Contributors
On 12 February 2021 the High Court delivered its verdict on "Kids Company" – technically The Official Receiver v Atkinson & Ors.
The case considered the possibility of director disqualification orders being made against trustees of the insolvent charity Kids Company, and whether the charity's Chief Executive Officer should be classed as a "de facto" director, and also disqualified.
Background to the Kids Company case – a reminder
Kids Company entered into insolvent liquidation in August 2015, having grown substantially since 1996. Kids Company was incorporated as a company limited by guarantee. Its trustees also acted as company directors, and were therefore subject to duties under both charity and company law. They were also subject to the insolvency law regime as it applies to companies.
The case against the CEO and trustees
The Official Receiver's case (brought under the Company Directors Disqualification Act 1986) was that the CEO and trustees "caused and/or allowed Kids Company to operate an unsustainable business model" and should be disqualified from acting as directors or being involved in the management of a company.
The case focussed on allegations around the sustainability of Kids Company’s "demand-led" model of “never turning a child in need away”, as well as inadequate financial governance, failing to build up reserves, and failing to plan for increasing risk as the charity grew substantially.
While Ms Batmanghelidjh was CEO of the charity and not formally appointed as a trustee/director, the Official Receiver sought to establish that given her prominent role in the charity and given her influence over decision making, she was in fact a "de facto” director, and sought a disqualification order against her in addition to the trustees.
CEO was not a "de facto" director
Under company law, a “director” is anyone formally appointed as such but can also include “any person occupying the position of a director, by whatever name called".
Like many charity CEOs, Ms Batmanghelidjh attended trustee board meetings and will have taken part in the debate and made recommendations to the trustees, she entered into significant transactions on behalf of the charity and played a leading and central role in its operation.
Despite this, the court decided in this case that the CEO was not a de facto director. The court found that Ms Batmanghelidjh had a "significant degree" of delegated authority from the trustees, which she may have even exceeded. However, on the evidence, the court concluded that she was at all times still subject to the trustees' supervision and authority.
The judgment explains that, when determining whether a person is a "de facto" company director, the court will take into account "all relevant factors and look at the matter in the round". In Kids Company, the court therefore conducted a detailed analysis of Ms Batmanghelidjh's role and actions as CEO, and how this related to the Board of trustees.
The court gave express reassurance to trustees on the ability to delegate authority to executive management. From reading the judgment, charities looking to avoid risk in this area should ensure that the decision-making structures between the Board of trustees and the executive are clear, appropriate and, importantly, properly followed.
Charities which are limited companies – a benevolent approach
The court decided that, based on the facts of the case, the conduct of the trustees did not make them unfit to be concerned in the management of a company. This decision is significant for the sector. It may even be a relief to trustees of charitable companies and others in the sector.
The court confirmed the position that trustees of charitable companies are subject to the same duties as directors of other types of companies. However, the court also found that this did not mean that the fact of this being a charitable company should be ignored. It said that the trustees' conduct must be looked at "in the context" of a charity. The court's position was that conduct which might merit a finding of unfitness in a director of a commercial company would not necessarily lead to the same conclusion in a charitable company.
Previous cases have taken a similar approach to charity trustees if mistakes are honest, and there has been no wilful misapplication of the funds of the charity. However, there is always a spectrum of responsibility and that can range from wilful poor practice, to passive acceptance of a poor or deteriorating set of circumstances.
The court was keen to highlight the risk to the sector of discouraging people from volunteering to act as a trustee. There is clearly goodwill towards volunteer charity trustees who are faced with the increasing demands of a compliance driven sector, whilst operating in a non-executive model. In the event of an allegation against a trustee of unfitness to act as a director, the court will assess the individual conduct of the trustees and the role they played, in the context of factors such as the nature of the charity and its activities. It seems it may not matter as much about the level of skill, experience or knowledge of the trustee in question, but more about the conduct of them in their management and oversight of the charity.
Charities operating with "demand-led" models
The charity's "demand-led" model of “never turning a child in need away” created a situation where the charity committed financially to helping its beneficiaries and then looked to find the funds to cover the costs of this.
Although this meant an obvious and continuing risk to the financial solvency and management of the charity, the court felt that the demand-led model should not be criticised on the facts of this case.
What the court found important was that the trustees understood the risks, were satisfied sufficient funds could be raised to cover financial commitments as they arose and that the charity had managed to get through previous years of raising additional funds needed to meet increased demand.
This is very interesting and demonstrates that taking a risk–based approach to financial planning may be acceptable, notwithstanding the duty to ensure that the charity is solvent and able to deliver its charitable mission.
Charity reserves
Level of reserves (or not) was part of the Official Receiver's case against the trustees.
In this case, the court found some validity in the criticism that Kids Company was operating without reserves. However, it was found to be reasonable for the trustees to prioritise spending on the charity's purposes.
The court also went on to say that even if Kids Company had built up reserves equivalent to three months of operating expenditure, this would still have been short of what was required to see it through financial difficulties experienced following an investigation by the Metropolitan Police into allegations of sexual misconduct involving the charity, notified to it shortly before it entered into insolvency.
What happens next?
The Official Receiver has said that it will consider the judgment before deciding whether to appeal.
In the Official Receiver's case, the judge pointed to the standards and enforcement powers of the Charity Commission and that it was the regulator with the "most appropriate expertise".
The Commission's separate statutory inquiry into Kids Company was opened back in 2015 but was put on hold while this case concluded. The inquiry will address concerns about the administration, governance and financial management of the charity. We await its outcome and will publish a further update in due course.
Commentary
The judgement was long-awaited. This case was one of the most high-profile cases of its type in a very long time.
Despite the sympathy generally shown towards charity trustees who act as volunteers and whom the law requires act reasonably and in accordance with their duties, in our view, the judgement is still unexpected. This is not though only because of its outcome, but is due to its commentary in relation to the decision-making of the trustees (re reserves, financial commitments and conduct of trustees) and their approach to the charity's financial management.
The decision may also be a surprise in relation to finding that the figurehead of the charity, Ms Batmanghelidjh, was not acting as a de facto director, even though she had a significant amount of authority. Despite this autonomy, the court found she had the oversight of her Board. Query whether they held her to account sufficiently, and this may be a lesson for other charity Boards in the way in which they interact with and manage their CEOs.
What will be interesting is to see what the Charity Commission does next. The Commission has focused a lot of energy and effort in the last few years in reinforcing the importance of adequate trustee oversight, particularly in larger charities with complex operations. The Commission may of course take a different approach, and there have been suggestions in the sector media that while it will publish an inquiry report setting out findings and conclusions, the Commission does not intend to take regulatory action against the trustees. Whatever happens, this will be a landmark outcome for all charities and their trustees.
