Thinking about updating your charity’s legal structure?

We all know how important it is to keep our charity’s constitution and purposes up to date. Depending on how your charity is constituted however, it may also be appropriate for the trustees to consider taking one step further and asking whether or not the charity also needs to update its legal form.

Does your legal form potentially expose the charity and the trustees to a higher degree of risk? Having a corporate form is the best way to maximise the protection available, usually by being either a charitable company limited by guarantee, or a Scottish charitable incorporated organisation or SCIO. Royal Charter bodies and certain other forms of charity created under statute are also a form of body corporate. Setting up as a SCIO is now the most popular legal form on the charity register for new start charities and for existing charities that want to become a SCIO.

Taking on corporate form

There are many advantages to being a form of body corporate. Some of the key advantages are:

• A body corporate has its own legal personality, so the charity exists in its own right. So for example, contracts will be taken out in the charity’s name. It can sue and be sued in its own name. It also holds assets in its own name, so remains unaffected by changes in the charity trustees/directors.
• Limited liability protection means that in a company limited by guarantee, the liability of the members is usually limited to the amount specified in the articles of association, such as a £1. In a SCIO, members are not liable to contribute to the assets at all if it is wound up. Personal liability can still apply however for any criminal acts or acts of gross negligence or recklessness.
• Charitable companies are of course subject to the requirements of the Companies Act 2006 and will deal with Companies House. A SCIO by comparison is not and will only deal with one regulator – the Office of the Scottish Charity Regulator (OSCR) and not Companies House.
• The legal structure of a charitable company and a SCIO are also very similar. They can both have a single tier structure, where the charity is managed by the trustees who will also be the members of the charity. Or they can have a two tier structure where the charity is controlled by the trustees and there will be a larger membership.

The SCIO conversion process for companies limited by guarantee

We are increasingly seeing a number of existing charitable companies limited by guarantee convert to SCIO status to simplify their affairs going forward. The process of transferring from a charitable company to a SCIO can be relatively straightforward under the OSCR conversion process that allows OSCR to work with Companies House. Once Companies House register the necessary members resolutions and cancel the company registration, the company automatically becomes a SCIO. Under this process all the property, rights and liabilities held by the company transfer automatically to the SCIO under the Charities and Trustees (Scotland) Act 2005 (“2005 Act”).

Before undergoing any such process however trustees are reminded of the following:

• Is the SCIO form appropriate for your charity? SCIO members are subject to some of the same statutory duties of care as trustees, which they do not have under company law, and a SCIO cannot take out a floating charge.
• To check that the articles contain the necessary powers to allow the conversion to take place.
• To do their homework first in terms of the assets/liabilities held and to identify any potential difficulties, e.g. do you have any loans registered with Companies House that could mean Companies House object to the conversion? Any unpaid penalties? Any contracts/agreements/restricted assets where the variation should be agreed with the other party first? Any potential pension problems? This is a vital stage that will show whether or not conversion is possible and should never be overlooked.
• Remember that the members will need to formally approve the change to SCIO status, the transfer of assets and liabilities to the SCIO as well as the terms of the new SCIO constitution, so there must be sufficient support.

Unincorporated Charities – unincorporated bodies and charitable trusts

An unincorporated body or charitable trust does not have a separate legal personality like a form of body corporate. This means that assets can only be held in the name of the trustees on behalf of the trust/unincorporated body, which can cause difficulties when trustees come and go. Likewise, contracts are taken out in the name of the trustees on behalf of the trust/unincorporated body and it can only sue and be sued in the same way.

This means that trustees potentially face the risk of incurring unlimited personal liability, with the trustees being held personally liable for any debts that the trust/unincorporated body is unable to pay from its own assets. This means that the charity’s creditors could potentially seek to sue the trustees personally to recover any monies they are owed, even if there has been no breach as such of the trustees’ statutory duties of care and responsibility as trustees. Trustees who have acted properly, lawfully and responsibly in terms of complying with their statutory duties of care, who have followed the powers set out in the charity’s constitution and who have not taken unreasonable levels of risk can be properly reimbursed from the charity’s funds, provided that it has the funds to repay them.

Trustees can also be held personally liable to account for any loss to the charity where they have breached their statutory duties of care. This can include all financial loss suffered to the charity until that money is restored. In the 2017 case of Chandra v Mayor, the committee members of an unincorporated body were all held liable to contribute to the costs awarded to the former chair of the charity after they won a wrongful dismissal claim.

A well run trust/unincorporated body with reasonable reserves and minimal risk exposure in terms of the activities can be carried out, such as a large grant giving trust, can mean that the risk of potential unlimited personal liability may be fairly low, but it is always a risk. Trustee insurance cover is a must, but it will contain limits on what it can and cannot insure. There may also be an immunity clause or other form of protection in the constitution, but again there is a limit on how far such protection can go, for example, gross negligence would not be covered.

Charitable trusts are also subject to strict rules regarding accumulations of income. This rule allows trusts to convert accumulated income into capital for the first 21 years, but after this period are required to distribute their income. This can be extremely prohibitive.

For this reason, trusts/unincorporated bodies may find it harder to retain existing trustees, recruit new trustees or secure funding until steps are taken to reduce the risk profile. This is done by changing legal form and becoming either a charitable company limited by guarantee or a SCIO. Becoming a SCIO still remains the most popular choice.

Factors to take into account will include:

• Does your constitution contain the power to change its legal form? If not it may be necessary to use the reorganisation provisions set out under the 2005 Act.
• Is a SCIO an appropriate choice for your charity and will it be supported by your members, if any? See the points covered above.
• The conversion process from charitable company to a SCIO does not apply to trusts/unincorporated bodies. Instead the process will involve setting up a new SCIO with a new charity name and number, the complete transfer of all assets and liabilities to the SCIO/company as a separate exercise and the winding up of the old charity, so it can be a time consuming and expensive process.
• A full due diligence exercise will be needed to look at all the various assets and liabilities held by the charity to identify the work that will be required. This will identify issues such as any heritable property to be transferred, any leases, contracts or agreements to be cancelled or assigned over to the new body, and any agreements required in relation to matters such as intellectual property rights, any employees who require advice under TUPE, setting up a new bank account, possible pension issues etc.

Conclusion

This article provides a general overview of the way in which a charitable company, trust or unincorporated body can seek to change their legal form and the advantages of doing so. Changing legal form is a major undertaking and is not necessarily appropriate for every charity. If you are considering taking this step it is important to get legal advice at an early stage to identify any potential difficulties and to help guide you through this rewarding process. One of our experts will be more than happy to help if you have any questions on whether or not this is the right step for you, and of course, on how to get started.

You may also be interested in the following articles:

• The effect of financial sanctions on charity trustees
• Wick Academy Development Fund – implications for charity trustees
• Gift Aid Changes following the Spring Statement
• Time to get your charitable house in order
• Trading Companies and Charitable Status – The New Lanark Trust

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