Between a rock and a hard place

Between a rock and a hard place

 

When the going gets tough, the tough seek assistance from their professional advisors.  Or at least they should. In this final instalment of a series of articles looking at how the charitable and not-for-profit sector can survive ongoing economic difficulties, Stephen Goderski, Head of Advisory at PKF Littlejohn Accountants and Business Advisors takes a look at options available to Trustees when their organisations are failing or threatening to fail including what steps Trustees should take to demonstrate that they have acted in accordance with their fiduciary duties.

It happens.  Every business cannot succeed, there will always be a number of business failures resulting from misfortune, mismanagement or a combination of the two.  If it is going to happen to you let's try to ensure that you are on the misfortune side of the fence - as that means that no one is going to successfully attack your personal assets.

 

We have in the previous articles established that Trustees need to be on top of every aspect of their organisation's financial performance, including budgeting, and attuned to both their particular sector as well as those of their main donors.

 

Even assuming that these good habits have been followed diligently, organisations can still find themselves in financial difficulties.  So what should you, dear Trustee, do if you find yourself in such a place?

 

Firstly ascertain the scale of the problem, especially whether the organisation is insolvent.  Insolvency is defined on two bases - the balance sheet test and the section123 Insolvency Act 1986 test.

 

The balance sheet test is very simple - do liabilities exceed assets?  If they do, the organisation is insolvent. You will need to be realistic with assets values here, making justifiable provisions and obtaining property valuations where appropriate.

 

The section 123 Insolvency Act 1986 test is pretty straightforward too - can an organisation discharge its liabilities as and when they fall due?  That is when they contractually or statutorily fall due, not when you usually pay them. If the answer is no, the organisation is insolvent.

 

Insolvency has implications for Trustees.  For one, they need to act to either take the organisation out of its insolvent state (by cost cutting or introducing additional capital for example) or, if this is not possible, by ensuring that they minimise the loss to creditors.

 

How Trustees will be judged following a formal insolvency depends very much on their actions on discovering the insolvency and how they deal with it.  There is a test, which is what would a reasonable person do. Although this is necessarily subjective, it is something that the courts place great store upon so Trustees should exercise caution, take proper professional advice, act upon that advice and (and I cannot stress this enough) document their decisions and the reasons for taking them so that there is a contemporaneous record of why they acted as they did.  You can be certain that without such a record six months down the line no one will be able to remember why a particular decision was taken - just that it was not them that took it!

 

The reasonable persons test is actually a misnomer.  If the Trustee is, for example, an accountant, a lawyer, a successful entrepreneur or someone with a business related skill set, then the test is actually more stringently applied than it would be to a Trustee without such skills.

 

Focus

 

There is extremely unlikely to be just one solution which solves an organisation's problems.  Rather the solution will lie in a suite of remedies which will need to run concurrently and Trustee's should ensure that they focus on implementing all of them once they are agreed.

 

If the board is large a trouble-shooting sub-committee might be appropriate and individual members tasked with implementing each separate element of the overall strategy.

 

Cutting costs

 

Every piece of expenditure should be scrutinised and unnecessary extravagances, if they exist, are manna from heaven to the cost-cutter (I am thinking pool cars, first class business travel, staff bonuses, etc).  The reality is more likely to be sub-contractors, salaries or rent.

 

Sub-contractors are very much in the cost-cutter's front line, assuming their role can be carried out by someone else of course.  Salaries are harder to trim as there is often a catch 22 in that an organisation needs to make redundancies but does not have the money to make the redundancy payments.  Some good news if you are in that position; there is a government scheme which provides support to enable certain businesses to manage the cash flow impact of redundancies.

 

The Financial Assistance Scheme, operated by the Redundancy Payments Service, requires that certain criteria are met, as follows:

  • The organisation lacks the funds to meet statutory redundancy obligations

  • The organisation’s existing funders have declined to fund the redundancies

  • The action will save a significant number of jobs or secure the solvency of the business

  • The organisation will be able to repay the money within an agreed timeframe

Rent may also seem impossible to cut, especially if the organisation has entered into a lease.  My experience, however, is that a growing number of landlords will listen to reason, that reason being that if they do not either reduce the rent or agree to a variation of the terms of the lease (for example to reduce the floor space occupied to a more affordable level) they will lose a tenant.  This does tend to focus minds.

 

There are other possible options, including:

 

Property sharing with another organisation Outsourcing Merging with a similar organisation Convert restricted funding to unrestricted (with the agreement of the funder(s) of course)

 

There is not enough space here to discuss the pros and cons of these options, suffice to say that the greater warning a Trustee has of financial difficulties ahead, the greater their ability to plan and the larger the number of options they will enjoy.  At the end of the day therefore it all comes back to good governance.

 

Communication with key stakeholders

 

This is vitally important, especially if the organisation is insolvent or likely to become so.  People have long memories and any false or misleading statement will inevitable come back to haunt you.   The language you use in your dealings with stakeholders, especially creditors, therefore needs to be carefully considered.  By way of example, which of these two statements would find most favour with you?

 

"Hi, sorry we haven't been able to pay your last few months’ invoices.  Our funding has fallen off a cliff and we haven't been able to pay anyone for ages.  We're hoping it's just a blip and that we should be able to start making payments to you again sometime soon - touch wood and all that.  If you could just continue trading with us we'll let you know in the next month or so when we can pay you something."

 

Hi, I am just calling as we are going to have some difficulty paying your latest invoice on time; it's due in three weeks but I thought I would call you now to warn you.  We are speaking to our funders and hope to be able to secure sufficient funding to pay you on time but in case we do not we have a contingency which involves cost cutting and a more focussed purchasing policy to ensure that we do not incur any credit we cannot discharge going forward.  Obviously we hope that this is just an false alarm but we always plan for the worst so we hope that you will be happy to continue supplying us while we work our problems out."

 

No guarantees either way but I suspect I know which language you have decided is more appropriate.

 

And in message 2 there is a key point about not incurring credit which you cannot discharge.  Being open and honest with your suppliers, employees and funders is essential and might even produce some pleasant surprises  and support which you may not have thought possible in the circumstances.

 

You know this but but I will say it anyway, there is no substitute for independent professional advice and no contest between a Trustee facing severe financial difficulties for the first time in their lives against a professional who deals with such matters on a daily basis.   It also makes a huge difference to a board to be able to say that they have taken advice and are following it rather than just either burying their heads or making it up as they go along (please refer to the references to mismanagement in the opening paragraphs).

 

We certainly live in interesting times and the only thing economists agree on is that no one can predict where our economy is heading.  We are sailing into largely uncharted waters and if a little help is required in determining a safe course for your journey you would, I suggest, not be fulfilling your duty as a Trustee if you did not take it.

 

Stephen Goderski heads up the advisory division at PKF Littlejohn which incorporates restructuring and insolvency and is in his 34th year in the profession.

Tags: