Companies facing up to insolvency undergo a painful process which needs to be managed carefully. Sean Egan looks at some of the issues that can affect arts organisations in this process and seeks to offer some practical advice if such a prospect looms.
When an organisation is in financial trouble, those leading the organisation should have particular reference to the organisations legal liabilities and their own. Ideally, the prospect of insolvency is not a surprise but there can be shocks and companies can fall like a pack of cards. These situations tend to arise when an organisation has no true awareness of its ongoing liabilities and alternative plans if funding arrangements fall through. The process can become unnecessarily fraught if creditors are not provided with information on which they can rely. It is most important that the organisation seeks to address the financial difficulties it faces even if that means ceasing to trade. If problems are left they will only become far worse and may result in personal liability for not taking proper action.
Communication
Part of any process of management is clear communication between the executive board and the organisations officers. For a charity, the ultimate responsibility for the organisation falls on the trustees to ensure that the organisation is run properly even though they are providing their time on a voluntary basis. An important element of the governance of a charity will be the proper convening of trustee meetings and the provision of information to trustees about the operation of the organisation. Trustees should always expect to have sufficient information to be able to approve or scrutinise decisions effectively. Board meetings and committee meetings are a crucial tool for trustees to exercise these management skills and the importance of effective meetings cannot be underestimated.
Minutes of meetings need to accurately represent not only the decisions taken but the reasons for those decisions. It is all too easy for trustees to appear to have acted irresponsibly unless coherent reasoning for particular decisions is reflected in the minutes. It is perfectly acceptable for charities to take proper risks in order to pursue their charitable objects. These risks may even result in the charity being insolvent and having to be wound up. But Trustees will not be able to demonstrate that they acted properly unless the clear rationale for their decisions can be presented and proper minutes are essential for this.
Personal liability
A crucial distinction is whether the organisation is incorporated or not. For trusts, clubs, associations, societies and other unincorporated organisations, the liabilities of the organisation fall on the trustees or other executive individuals, depending on the nature of the constitution. As unincorporated organisations do not have a separate legal entity, the liabilities of the organisation remain with the individuals. Usually charity trustees have the right to be indemnified out of charity assets, but that is of no value in the event of insolvency. The legal position is different for incorporated organisations which divide into two groups. Those that are not charities (commercial companies limited by shares or limited by guarantee) and the recent innovation of community interest companies. Incorporated charities will usually be companies limited by guarantee and in addition to their responsibilities as trustees, directors will have additional duties as charity trustees. If a breach of trust on which charity assets are held gives rise to a loss to the charity, trustees are vulnerable to a claim to reimburse the charity for the loss caused. Such a claim will be instigated by the Charity Commission or the Attorney General or indeed by the other trustees. Though this covers not just insolvency of the organisation, this is often the trigger for such a claim to arise. So long as charity trustees act in good faith, it is fairly rare that they will be personally liable and the courts have the power to relieve a trustee from personal liability where he or she has acted in good faith.
It is worth mentioning trustee indemnity insurance in this context as it is frequently misunderstood. This is a policy protecting trustees in the event of claims against them personally and the precise scope of the cover will depend on the individual policy. Generally speaking, this type of insurance will cover breach of trust claims and wrongful trading (see below) and associated legal costs. It will not cover the personal liabilities of trustees of unincorporated organisations for debts due to third parties. This cover is almost certainly restricted to cases where trustees have acted in good faith.
For a company director, the principal sources of personal liability are:
" If a director knows there is no reasonable prospect of the company being able to pay its creditors and knowingly continues to carry on business fraudulent trading.
" If a director knows or ought to know that there is no reasonable prospect of a company avoiding insolvent liquidation and still allows the company to keep trading wrongful trading.
" If a director wrongfully gives preferential treatment to one creditor over another when the company is facing insolvency fraudulent preference.
" If a director acts whilst disqualified from being a director.
Liquidation
Insolvency is when a companys liabilities exceed its assets. Insolvent liquidation is when a company is wound up because it has become insolvent. Directors often face an incredibly difficult decision in that the level of commitment to an arts organisation is likely to be very high indeed and that no-one in the organisation wants it to cease trading. The temptation will be to continue trading even though the directors should call a halt.
If the desire is to continue, then the directors need to precisely formulate the basis on which that decision is made. It is not acceptable for the directors to believe that the organisation can trade its way out of its current problems and that something will turn up! If there is a real prospect of financing materialising or that the organisation can continue with work that in itself is profitable and therefore can reduce the sums owed then the directors may be in a position to allow the organisation to continue trading. At each step however, the directors will need to assess the viability of their plan and ensure that the reasoning is reflected in minutes of meetings. Taking legal advice when faced with potential insolvency can have two benefits. First, it can clarify the organisations position and the basis on which the organisation can continue trading. Secondly, if directors are following legal advice or advice from other professionals, that is likely to establish that they are behaving properly and acting on that advice should minimise any risks of personal liability from their actions.
I have focused on trading difficulties as the main source of insolvencies but in the regular risk assessments that organisations should undertake there should be reference to health and safety obligations. Directors can expose themselves to liabilities for breach of health and safety law as a criminal offence and where there is a claim by the public, i.e. public liability for an injury or other damage, it is essential that those liabilities are insured to avoid the risk of insolvency.
Sean Egan is head of Theatre and Arts at Bates, Wells and Braithwaite Solicitors.
w: http://www.bateswells.co.uk