Update | Charity: increasing sophistication

Charities are increasingly adopting working practices developed in the commercial world, and changes which impact upon charities are often also relevant to the wider social enterprise sector. Most lawyers operating in charities now think of themselves as 'charity and social enterprise' lawyers, and firms have put their charity practitioners firmly within their corporate/commercial teams, rather than private client teams within which most ?sat historically.

Charities form only a part of the third sector. Clients of ours with a new idea for social action or a good cause will often want to set up a new enterprise, although not necessarily a charity. Gov.uk (the government's new website for services and information) refers to a social enterprise as a 'business that helps people or communities', which might include a limited company, co-operative, industrial and provident society, community interest company or a charity. For many, charities may not be necessary or even appropriate, such as where the founders wish to be on the board and also receive a salary. For others, the best overall structure may involve having a charity, but only as part of a wider group of entities.

Certain recent legal updates apply equally to charities and to other organisations within the third sector. Others, although relevant only to charities, reflect their changing nature, demonstrating the more business-like approach charities are taking, both in relation to funding and also operations generally.

Social Value Act 2012

The Public Services (Social Value) Act 2012 is coming into force in January 2013. For the first time, public bodies in England and Wales will be required to consider how services which they commission might improve the economic, social and environmental wellbeing of the area within which they operate. Procurement law already enables contracting authorities to take factors other than cost into account but some commentators believe that this new legislation will make it easier for voluntary sector organisations to compete with the commercial sector when tendering for public sector functions.

The concept of social value underpins this Act. Demonstrating and measuring social value is increasingly important to third sector organisations. Generally, the sector has had to start being more proficient at showing its social value and how it assists its beneficiaries and the community. Third sector organisations will need to maximise the benefits provided by this Act when producing tenders and, specifically, social value will have to be incorporated into the design of the service. Charities which already receive most of their income from service provision are adept at evidencing social value in the services that they run, but generally the sector still has a long way to go in defining this and demonstrating the good that it does.

Payment by results

In October, David Cameron said that he wants to see an increase in payment-by-results schemes (PBR) being used across rehabilitation services. This led to renewed discussion about these forms of contract. Although people speak about PBR as if there is only one model, there is no single form and contracts differ considerably. The term is loosely used for commissioned services which are paid for only if and when a specified outcome is achieved. A key driver is shifting risks to the provider away from the public sector, allowing the provider to 'get on with it' but be paid only when they deliver on results.

Broadly, PBR can be divided into output and outcome-based contracts. The former is widely used in NHS contracts, with healthcare providers being paid for the number of patients seen or treated (taking into account individual circumstances). It is the latter, outcome-based contracts, which are arousing interest at present. The Department of Work and Pensions' 2008 commissioning strategy put greater focus on payment by results when awarding welfare-to-work contracts (requiring evidence that the beneficiaries of the service had returned to work for a certain period). More recently, the Ministry of Justice has been leading the use of these arrangements. The most acclaimed scheme, launched in 2010, was aimed at reducing reoffending among people leaving Peterborough Prison. This involved social investors funding the scheme (social impact bonds) and taking on the risks of service delivery, with repayment contingent on the project being successful in reducing reoffending over a six-year period.

In November, the Cabinet Office launched the Social Outcomes Finance Fund, a £20m fund to support the creation of social impact bonds, suggesting that we will be seeing more of this type of scheme in 2013. It remains to be seen whether PBR will become the norm when taking on public functions with a measurable outcome but many smaller charities are currently afraid to engage with this issue because it appears to be surrounded in complexity. Financially sound organisations which are confident in their abilities stand to benefit from increased use of PBR. However, they will need to ensure that performance is based on clear, measurable indicators and that timing for achieving them is realistic. Third sector organisations also need to be aware that funding may not start flowing for some time and seek additional upfront financing if required. In financial terms, organisations whose main source of income is PBR will need to start thinking like 'normal' for-profit businesses, with income/profitability being more directly aligned to performance.

Response to Lord Hodgson

My colleague Reema Mathur described the highly publicised review of the Charities Act 2006 carried out by Lord Hodgson (Trusted and Independent; Giving Charity back to Charities) in Solicitors Journal in August. ?On 3 December, Nick Hurd MP, minister ?for Civil Society, sent an interim response ?to that report.

