Keeping to the rules when borrowing from a trustee
Funding is key to any charity meeting its charitable objects. As part of raising funds, borrowing will inevitably be one of the options for a charity to consider where other funding options are unavailable or a charity does not wish to, or cannot, spend its reserves for whatever reason. Borrowing from a bank will of course be the more traditional option but what if the terms of the bank’s offering are unattractive or the time it takes to obtain the loan is too lengthy when the charity might need funds urgently?
Could the charity look closer to home for funding, such as from one of its trustees? If so, what is the status of such a loan and what must a charity consider when entering into a transaction with a trustee? A summary of the key considerations for charities which are considering borrowing from a trustee is set out below.
Status of trustee loans
Trustee loans to charities are perfectly possible. However, it is important to note that whilst the arrangement might feel informal due to the proximity of the lender trustee and borrower charity, not only must the charity approach it in the same way as it would with any commercial lender, by ensuring that the arrangement will be in the interests of the charity and will be clearly documented, but it must take additional care in managing the inherent conflict of interests such a transaction gives rise to.
The recent Charity Commission report on its inquiry into the Bersam Trust charity highlighted a number of failings in the running of the charity, not least in its management of loans made to it and conflicts of interest. This case has brought the matter of loans to charities and management of conflict of interests firmly into the spotlight.
It is important that charities considering such borrowing understand the remits within which such loans are permitted and how they must be managed under charity law.
Extent of the need
At the outset, as part of its financial planning, the charity will need to consider whether the borrowing is necessary to enable the charity to carry out its charitable purposes. If so, is the loan proposed affordable or are there alternative, more attractive, sources of funding available?
Power to borrow
The other key question to address at the outset is whether the charity has the power to borrow. Most charities' governing documents will include an express power to borrow. In the event that a governing document does not (perhaps because it is a particularly old one), there may be power to rectify this. There could there be a power of amendment available or under a "catch all" provision allowing the charity to carry out what is needed to further the purposes of the charity. Advice should be sought in this situation.
Conflict of interest
The importance of noting that such a loan gives rise to a conflict of interest cannot be stressed enough. One of the main criticisms by the Charity Commission in its inquiry into the Bersam Trust was that it failed to manage conflicts of interests adequately, an area in which the Charity Commission is increasingly focusing its attention. It is important that the charity and the lending trustee understand how such a conflict is to be managed by reading any conflict of interest policy the charity has in place and following any rules set out in the charity's governing document.
As a minimum, the lending trustee must not be involved in the charity's decision to enter into the loan and must be absent from any discussions regarding the loan. Any such loan should be recorded by the trustee in a trustee declaration and register of interest form to be stored by the charity.
Benefit to the trustee
If the trustee requires interest to be paid on the loan, check that this is permissible under the terms of the governing document. The general rule under charity law is that a trustee cannot receive a financial benefit from the charity unless that benefit has been authorised by the Charity Commission or is permitted in the charity's governing document. Interest paid to the lending trustee without authority would amount to a breach of trust which can open the charity's management up to investigation by the Charity Commission and expose the charity to reputational damage at the very least.
Most modern governing documents, however, include a power for trustees to make loans to their charity and to be paid interest subject to certain controls. For example, the Charity Commission's current model governing documents permit interest being paid on trustee loans provided the rate of interest is reasonable and does not exceed the Bank of England base rate.
Documentation as evidence
Documentation evidencing the terms of the loan is essential. The Bersam Trust was criticised for not having documented the majority of loans it had received and, in some of those that had been documented, incorrect parties had been named.
As a minimum, the loan agreement should confirm who the lender and borrower are, the amount of the loan and term, whether interest is being paid and/or security being charged. Care should be taken to ensure that the agreement is signed by the correct parties on behalf of the charity. Requirements in this respect differ dependent upon the structure of the charity and, if security is being granted, additional content and signing requirements might apply as touched on below.
The charity must also be conscious of its structure when agreeing to the terms of a loan. Trustees of charitable trusts, for example, must enter into loan agreements personally on behalf of the charity (as such structures do not have separate personality from its trustees) and would be personally liable to repay the loan if the charity cannot. They may therefore want to limit the liability under the agreement to the assets of the charity. Whereas this should not be needed for a charitable company or a charitable incorporated organisation (CIO) as they can enter into the loan agreement in the company or CIO name.
Security and the Charity Commission
If the lending trustee requires security over land belonging to the charity, this will give rise to further issues for the charity to consider. As the mortgage would constitute a disposal of land to a connected person (the lending trustee), Charity Commission consent would be needed prior to the transaction due to the inherent conflict of interest. The Charity Commission has an online form that can be completed to request such consent within which it would need to be clearly shown why the granting of security and the proposed loan is in the charity's interests.
Before applying, the charity will need to be clear over whether there are any restrictions on the use of the land in question which might impact upon the type of application that would be needed to allow the charity to enter into the mortgage.
Prior to applying for such consent, the charity should also seek written advice from a financial expert addressing the suitability, affordability and risks of the mortgage. Often the expert in this case can be the charity's finance director albeit in more high risk scenarios it may be more appropriate to seek external advice or even a combination of advice from someone internally, who is familiar with the charity's financial position, and from an external adviser familiar with the lending market. A statement should later be included in the mortgage documents confirming that such advice has been sought.
It is important to bear in mind that it is the trustees of the charity in their personal capacity who must provide this statement. If the charity concerned is a company or CIO the mortgage document will need to be signed not only on behalf of the charity as an entity to agree to the mortgage terms but also by the individual directors/trustees to provide the requisite Charities Act statement. There are means of delegating the signing on behalf of all of the trustees to just two of them in this respect should it be too unwieldy for all of the trustees to individually sign.
The mortgage document should also confirm that the Commission has consented to the mortgage being entered into between connected parties. Any security should be registered with the Land Registry.
Applying for Charity Commission consent as early as possible is a must. It is important for a charity to be conscious of the length of time it can take to obtain Charity Commission consent and this must be factored into the charity's financial planning/cashflow situation.
Borrowing from a trustee gives rise to a host of issues for the charity to consider and if it involves giving security it will add a further dimension to the procedures that a charity must follow, not least the Charity Commission's involvement. Seeking legal and financial advice when navigating the above issues is key to protecting the charity.