonshires has already submitted some views on the draft guidance to the Charity Commission. If you would also like to make a submission, the deadline for comments is 15 May 2018.
We will be running a workshop on the issues in the near future. Details to follow.
If you would like to discuss this note, please call the partner with whom you normally deal or any of the following:
Jonathan Jarvis, Partner; Andrew Crawford, Consultant; Andrew Cowan, Partner; Keith Jenkins, Consultant or Michelle Mullen, Solicitor.
