Stephen Claus – Charity borrowing: Risks, responsibilities, and financial considerations

Charities are in many ways no different to businesses and in that context, from time-to-time, will wish to borrow money.  Borrowing can enable a project to be brought forwards, for example.  If that is right for the charity, then it is something the Trustees might be able to consider.  It may be that completing a project early will generate a larger income and if the repayments can be afforded, it makes good business sense.  Trustees are after all, meant to act as reasonable and prudent people of business.

Borrowing may be for property purchase or improvement, but it can also be for a range of other purposes.  Except with careful thought and advice, it is troubling if you are borrowing because you are in debt, unless there is a clear plan to move forwards and the borrowing is a prudent feature of that plan.  Some borrow to invest in new technology or to expand their offer to beneficiaries. This article is intended to be a broad view of borrowing and what to think about when considering financing.

So, is there such a thing as a typical charity or loan?

Absolutely not.  Charity is very diverse and serves society in a very large number of ways.  Some are very professionally run, others less so.  Some are big multi-million-pound businesses, others very small, often with an income of less than £10K.  A key question is whether the charity can demonstrate to potential lenders that it is sufficiently creditworthy and therefore good for the money.  All prudent lenders expect their money back.  Sometimes a philanthropic individual may loan the money to the charity.  Often their due diligence is more relaxed than a commercial lender.  However, you should always consider whether the borrowing is in the interests of the charity.  Charity applicants for loans will be treated to the same commercial considerations any lender will apply to any applicant by commercial sources.

In life, an applicant with a good, reliable job can often borrow more readily, whereas a person who is self-employed and subject to general trading restraints may find it more challenging to obtain borrowing, and certainly when just starting out.  Fixed interest loans are easier to assess than floating interest rates such as that with many mortgages, because if the economy becomes less buoyant then the cost of borrowing rises, so your ability to absorb variations is also very relevant.

So, a charity with a regular – and therefore predictable income, may be more attractive to a lender.  An Alms-house charity (a charity providing residential accommodation) that may wish to borrow for development or refurbishment of its property, may be more attractive to a commercial lender than a charity reliant on unpredictable grant income or fundraising, is a perfect example to make this point.

Commercial lenders will often look for security for the borrowing.  This is typically against assets owned by the charity; such assets go to prove you are creditworthy and this can also represent a lower interest rate as the lender is subject to less risk in such circumstances.  Please note any loan secured against property by way of legal charge must comply with the Charity Act when taking such a loan.

Any charity which has an unencumbered property or event investment portfolio, that is able to grant security over such assets to a lender may be able to reduce the cost of borrowing.

Just like a private borrower buying their first house, a charity, big or small, might use that asset to secure borrowing against it (a mortgage). In case of non-payment of the loan, the lender can repossess the property and sell it to recover the debt, only returning any surplus funds to the borrower if there are any.

Some considerations when thinking of borrowing

The first thing to think about is whether a charity has the power to borrow. Most charities have an express power to borrow and grant security in their governing document.  However older charity’s may not.  Although Halsbury’s Laws of England suggests a power to borrow is not strictly necessary, most lenders will insist on an express power to borrow and ask you to update your constitution.  These days, this can often be done without having to involve the Charity Commission.

Charity’s must be clear that borrowing is an effective means of furthering the charity’s objects and be able to demonstrate that.  All discussions should be carefully recorded so this is clear after the event.  Consideration should be, for example, given to the fact that assets used as security can limit what they can be used for.  Such restrictions are often referred to as “banking covenants.”  Often, and in fact usually, a lender will want a degree of control over assets used to preserve value and maybe accessibility, given those assets are now collateral for the loan.

So, is borrowing a risky thing to do?

Borrowing carries risk if there is no or late payment.  This risk will vary from charity-to-charity.  Generally speaking, while borrowing will enable expenditure which might otherwise be impossible, it almost certainly will increase outgoings with repayments of interest and capital. The returns on the investment may not be sufficient to repay the loan. This type of arrangement could leave the charity with a debt that cannot be repaid.

Financial forecasts and business plans must be available and considered when assessing affordability. If other forms of funding are available (e.g. grant funding), this may be a better and easier option, and in fact may be essential where no assets exist or are available to provide security to the lender.

If your charity has a permanent endowment, you may in fact be able to borrow from that endowment, usually on a recoupment basis, meaning the borrowed funds are repaid back into the endowment over time to restore its original value.  This area is complex, and you should consider taking advice.

Finally, if your charity seeks to observe an Environmental, Social, and Governance (ESG) policy, be aware that often a smaller institution, with whom you may be happy, will seek to syndicate larger loans.  This may not always comply with your ESG policy and people have been disappointed to discover this has happened after the event.  Finally, any secured borrowing requires compliance with the Charities Act 2011.

It is also worth considering the potential personal liabilities Trustees may carry. For instance, Trustees may be liable for paying unpaid debts.

This is only a summary of the law, and appropriate legal advice should always be taken before you act.

Please Note

There is no substitute for taking specific legal advice in respect of issues, and this note is only meant to be a general summary of the law and not legal advice.

These are the views of Stephen Claus and therefore do not constitute individual legal or financial advice. This article is for information only. If you require guidance or advice, please get in touch.

Ramsbottom office: Email enquiries@rosebridgeltd.com or call 01204 300010

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Leeds office: Email enquiriesleeds@rosebridgeltd.com or call 0113 243 7100

Or, click here to go to our Charities and Trusts page to read about our approach when it comes to guiding and advising Trustees.

The Financial Conduct Authority does not regulate trusts.

Stephen Claus

December 2024.