What happens when a charity becomes insolvent?

We take a look at what running insolvent means, and what charities can do to avoid it in the first place

It’s become clear that charities were not flushed for cash before the pandemic. But increased demand, while trying to adapt to changing working conditions, decreased donations, and the cancellation of physical fundraising events have had a significant impact on funding streams.  

Bills might have started to pile up, and debts go unpaid for months on end. 

At what point however, are charities (legally) required to declare insolvency and shut their doors for good? And are there any preventative measures that can be taken before getting to that point? 

We take a look.  

So what does it mean to be insolvent?   

Put simply, a charity is insolvent if it cannot pay its debts as and when they become due and payable.

Insolvency is determined by looking at the financial position of an organisation as a whole. So if a charity has experienced an irregular shortage of cash it doesn’t mean it’s insolvent. For example, if a charity has lost income, but there is enough money to cover its debts, then it’s not insolvent.   

An organisation unable to pay its debts as and when they become due, an organisation that has overdue taxes that it can’t pay, an organisation that is operating at a loss for several months, or an organisation unable to pay for goods it has received, could be operating insolvent. 

Is there anything that can be done before a charity gets to the point of insolvency? 

Yes, but it needs to be nipped in the bud early on. 

According to Murray Baird, principal of Murray Baird Advisory and former assistant commissioner of the Australian Charities and Not-for-profits Commission (ACNC), it’s up to the charity’s board to be constantly monitoring whether or not the organisation has enough resources to meet its responsibilities. 

He said boards needed to keep an especially close eye on the financial reserves needed to see the organisation through and out the other side of the pandemic.        

“If they get to the point where they have suspicions or doubts about that, their responsibility is to get professional advice on whether they are solvent or not,” Baird told Pro Bono News. 

And while the board is predominantly in charge of driving this process, Dr Matthew Turnour, the chair of Neumann and Turnour Lawyers, said it was critical that the board and executive team were communicating effectively during this time. 

“The relationship between the board and the executive is a critical relationship in any circumstances… but the context of insolvency simply heightens the need for that relationship to work better,” Turnour told Pro Bono News. 

He also said that if a charity was reliant on government or philanthropic funding (which most are) communicating difficulties early enough could be the thing that saves an organisation. 

“If government, philanthropists, or members are told well enough in advance that there are challenges, sometimes things can be fixed… but you can’t suddenly spring it on members, philanthropists or government and say, ‘hey, we need $1 million’,” he said.  

Has anything changed because of COVID-19? 

Slightly. Back in May, the ACNC said that in response to the COVID-19 pandemic, the commission’s approach to its Governance Standard Five (requiring a charity’s responsible people to ensure the charity does not operate while insolvent) had been aligned with the amendments made to the  Corporations Act 2001 by the Coronavirus Economic Response Package Omnibus Act 2020.

Baird explained that this means if charities get into a dire financial situation during the pandemic, but believe they can find their way out post-COVID, the regulator is going to give slightly more leeway. 

Something to keep in mind however is whether or not that will stand up against creditors who are owed money. 

And what happens if you leave it too late? 

If professional help isn’t called in early enough to check whether or not the organisation can be saved, the board becomes personally liable for the charity’s debts.  

If the charity is found to be running insolvent, the easiest way to deal with the issue is to appoint a liquidator or administrator to manage the charity. In some cases, if a charity is insolvent it must be wound up. 

There is also the option to merge with another charity, but that needs to be done early on in the piece because it’s unlikely another organisation will want to take on massive amounts of debt.  

If a charity is insolvent and has not acted to appoint an official person to do so, a court may order that the charity be wound up. 

The charity will also need to have its ACNC registration revoked.  

The process of winding up a charity is a whole other issue, but more information can be found on what exactly is required here. 

If your charity is in serious financial trouble, please seek the help of a lawyer. While this article offers a basic run-down of the issue, the contents are not intended to be a substitute for legal advice and should not be relied upon as such. It’s important to seek expert advice if you really need it. 

There are also some really handy (and free) resources that can be accessed here: 

The ACNC: Insolvency

Justice Connect’s NFP Law: Insolvency and your organisation

Justice Connect’s NFP Law: Changing or ending your organisation