The Academies Financial Handbook is updated annually by the Department for Education and the Education and Skills Funding Agency; it contains a number of governance requirements for academy trusts.
“Reserves … would have been desirable …[but]… It is also important to note that there is no legal requirement for reserves”
“The decision to prioritise spending on charitable objects is one that, in my view, the trustees could reasonably reach”
“Most charities would, I would think, be delighted to have available to them individuals with the abilities and experience that the trustees in this case possess”
If the media had been asked to predict the key quotes from the ten-week trial that focussed around the charitable company Keeping Kids Company, known as Kids Company, it is unlikely they would have penned any of the above. However, those are the words of Justice Falk in her judgment and for trustees of charities throughout the country, they will have come as music to their ears.
The case was brought by the official receiver who sought disqualification orders under section 6 of the Company Directors Disqualification Act 1986 (CDDA 1986) against the seven trustees of Kids Company and its CEO. Re Keeping Kids Company (Official Receiver v Sunetra Atkinson & others)  EWHC 175 (Ch) (Official Receiver v Batmanghelidjh & Others).
Following the charity’s insolvent liquidation in August 2015 a lengthy investigation took place with the official receiver ultimately commencing proceedings against the trustees. The proceedings focused on the single allegation of ‘unfitness’, meaning that the defendants allowed Kids Company to operate an unsustainable business model. The case also considered whether the CEO, Ms Camila Batmanghelidjh, was a de facto director and as such should also be disqualified under section 6 of the CDDA 1986.
The legal test for disqualification
The test for disqualification under section 6 of the CDDA 1986, in addition to the principle of protecting the public under section 7(1) CDDA, contains two stages to satisfy:
- an allegation or allegations about the defendant’s conduct must be proved; and
- the court must be satisfied that the conduct complained of, insofar as it has been proved, justifies a finding of unfitness. In the context of a case based on allegations of incompetence, this means demonstrating incompetence of a 'high degree'.
Justice Falk found that the single allegation of ‘unfitness’ had not been made against the trustees and, therefore, no disqualification orders were made.
Kids Company began in 1997 as a company limited by guarantee before gaining charitable status the subsequent year. The charity worked with some of the most vulnerable children and young people in the UK through several centres primarily in London but also in Bristol.
As Kids Company was both a company and a charity, its trustees were both charity trustees and company directors. This means that they were subject to the fiduciary duties of charity trustees and directors’ statutory duties under the Companies Act 2006 (the Act). The judgment comments on directors’ statutory duties, although analogies can be drawn with trustees’ fiduciary duties which are very similar.
There are seven general directors’ duties under sections 171 to 177 of the Act, and the case touched but did not hinge on, those in sections 172, 173 and 174, namely:
- to promote the success of the company and act in good faith;
- exercise independent judgment; and
- to exercise reasonable care, skill and diligence.
How did the trustees demonstrate that they had fulfilled their duties?
Whilst there was no finding in the case as to whether the trustees had fulfilled their duties as directors, Justice Falk praised the trustees saying that:
“Most charities would, I would think, be delighted to have available to them individuals with the abilities and experience that the Trustees in this case possess.”
Also, throughout the judgment are practical examples of how the trustees sought to ensure the best outcome for Kids Company and to manage the risks, highlighting that:
- The trustees and sub-committees met regularly (often monthly)
- There were several external independent reviews of the charity’s financial management and governance
- The trustees were appropriately skilled and held relevant expertise which could be applied to the charity’s needs and where necessary, this expertise was suitably relied upon
- The trustees regularly sought legal and financial advice
- The charity had stringent and appropriate policies relating to finance and governance
- The trustees held reasonable expectations of their voluntary responsibilities in comparison to paid members of staff
- The trustees understood the purpose of statutory accounts being fair and balanced
- The CEO’s job description clearly set out her managerial responsibilities in addition to the board’s overall control
- The board recognised the financial difficulties of the charity and took steps to improve its stability
- There was communication between the senior management team, the CEO and board of trustees despite disagreements
Charity trustees should take comfort from the above examples. They demonstrate that they are not required (despite what the media might say) to be infallible and even where a charity must close this does not mean they have failed in fulfilling their duties.
Questions were raised in the case as to whether the trustees did ‘too little too late’ in terms of addressing the financial stability of the charity. It was highlighted that there was the difficult balancing of the CEO’s drive for prioritising the needs of children and the expansion of the charity with stagnant government funding and private donor fatigue.
Justice Falk also highlighted that the context of Kids Company being a charity was an important one. Although the charity had virtually no financial reserves (at the time of it ceasing to operate in 2015 the charity's most recent accounts showed free reserves of £434,000 - less than a week's expenditure), Justice Falk was keen to point out that the business model of the charity could not be described as ‘unsustainable’. Having 17 years of success and with a mantra of “never turning a child in need away,” it meant that the needs of children came first and the financing of this often came second.
