When two become one

In March 2015 the Law Commission issued its consultation paper ‘Technical issues in charity law’. Chapter 12 of this paper focuses on legal obstacles that exist to charity mergers and how the legal framework could be amended to help facilitate mergers.

The proposals set out by the Law Commission would help smooth a number of issues arising with pre-merger vesting declarations and the treatment of bequests to a charity that has merged.

However, despite a number of legal issues with the charity merger provisions introduced by the Charities Act 2006, it is not the law relating to charity mergers that prevents more charity mergers from taking place.

Survey says

While surveys of the charity sector show that around 35 per cent of charities are collaborating with others in the delivery of services or fundraising/bidding, the percentage of charities contemplating a merger remains low (between 3 and 7 per cent).

The ‘Good Merger Index’ (produced by Eastside Primetimers, which was the first comprehensive review of charity mergers in 2013/14) uncovered a very small number of large transformative mergers but a long tail of local small mergers.

The report, which considered mergers undertaken by 189 charities, concluded that charity consolidation was at a fairly early stage. This picture appears to have continued through 2014 and into 2015. There have been very few headline mergers, such as the merger of Breast Cancer Campaign and Breakthrough Breast Cancer and that of KCA and Addaction.

At a local level, there are mergers happening between charities that are roughly the same size and which are often part of the same national federations (for example, Age UK, Crossroads).

There would also appear to have been an increase in what is becoming known as ‘group mergers’, where a larger charity becomes the parent charity of a smaller charity, but allows the smaller charity some continuing autonomy and often an independent board.

The main driver for mergers continues to be the external funding environment. Most sector professionals have been commenting for at least a decade that the rate of consolidation within the sector is much lower than expected and, depending upon your point of view, required.

So, what is involved in a charity merger?

• Compatible objects: Charity mergers require an initial step that is not required in commercial mergers. Both parties will need to ensure that they have charitable objects which are compatible. If their charitable objects are not sufficiently similar, then legal advice will need to be taken to establish what can be done to amend the charity’s objects so that they can be sufficiently aligned ahead of the merger.
• Exploratory discussions: These talks can begin with trustee boards or senior management teams. The decision around who to bring into these discussions, and when, is often more difficult in the context of a charity with an unpaid voluntary trustee board who are responsible for the charity and a paid senior management team who must implement their strategy. Both groups are critical to the success of any merger project, but which group is driving the process can impact the journey significantly.

• Confidentiality agreements: Such agreements are now often put in place to try to prevent the leaking of the discussions and the information shared between the parties. Charities depend on their many stakeholder groups for their success, and effective communication with all these groups in a planned and organised manner is critical.
• Heads of agreement: Merging takes time and money. Many charity trustees like to have heads of terms agreed and signed at an early stage, which set out the process, the timing, and the future governance of the new charity. This document can also be used to set out the shared vision of a new charity – how will the merged charities deliver more for their beneficiaries? Without agreement on this vision, it will prove difficult to motivate the charity’s stakeholders and obtain their commitment and buy in to the process.
• Due diligence: The due diligence process is vital to the merger process. It serves two principal purposes. First, it ensures that the charity trustees have complied with their charity law duties to interrogate the other entity and have a good picture of the charity with which they are proposing to merge, including all its assets and liabilities.Second, it helps with the future planning process. Unlike in a commercial merger, there are generally no representations or warranties given in a charity merger upon which either party can rely. The assets will usually be combined and therefore there is no recourse for charity trustees who find they have entered into a bad deal. The due diligence process will usually incorporate commercial, financial, and legal due diligence, and helpful checklists have been provided by the Charity Commission. The due diligence process will also help inform the structure of the merger – which entity should be used post-merger, or whether a new charity should be created going forward.

• Staff: As with any form of restructuring, careful advice on employment law will need to be taken at an early stage to make sure that each charity can comply with any obligation that it may have to consult and inform staff. There is often a desire to have the ‘top team’ in place on the merger date, or at the very least to have selected the new chief executive, and careful advice needs to be taken to ensure that risks are minimised.
• Pensions: Final salary schemes and their deficits have been the reported cause of many charity mergers not proceeding. Often, one party will be a member of a local government pension scheme and will quite possibly not have realised the full extent of its liability until it has been considered as part of the merger process.
• Contracts: For many charities, ensuring that their contracts will remain in place is critical. Most contracts will contain a prohibition on assignment, and charities will therefore need to have a number of careful conversations with their commissioners to ensure that the necessary transfers can be made. It can often be impossible to have those conversations before the merger has been announced. In some cases, this has meant that, rather than merge one charity’s assets and liabilities into the other charity, the first charity has instead become a subsidiary of the second charity (which is less likely to enable government contractors to bring the contracts to an end). The merger has then been brought about in two stages, with staff and contracts moving from the first charity to the second charity six months down the line, once the charities have been able to have full discussions with both commissioners and their staff.

• Special trusts: Any special trusts held by a charity will need to be reviewed in advance to ensure that the funds, or at least the trusteeship of those funds, can be transferred to the merged charity. Advice at an early stage is recommended in case the Charity Commission’s assistance is required, and to avoid last minute panic.
• Regulators: Many charity mergers will be able to take place without requiring the consent of the Charity Commission. However, the Office of the Scottish Charities Regulator requires charities which are registered with it to apply for prior written consent if they wish to merge. Charities will also be regulated by other regulators, and a careful plan needs to be made for when and how each required regulatory consent will be obtained.
• Designing the new charity: Whether or not a new entity is being established on merger, most charity mergers will in some way adjust the governance of the merged charity board to reflect the requirements of the new merged charity. In simple cases this can involve appointing a number of trustees from the other charity; in other cases it can involve a complete redesign of the charity’s governance. Since both charities usually have strong views about what works best, sufficient time needs to be built into the process for these discussions to take place.
• Name: Finally, the parties will need to decide on the new name for the charity. This is often one of the hardest tasks, and those who watch the charity press will notice that many charity mergers are now announced and implemented with an interim or holding name, often comprising all or part of the names of the original charities.

Those who have been through a charity merger will tell you that it is both labour intensive and costly. It is important to set a timetable which ensures the process can be completed properly, but which does not begin to drag the charities backwards.

A significant number of charity mergers are ‘forced mergers’, either because a particular income source is being squeezed, because a key member of the senior leadership team is departing, or commissioners are demanding that charities come together.

It is not the legal process that is the barrier to merger, but the cultural, emotional, and personal issues that arise. As lawyers, these are much harder issues for us to manage. SJ

Jo Coleman is a partner and head of the charity team at IBB Solicitors