When Charities Face Insolvency: What Duties do Trustees Have?

Charities across the UK are operating in an exceptionally challenging environment. Rising demand for services, escalating costs, and public funding that has failed to keep pace have placed significant strain on the sector. Many organisations now face difficult decisions about how to sustain operations while continuing to deliver on their charitable purposes.

Charity trustees have core legal duties that stem from statute. These general duties vary slightly between Scotland and England & Wales but across both jurisdictions, the primary duty is to act in the best interests of the charity and its beneficiaries. Most trustees will be familiar with these general duties.

When financial distress arises, the duties become more complicated. The precise obligations depend not only on the charity’s legal structure—whether it is an unincorporated association, charitable trust, or charitable company—but also on the extent of the financial difficulties faced.

Both the Office of the Scottish Charity Regulator (OSCR) and the Charity Commission for England & Wales have issued guidance to help trustees navigate these challenges. In summary, trustees are expected to:

• Regularly monitor the charity’s finances to identity if it is insolvent or at risk of insolvency;
• Seek professional advice early;
• When the trustees know, or ought to know, that there is no reasonable prospect of avoiding insolvency, they must take every step necessary to minimise the potential loss to creditors;
• If the charity is to be wound up, ensure the procedures follow the charity’s governing document as well as statutory requirements.

Failure to act appropriately can expose trustees to regulatory or personal consequences. Both OSCR and the Charity Commission have powers to investigate potential misconduct or mismanagement, which may lead to trustees being removed or disqualified. In more serious cases, trustees could face legal action for breach of trust, resulting in personal liability. It is important to review the charity’s constitution for any indemnity provisions and to confirm whether trustee indemnity insurance is in place.

If a charity is an unincorporated association, it does not have a separate legal personality. That means that the individual trustees could be liable for the charity’s debts if they cannot be met by its assets. Again, the charity’s constitution should be checked for any apportionment of liabilities.

Additional Duties where the Charity is a Company

Where a charity operates as a company, its trustees will also be company directors. In that dual capacity, they have duties under the Companies Act 2006 and, when insolvency is in prospect, under the Insolvency Act 1986.

Companies Act: the Creditor Duty

Directors have general duties set out in the Companies Act 2006, including the core duty to promote the success of the company for the benefit of its shareholders. However, if a company reaches the point where insolvency is “probable”, the creditor duty is triggered and directors/trustees must start to give weight to the interests of the company's creditors over its shareholders. This could mean avoiding incurring liabilities or paying out funds if it might worsen the creditors’ prospects of recovery.

Probable insolvency can occur much earlier than actual or imminent insolvency and earlier than the trigger for wrongful trading mentioned below. It’s important that trustees seek advice if there are any concerns about being in the zone of probable insolvency.

Insolvency Act Provisions:

The key provision for directors/trustees to avoid under the Insolvency Act 1986 is wrongful trading. This is continuing to trade (incur liabilities) when the directors know or ought to know that the there is no reasonable prospect of avoiding insolvent liquidation or administration.

There is also the more serious fraudulent trading which involves an intent to defraud creditors and misfeasance which is a director misapplying or retaining money or assets belonging to the company/charity.

It can be possible to continue to trade when in the zone of wrongful trading provided it can be shown that the directors took “every step” to minimise potential loss to creditors. It is crucial that any directors or trustees operating in these circumstances seeks specialist insolvency advice.

Once a charitable company does enter an insolvency process, the appointed insolvency practitioners will review trustee/director conduct in the run up to the appointment closely, assessing whether financial decisions potentially worsened creditor losses or diverted charitable assets. If a trustee is deemed to have breached the rules, they can be found personally liable for the losses.

The Practical Overlap between Charity and Company Law Duties

The dual role of trustee–director can be complex. Charity law focuses on furthering charitable purposes and protecting assets; company law focuses on protecting the shareholders’ interests; and then when in the zone of insolvency, company and insolvency law focuses on creditor protection. Trustees must recognise that when insolvency becomes at least probable, the creditors’ interests start to take precedence. Failing to adjust decision-making accordingly risks breaches and personal liability.

For many charities, financial distress has become an enduring feature of the operating landscape. While trustees cannot control wider economic forces, they can control how they respond. Early recognition of financial challenges, seeking professional advice at an early stage, and maintaining clear records of prudent decision-making are essential to fulfilling trustees’ legal duties and protecting against personal exposure. When insolvency risk arises, it’s more important than ever for trustees to be aware of and act in accordance with their duties – to preserve value and to prioritise creditors’ interests when necessary.