In the absence of a steady income stream from fundraising or trading during the coronavirus pandemic, it has been necessary for the trustees and executive boards of many charities to see what funds a charity may already have available to allow it to carry out activities in pursuit of its charitable Objects, even if some of those funds may previously have been earmarked for other purposes, or long term plans.
While it now appears that the UK may be over the worst of the coronavirus pandemic in some respects, and as the Government tries to find ways to ease the country safely back to some kind of normality, it is clear that the financial situation of many charities is not going to ease significantly any time soon.
Social distancing of one kind or another is likely to be in place for some time, hindering traditional fundraising events, as well as reducing footfall on the high street for those charities with shops that normally generate income.
So, this article looks at the types of funds charities might have available to use, how charities can avoid creating restrictive funds in the course of their fundraising, the need to expect greater scrutiny of expenditure from funds subject to restrictions, and the consequences for trustees of incorrectly using restricted funds.
Different pots of money, different names… but which are available to use?
Charities often have many different “pots” of money and, when considering what funds are available to a charity in financial difficulties, the key question to consider is: is the fund in question “restricted”?
How can a restricted fund be identified?
An “unrestricted fund” is a fund that is available for general use for all or any of the charity’s purposes. A “restricted fund” is a fund that, as the name suggests, is subject to restrictions on its use to limit how it can be applied by the charity – and to be formally “restricted”, the restriction on a fund must have been imposed by the fund’s donor or donors.
Such funds may have been:
- a gift by an individual that specified the purpose for which it was spent, or
- it may have been raised as part of an appeal for a particular project the charity was working on, such as the construction of a new building, or
- received from a funder as a grant to carry out specific charitable activities, for example.
It will be necessary to look back at the donation agreement or deed of gift, appeal documents or grant agreement in relation to funds to check whether those funds are restricted.
If a fund is restricted, the trustees must ensure that it is used only for the purpose for which it was donated or raised.
It may sometimes be possible to amend the restrictions to access or release the funds, but professional advice would be needed to see if this is possible in any particular case, and the Commission’s recent guidance suggests that such a strategy should be considered only if no other options for accessing funds are available.
I’ve heard our charity might have “permanent endowment”. What is that, and can we spend it…?
Permanent endowment is a kind of restricted capital fund, which can come in two forms:
- investment permanent endowment, where the income from the fund is expendable at the discretion of the trustees, but the capital is not available for direct application towards the activities of the charity, and
- functional permanent endowment, which is a capital asset, such as land, that can only be used for the specific purposes of the charity holding it – such a land held by an educational charity to provide a school for its beneficiaries.
Whether permanent endowment can be accessed and spent very much depends on the type of endowment being held.
The Charities Act 2011 provided a statutory power for the expenditure of permanent endowment, but how these provisions operate varies depending on the size and assets of the charity seeking to rely on them, and the provisions can in any case only usually be of assistance to trustees in relation to investment permanent endowment.
The Commission is of the opinion that it would be “unlikely that trustees will be able to use the powers to spend functional permanent endowment in its entirety”, as the sale of such property would have the effect of defeating the charity’s Objects, and require a change of the charity’s purpose.
Where the statutory power is not available to trustees, the Commission’s involvement will generally be necessary to authorise the expenditure of any permanent endowment.
What about funds earmarked for certain projects by the trustees? Are they restricted?
Funds that have been earmarked for a particular project by the trustees, but are not subject to any restrictions imposed by the donors, are not formally “restricted” funds.
They are usually called “designated” funds, and if the trustees decide that it is in the best interests of the charity to bring such funds back into general use by the charity, taking into account all relevant factors, they are able to do so.
What about reserves? Can they be used?
Reserves are not restricted funds. They are funds kept aside to protect the charity against drops in income, or sometimes to allow it to make the most of new opportunities, but they can be spent on any of the charity’s aims. They are, in effect, funds held for the charity in case of a “rainy day”.
Given that it is, metaphorically, pouring out there at the moment, it is exactly the time for trustees to be considering whether it might be necessary to use some of the charity’s reserves.
If, however, your charity’s reserves are held as investments, you will need to consider also whether it is in the charity’s best interest to realise these at this stage, given the likely loss of value as a result of the current state of the financial markets.
How can we avoid creating more restricted funds through fundraising appeals?
If you are thinking restricted funds sound like they can be more trouble than they are worth, you would not be alone. Research by nfpSynergy in 2018 suggested that the average charity would trade a £1 million restricted grant to get just half as much unrestricted income!
When fundraising, many charities wish to avoid creating new restricted funds, to allow greatest flexibility when deciding how to achieve the charity’s Objects.
Therefore, great care must be taken in preparing fundraising appeal literature. While it is important for a charity appeal to be specific so that potential donors have a clear idea as to how their donation will be used, when a charity raises funds by means of an appeal for a particular purpose, all funds raised for that purpose must be used for that purpose.
So, charities need to think carefully when phrasing their fundraising appeals to avoid creating unnecessarily restrictive “restricted funds”.
A charity wishing to avoid any risk of a restricted fund should campaign simply to raise funds for the charity’s general purposes. It is still possible in a fundraising campaign, with the right wording, to highlight particular activities the charity carries out in pursuit of its charitable Objects without restricting the charity to spending funds raised from that campaign only on those activities.
If, however, a charity wishes to raise funds for a particular stated purpose, even though they will then be restricted to using the funds raised for that purpose, perhaps because they think they will get a better response from the general public to a very focused request, it should take care to phrase the fundraising appeal literature to avoid the appeal inadvertently “failing”.
Sometimes an appeal may fail because it is for a specific charitable purpose that is no longer needed, or cannot be carried out. An appeal may also fail if:
- money in excess of the sum stated to be required for the intended purpose is raised, and the charity has not made clear in its fundraising appeal literature what will happen to such surplus funding; or
- insufficient funds have been raised to achieve the intended purpose set out in the fundraising appeal literature by the charity, and the charity has not made clear what will happen to the smaller amount of funds raised if the appeal should fail to raise the desired funds.
If an appeal fails, the charity will need to return unused, surplus or insufficient funds to donors, or to request assistance from the Charity Commission in applying the funds (which request may or may not be successful).
The easiest way to avoid these problems is to ensure that any fundraising appeal literature always includes a broader secondary purpose for any funds raised in response to the appeal.
Finally, for charities planning an appeal, the Fundraising Regulator has recently published guidance on the practicalities of setting up fundraising appeals.
What happens if a restricted fund is used to fund the general charitable purposes of a charity?
Trustees have a duty to manage their charity’s funds properly. This means that, amongst other things, they must know which of their charity’s funds are restricted funds, and ensure those funds are only applied in accordance with the restrictions placed on the funds by the funds’ respective donors.
Failure to do so is likely to result in a breach of trust as well as that trustees’ duty, and may in some circumstances result in the trustees’ incurring personal liability for the consequences of the breach.
The Charity Commission has recently issued new guidance to independent examiners “Guidance for Independent Examiners during Covid-19 or in a time of national emergency” which emphasises that independent examiners will need to be alert to the risk of restricted funds being used incorrectly, and take care to ensure this is not happening.
This shows that, although the Commission is well aware that charities are under financial pressure at present, it is also alert to the risk of charities incorrectly using restricted funds during the pandemic – and reinforces the need for trustees to manage their charity’s funds properly, even if their charity is facing financial difficulties.