Practice trends: charity law

Slowly and creakily, two major pieces of legislation which have the potential to change the way charities are run, are being brought to life. The first and arguably most significant, is the Charities Act 2006, which charity lawyers have been warning their clients about since the Bill was first introduced in 2004. The second, the Companies Act 2006 is also being implemented on a piecemeal basis and is expected to increase the regulatory burden on charities set up using a company structure, which is the case of the majority of large charities.

Society benefits from charity sector

At the heart of the Charities Act is the acknowledgement of the social dimension of charitable work; the idea that society as a whole can benefit from the services offered by the charitable sector.

The main manifestation of this principle is the new requirement in the Act for charities to deliver 'public benefit'. Put simply, this means that a charity has to be set up for the benefit of the public at large, or a section of it, and be able to demonstrate that it meets this requirement at all times. More specifically, the annual trustees' report will have to include details of the steps taken by the charity in this regard.

All charities, big and small, will be affected but certain types of charities, such as independent schools and independent hospitals, which charge a fee for their service, or those where there is a membership fee, such as royal colleges and professional associations, have to be particularly vigilant, according to Chris Priestley, a principal at Withers.

However, Priestley says that charities in England and Wales should be able to take comfort from the Scottish experience. The Charities and Trustee Investment (Scotland) Act 2005 has been in force in Scotland since 2006 and introduced a 'charity test' which contains, among other things, a similar 'public benefit' requirement.

'Since then,' continues Priestley, 'the Office of the Scottish Charity Regulator, the counterpart to the Charity Commission north of the border, has cleared independent schools through the 'public benefit' hurdle and has allowed them to retain their charitable status, starting with the pilot review programme involving Dundee High School and Dundee University.'

In practice therefore, the main bugbear for charities, which could be particularly onerous on smaller ones, is the amount of administration time and effort that compliance could involve. The new 'public benefit' requirement has been on the cards since the Charities Bill was first unveiled in 2004 (it ran out of time and was re-introduced in 2005) and charity lawyers like JonathanBurchfield, a partner in the charity and education team at Stone King, have been working with their clients as part of an ongoing process to make them understand how this will affect them and what steps they need to take.

Taking steps to comply

'We have hundreds of clients and have been encouraging them to review how they provide a public benefit ahead of next year', says Burchfield. 'Private schools, for instance, would have to start asking themselves a few basic questions: to whom are they providing their services and is this service genuinely accessible?Are there ways in which they should make their services or facilities to a wider public?'

Provided the trustees are satisfied that their services are genuinely accessible, this, in simple terms, is where the school's responsibility would stop and would ensure compliance with the 'public benefit' duty.

Whether people actually decide to take advantage of the educational service offered by the school is not the school's ultimate responsibility, unless there is strong indication that lack of uptake is the consequence of the school's failure to take adequate steps, in which case the Charity Commission would be entitled to ask the school to carry out another self-assessment and come up with more appropriate measures.

As a result, initial concerns appear to have subsided, as many governors have realised that in most cases, the solution will merely involve using their resources more creatively to ensure they reach their objective of educational work.

'Draft guidance published by the Charity Commission shows that compliance will probably not be as complicated,' says Hannah Candlin, a solicitor with Speechly

Bircham. 'Some charities were petrified but most are now reassured. Not just schools but also, for instance, small, local arts charities. Simply by putting their collection on the web will ensure that virtually the whole world can access their collection, which is a very straightforward way of complying with the requirement'.

'There is a lot of guidance out there, and more will be produced by the Commission and the National Council for Voluntary Organisations,' concurs Priestley. 'Part of the Commission's role is to help charities, and a simple step to take for any charity is to look at the Commission's website, or the Office for the Third Sector, which have guides to the Charities Act.'

Priestley says that although the presumption that a charity acts for the public good has been removed, showing that it does is not intended to be an insurmountable task.

'There are obvious causes, such as charities fighting against cancer,' he continues, 'but even for the less obvious ones, it should not be difficult. Charities will need to think more strategically about what they do and be comfortable that it is perceived to be for the benefit of the public. Logic tells you that this shouldn't be difficult to show. It should also have a positive effect on organisations where there has been a 'mission drift' '“ where charities have moved away from their original purpose and are no longer doing quite the same things but have never changed their objects. This will be the opportunity for these charities to re-assess what they do.'

No compliance 'tick list'

Although the answer may not be as straightforward for all charities, there is now a sense that the requirement will not be as stringent as originally feared. The Charity Commission has clearly indicated that this is not a 'pass or fail' procedure. There is no step-by-step compliance precedent or a 'tick' list. The whole process is rather softer, with a lot relying on common sense and self-assessment.

There is also a practical consideration that the Commission does not have the resources to police them all anyway, but then again, a collaborative approach has been the norm in the traditional set-up of charity regulation, where the regulator is both friend and policeman.

'The Commission does not have the resources to investigate whether all charities comply and it will have to prioritise,' says Priestley, 'hence the decision by the Office of the Scottish Charity Regulator to concentrate on independent schools initially.'

As the charities' friend, the Commission only resorts to draconian sanctions in extreme cases. When carrying out an investigation into a charity's conduct, it is more likely to produce a list of items for review, and only if the charity in question fails to implement the requisite changes will it take remedial action.

'For charities and their trustees the threat of deregistration is a powerful incentive,' says Priestley, 'as is the possibility for trustees to be held personally liable for breach of trust as a result, particularly if there have been losses'. Looking back at the pilot project in Scotland, only two charities failed the charity test on technical grounds and were issued with directions.

The draft guidance issued with the consultation started in March is now being finalised by the Charity Commission as it examines the responses received '“ including that submitted by the Charity Law Association, the near 1,000 strong organisation acting as a forum for the exchange of ideas and experience for charity lawyers and charities.

