Page1 Scots Law Times 2011 The bonfire of the charities - winding up unregistered entities Derek Francis Roger Laville Subject: Charities. Other related subjects: Insolvency Keywords: Administration orders; Inherent jurisdiction; Registered charities; Royal Charters; Scotland *S.L.T. 63 The authors discuss the contexts in, and principles upon, which the courts admit administration proceedings of entities which differ widely from registered companies. It is an accompaniment of the interesting times in which we live that there appears to be a small but growing number of not for profit entities which is plumbing the depths of absolute insolvency. Typically, these are charities, but they need not necessarily be. A common feature is, however, that they are controlled by volunteer directors or other office bearers who, quite understandably, have no stomach for exposing themselves to the risk of running ever deeper into insolvency and who lack the optimism, borne of perceived self-interest, which makes many directors of commercial concerns mistake for light at the end of the tunnel what is really an approaching train. They want to get out. But the question arises: how do you put an end to the concern? Or, how do you save what is worth saving by administration or whatever? The answer depends on the nature of the entity. It comes readily to hand if, for example, you are dealing with a company limited by guarantee. But as soon as you leave the straight and narrow paths of Companies Acts entities and venture on the byways of incorporation by charter and the law relating to friendly societies, the answer is not so easily got -- and it can be far from straightforward. Can you wind up the entity under the Insolvency Act 1986 (“the 1986 Act”)? Does the court have jurisdiction -- and what jurisdiction -- to wind it up or place it in administration? Whilst charitable companies incorporated by Royal Charter are the context for, or at any rate a leitmotif running through, this article, readers may find the article of more general interest and/or use as an exploration of some of the more unusual contexts in, and principles upon, which the courts admit winding up/administration proceedings of entities which differ widely from the usual registered company. Companies limited by Royal Charter The fact that chartered companies are such a familiar part of the public/charitable trust landscape might at first blush suggest that the way in which such entities are brought to an end would be clear. In one sense that is so. Just as the granting of a Royal Charter establishing a chartered company is an aspect of the prerogative, so one might expect that its surrender would be. And such is, indeed, the position. There is a well established procedure whereby the Charter may be surrendered by petition to the Privy Council. The effect of the granting of such an application is the equivalent, if you will, of the dissolution of a company incorporated under the Companies Acts. It is the writers' understanding, however, that the Privy Council expects that before such an application is made the winding up of the corporation will be concluded. It is obvious why: if the entity were simply dissolved its liabilities would go unadministered and its assets fall to the Crown as bona vacantia. In the ordinary case of a registered company incorporated under the Companies Acts, the procedure of winding up tends to obscure the separate steps of winding up and dissolution. That is particularly so in view of the fact that there is no longer any court order for dissolution, which instead occurs automatically after the expiry of three months from the Registrar of Companies' receipt of statutory notice: see the 1986 Act, s.205. Page2 Is an application to the court required? It is not unknown for the constitution of such an entity to include powers which on their face might, at least as a matter of language, appear wide enough so as to be capable of being exercised to enable the winding up of the entity. A degree of caution is required in arriving at such a conclusion, because such powers are likely to be fiduciary powers. Thus it would not be surprising to find that it is implicit that they are exercisable only for the ends of the entity as a going concern. And even if one could conclude that there were powers which entitle those having control of the entity to take steps to pay its creditors with a view to what amounted to an informal winding up and to eventual dissolution, they would do well to be wary of adopting that course where the entity is absolutely insolvent. Generally speaking the director (by whatever name called) of an absolutely insolvent entity which is not a registered company who finds himself in the absolute insolvency hole is well *S.L.T. 64 advised to stop digging. In both English and Scots law the provisions of the 1986 Act relating to misfeasance etc and wrongful trading need to be considered. Whilst these occur (as ss.212 and 214) in Pt IV of the 1986 Act, s.229 appears to extend the powers which are conferred upon the liquidator and the court to unregistered Pt V companies. In Scots law there is also the common law principle (Bell, Commentaries, Ch.II, Pt I, Book VI) that a person who knows that he is absolutely insolvent is in a position analogous to that of a trustee for his creditors. No doubt that applies with equal force to a company by Charter. As Lord President Emslie was at pains to stress in Nordic Travel Ltd v Scotprint Ltd, 1980 S.C. 1; 1980 S.L.T. 189 at p.10 (p.193), this is not to be taken too literally; for example, payments of debts subsisting and prestable in ordinary course of business cannot be challenged, even though the recipient knows of the insolvency. But as is discussed, ibid, persons who sought to use their powers informally to wind up the affairs of some entity could find themselves under a peculiar obligation to refrain from procuring it to make voluntary dispositions and to refrain from giving preferences which could be regarded as fraudulent. The observations in Nordic Travel follow a long line of authority, including What mough's Trustee v British Linen Bank, 1934 S.C. (H.L.) 51; 1934 S.L.T. 392. Understood with the Lord President's warnings against taking too literally the trustee analogy, there are echoes of this in English and Commonwealth cases too: see Liquidator of West Mercia Safetywear Ltd v Dodd [1988] B.C.C. 30, an appeal in a misfeasance application under what is now s.212 of the 1986 Act, per Dillon LJ at p.33, under reference to Street CJ in Kinsela v Russell Kinsela Pty Ltd (in liq) [1986] 4 N.S.W.L.R. 722, at p.730; (1986) 4 A.C.L.C. 215, at p.221 (“It [the absolutely insolvent company's estate] is in a practical sense [the creditors'] assets and not the shareholders' assets that, through the medium of the company, are under the management of the directors pending either liquidation, return to solvency.”) As if these were not problems enough, in Scotland the consent of Office of the Scottish Charities Regulator (“OSCR”) appears to be required before such informal winding up could take place. Section 16(2) of the Charities and Trustee Investments (Scotland) Act 2005 stipulates certain actions, viz a charity's (a) amending its constitution so far as it relates to its purposes; (b) amalgamating with another body; (c) winding itself up or dissolving itself; or (d) applying to the court in relation to any action set out in paras (a) to (c) -- which (subs.(1))maybe taken only with OSCR's consent and in accordance with any attached conditions. Subsection 16(3) disapplies subs.(1) in relation to any action (a) in pursuance of an approved reorganisation scheme; or (b) for which OSCR's consent is required by virtue of any other enactment. If, however, it were proposed to exhaust the assets of a charity in payment of its debts it would seem to be the case that OSCR's consent would be required irrespective of whether the company incorporated by Charter were dissolved. Section 16(2)(c) draws what appears to be a studied distinction between winding up and dissolution -- it refers to such steps alternatively so that OSCR's consent would seem to be required for either. We put matters in terms of what appears to be the case because there must be some question as to whether directors of an absolutely Page3 insolvent charity, who judged it to be their duty to make application to the court for a winding up order, could be impeded in that course by the absence of such a consent. Consideration of such matters is beyond the scope of this article. Moreover, in the only case of which we are aware, OSCR were commendably rapid in providing their consent, so that it was not an issue. There would appear to be no equivalent requirement in England other than in the context of there being unexpended (e.g. endowment) funds. It is difficult to find a convincing basis on which it can be said that a judicial application is not required. At lowest, where an entity's liabilities exceed its assets, the intervention of the court is desirable, not least as a protection for those who are its governing mind. What sort of application to the court? Winding up under the 1986 Act So you have concluded on the basis of these sorts of considerations that an application to the court is desirable.