Interestingly she said in the judgment:
“reserves in the form of liquid resources would have been desirable, and there is some validity in a criticism of their absence but creating them was much easier said than done. It is also important to note that there is no legal requirement for reserves, and their absence did not prevent unqualified audit opinions being provided. Creating reserves would have involved diverting resources from meeting the increasing level of need that the charity existed to serve. The decision to prioritise spending on charitable objects is one that, in my view, the trustees could reasonably reach”.
Given that a lot of media criticism in 2015 focussed around Kids Company’s lack of reserves, this is a key point for all charity trustees to note – reserves are “desirable” but “there is no legal requirement for reserves”.
The expenditure on children was also criticised by the official receiver, who argued that the level of trustee scrutiny was inadequate and poorly recorded. Justice Falk disagreed and found that the trustees exercised regular scrutiny of costs and (importantly) as volunteers could not be expected to oversee the spending on every single child which numbered tens of thousands a year. Instead, Justice Falk was critical of the official receiver’s focus on this rather minor point, to which one report totalled some 5,400 pages of exhibits on individual children’s costs alone.
It was highlighted that both the 2012 and 2013 statutory accounts showed positive net current assets and that the trustees were correct in approving these accounts following auditors confirming that there were no significant concerns. Further, the trustees were said to have appropriately relied upon the particular expertise of one trustee, Ms Hamilton, who was a qualified senior accountant.
Further, Kids Company was subject to allegations of sexual abuse in 2015 (found to be unsubstantiated) which had a significant impact on the funding of the charity. Justice Falk did not agree with the official receiver’s assertion that “if it had appropriate reserves, Kids Company would have been able to survive notwithstanding the unfounded allegations”.
CEO dominance v trustee control
A person may be held to be a de facto director without a valid appointment where they have assumed responsibility by participating in the decision making of the company. (Whilst not covered by this case, it is also worth noting that a person may be deemed to be a charity trustee, although not appointed as one if, in accordance with the definition of ‘charity trustees’ in section 177 of the Charities Act 2011, they have “the general control and management of the administration of a charity”.)
The question, in this case, was whether the CEO, Ms Batmanghelidjh, inappropriately had control of the charity and was a de facto director?
Justice Falk dismissed these allegations and stated that the CEO was not a de facto director. Ms Batmanghelidjh as CEO (and the only paid defendant,) “did have a central role, including in developing strategy, but she was subject to supervision and control by the Trustees.” The trustees were all voluntary with some dedicating 1-2 days a week to the charity showing their commitment to its aims. Indeed, whilst there was a general delegation of administration and management to Ms Batmanghelidjh under her employment contract, it was noted that the charity’s policies provided that the board held overall responsibility. Justice Falk also commented that the board’s “duty of supervision was clearly recognised”.
The case illustrates well the tension between the role of a fulltime paid CEO of a large charity and the role of its board as voluntary trustees/directors. While implementing cuts to the charity were met with serious resistance from Ms Batmanghelidjh, these were dealt with cautiously by the trustees who recognised the importance of her role and her extraordinary contribution to the charity. A change in Ms Batmanghelidjh’s role was discussed by the trustees in late 2014 (and as early as 2012) who agreed that she should not remain as CEO permanently but in the interim, given that it was in the charity’s best interests. There was also difficulty recruiting someone willing to take on the role due to the lack of stable funding along with the loss of most of the charity’s senior management team.
The point was made that overall the relationship between the trustees and the CEO was “very good” and while Ms Batmanghelidjh may have had a strong personality, it was arguably necessary for a such a role and the trustees attested to not feeling unable to challenge her.
As it was held that Ms Batmanghelidjh was not a de facto director, no disqualification order was made against her.
Justice Falk stated in her judgment that for the charity sector to thrive, “it is vital that the actions of public bodies do not have the effect of dissuading able and experienced individuals from becoming or remaining charity trustees.” The board of Kids Company were highly experienced individuals, with backgrounds in business, law, accounting and media and Justice Falk praised their devotion to the charity throughout. Ms Batmanghelidjh had established a charity that became well respected across communities in London and highly regarded by senior politicians.
Conversely, Justice Falk was critical of the official receiver’s actions and she said: “disqualification proceedings, or the perceived risk of them, based on wide-ranging but unclear allegations of incompetence rather than any want of probity, carry a high risk of having just that effect [dissuading able and experienced individuals from becoming or remaining charity trustees], and great caution is therefore required.”
Reference was also made to the longstanding position of the court in taking a “benevolent approach to charity trustees in circumstances where (as here) no dishonesty or wilful misconduct is alleged.”
This judgment is a breath of fresh air and goes a long way in supporting the actions of trustees who carry out their duties with due care and diligence and dedicate long periods of their time to voluntary services.
For more information
For advice or training concerning the duties and responsibilities of charity trustees/directors or any advice about the governance of charities, please contact Edwina Turner or your usual ACS contact.
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