Using an easily identifiable 'traffic-light' system, Hurd chose not to accept the controversial proposal to make it easier to pay trustees of charities (the generally unpaid nature of trusteeship being a factor quite unique to charities), but all other proposals made by Lord Hodgson were categorised as 'green' (broadly accepted but a few specific points may need to be tweaked) or 'amber' (more work needs to be done before a recommendation can be accepted or rejected). Some key points are as follows:

Trustee remuneration '“ Lord Hodgson recommended that large charities (income over £1m) should have the power to pay their trustees without prior Charity Commission consent. As mentioned above, the Cabinet Office disagreed with this, citing opposition from within the sector, mostly that the voluntary nature of charity trusteeship is a defining feature that could be undermined if there was more routine use of payment.

Commisson registration '“ Lord Hodgson recommended that compulsory registration for charities be raised to those with an income above £25,000 a year (from £5,000 a year currently) but that all charities claiming gift aid be required to register and all charities wishing to voluntarily register could do so. The Cabinet Office marked this as 'amber', stressed that this has received mixed feedback and stated they would need to investigate this further before taking ?a decision.

Social investment '“ Nick Hurd flagged that the UK is well placed to become a leader in 'this new and emerging field' and recognised the need to reduce bureaucratic barriers to its growth. Lord Hodgson had highlighted that the legal position for charity trustees is not totally clear, in that trustees are required to seek the best possible financial return and, although most practitioners feel that charity trustees can make mixed motive investments (and the commission guidance supports that), this does not have the force of statute. He had also noted that, when attracting external investors, there is an inherent problem with private benefit which charities should only permit where 'necessary and incidental'. Nick Hurd agreed that the government needs to clarify this position.

Other points '“ Nick Hurd supported the recommendation to strengthen self-regulation of fundraising and putting in place stronger regulation/licensing of charitable collections in public places.

Charitable incorporated organisations

After years of anticipation, the commission finally began to accept applications for new charitable incorporated organisations (CIOs) on 10 December. Although receiving applications, the commission cannot register any new CIOs until 2 January 2013 (they have to allow 28 days from the date the regulations were made).

By way of reminder, the CIO is a new corporate vehicle for use exclusively by charities. A CIO is regulated only by the commission (and not also by Companies House, as a charitable company limited by guarantee would be). Therefore, a CIO offers the advantages of incorporation but without the problems of dual-regulation. Consultation on the draft CIO regulations took place in 2008 but since then the introduction was delayed. Key features ?of a CIO are:

The CIO retains the two-tier structure ?of a company, but as with companies limited by guarantee, the trustees can be the only members (foundation model), or there can be a separate CIO membership (say, interested stakeholders or a sole corporate member) (association model);

a CIO must have a constitution and, under the provisions in the Charities Act 2011, this must be in the form specified in the regulations, or as near to that form as circumstances allow. The commission has produced two draft constitutions;

disappointingly, there is currently no provision for a Register of Charges (such as mortgages) and so this may not be a suitable form for charities which wish to borrow money against property.

There are provisions which, in the future, will enable existing companies limited by guarantee and CICs to convert to CIOs (aiming, broadly, to ensure that all charitable assets are transferred and there is continuous accountability) '“ this will probably not be until 2014. Existing unincorporated charities wishing to become CIOs will need to set up a new CIO and transfer assets across.

The CIO will be useful for smaller to medium sized charities (who may not require secured borrowing) and all service-providing charities. The commission is staggering registrations, starting with brand new charities and existing unincorporated charities with an income below £5,000 p.a.

Significant time and effort is going into the review of the Charities Act 2006. It is noteworthy from that review and from the long-awaited introduction of the CIO that work is ongoing all the time to make charities easier to operate and able to be more commercial.

Although the third sector is changing apace, it is evident that there is something appealing about charities in particular, beyond tax status. This is likely to do with the unique requirement of all charities to operate for the public benefit and independently of government or commercial interests. Although charities are being given opportunities to think outside the box like never before, the public clearly appreciates, particularly in 2012, that uniqueness and the trust which it instils.