Charities' new clothes

Another major development in the Charities Act is the introduction of a charity-specific structure, the Charitable Incorporated Organisation (CIO).

At present, many charities are set up as companies limited by guarantee, falling both under the jurisdiction of the Charity Commission and within the scope of company law regulation under the Companies Acts. This dual accountability, which generates cumbersome administrative work, should disappear when new regulations are adopted next year to implement the provisions in the Act on the CIO.

'Charities have operated within a legal framework tailored for organisations whose objective is to make a profit for the shareholders,' says Burchfield. 'These days many are run like businesses in terms of structure, accountability and general efficiency, and they generate revenue but, unlike a plc, profits are ploughed back into the organisation rather than distributed to shareholders. This is what the new CIO structure will acknowledge'.

Most charity lawyers have welcomed the opportunity to get away from a company law framework into one which recognises the nature of charitable organisations, but the change over to the new structure is likely to take time as charities, new and old, negotiate the transfer.

Aside from an uncertain implementation date '“ the latest indication from the government is that regulations will be laid down in spring 2008 '“ there are also concerns about the adoption of the new model. The procedure is expected to be straightforward but much will depend on the wording of the regulations. The most likely early adopters will be new charities, with no 'baggage' and nothing to lose in adopting the new CIO structure.

Whether existing trusts set up as companies limited by guarantees will convert is another matter, particularly as few lawyers will be prepared to use their clients as guinea pigs.

There is a good incentive though, in that the Companies Act 2006 has continued to increase the amount of detailed compliance '“ the best reason to shy away from the company form.

Public services delivery contracts

As charities look to generate further income from the public sector, another issue slowly creeping up the agenda is that of public service delivery contracts.

According to a recent Charity Commission survey, the public sector provides charities with an overall annual income stream of £5.3bn, representing 24 per cent of all revenue and making it the biggest single source of income for charities.

The change in the past few years however, is that charities are no longer relying purely on grants from the public sector but are entering into service contracts.

'This is a huge trend in the public sector,' according to Jonathan Burchfield, 'which raises the issue of independence and how charities can retain their autonomy and fulfil their own objectives.'

And as Burchfield predicts that the trend will continue, balancing the need for funding with independence will require charities to start carrying out proper risk assessment before they sign on the dotted line. Particularly because over two-thirds of contracts are for a duration of only one year.

'Charities are in a strong negotiating position,' continues Burchfield, 'but they are all in competition with each other and the strategy is also very short-term, which makes it all the more risky, so interested parties are encouraging local authorities to think long term for the benefit of all those involved.'

For his part, Priestley also believes that as government and local authorities are turning themselves into service commissioners rather than delivering the service themselves, there will be more opportunities for the voluntary sector. Already, he says, there has been a big increase in the request for advice on how to structure new ventures where charities are bidding for contracts from local authorities or NHS trusts to perform certain services.

'It has changed out of all proportion,' Priestley says. 'Charities are bidding for contracts falling within their existing core purpose, as well as contracts requiring them to use a skill they had to develop to perform their core mission. For instance, a charity producing publications as part of its work on treatment and care for a particular condition could be bidding for the publication of small booklets in respect of a different condition '“ the skills required are just the same and the money raised will go towards funding their core activity'.

The problem is to make sure that such ancillary fundraising activities do not detract from the charity's main purpose.

'The new venture needs to be structured properly,' says Priestley. 'Typically, the funds will be ringfenced in a separate legal entity which will be dealt with on an arms-length basis by the charity. If this separate entity is staffed by charity members, their time will need to be accounted for as such. And this separate entity has to charge for everything it does, it should not be subsidised. There are also questions of tax, and use of premises: are the entities grouped for VAT purposes? Should the charity charge for use of premises? This will create additional administrative and management time, but if successful, the arrangement can generate increasing revenue for charities and it can be worth doing.'

But failure in the voluntary sector can be as unforgiving as in the business world. Charities selling themselves short can end up bankrupt as their resources are siphoned into performing their contractual obligations, leaving them financially unable to run their core service.

'It is not enough to ensure that the contract will cover marginal costs; to be viable for a charity, it has to cover core costs too,' says Burchfield. 'A lot of charities initially lacked the experience of dealing with local authorities but they are getting there now, forming consortia and getting involved earlier in the tender process.'

The challenges of business

Beyond the headline legislative developments, charities are also facing other challenges, and in particular, they are experiencing a rise in the level of litigation.

'The world seems to have become more litigious,' says Hannah Candlin, 'and charities are now being hit by that flow. Mergers between charities are giving rise to employment problems with dissatisfied employees bringing claims against their charities, and there is also an increase in litigation surrounding legacies, with many more wills being contested.'

For trustees, this move is a painful dilemma requiring them to determine how best to use money initially raised for charitable ends. Should funds collected for the cause be used to compensate or pay off a disgruntled employee, or should it be used to defend litigation instead, with the risk that it might fail?

According to Candlin, trustees need more handholding as they are increasingly feeling the pressure and need to ensure that their course of action cannot be regarded later as unreasonable.

'Many choose to settle claims through mediation, even though it may not have been as good a result as if they had gone to court, but risk is measured on a different scale from business.'

The move towards merging is also encouraged as a means of reducing administrative costs and ensuring best use of resources, in a way which is not seen in business circles.

'There is a sense that charities are having to grow and merge, or disappear,' continues Candlin.

'It is a further sign that more and more, charities are run like businesses. Even long-established charities established by Royal Charter are now looking to change their constitutions '“ which is expensive and slightly mind-boggling, but if you want to run like a business, you have to be structured like a business.'

The answer to this question, in the end, could determine whether charities make use of the CIO option or if this new vehicle is destined to fail because it does not meet the modern business needs of charities.