Guidance

Charity reserves and defined benefit pension schemes

Published 10 May 2013

Applies to England and Wales

1. Introduction

The implementation of FRS17: Retirement Benefits for accounting periods beginning on or after 1 January 2005 has brought about the balance sheet recognition of pension assets or liabilities for charities that operate defined benefit pension schemes. The nature of this asset or liability is defined by and calculated in accordance with the methods set out in the Financial Reporting Standard. Detailed accounting guidance is provided in SORP 2005.

The accounting requirements of the FRS17 standard have focused attention on the health of pension schemes generally. For charities with a defined benefit pension scheme, this in turn can influence the stance taken by those parties with whom a sponsoring charity transacts. In addition, the balance sheet disclosure of pension assets or liabilities has raised questions as to how a charity’s reserves policy will be affected.

Whilst the Charity Commission’s guidance explains factors for a charity to consider in setting and explaining its reserves policy, it is recognised that accounting under FRS17 gives rise to a number of particular issues where further guidance may be helpful to charities when setting their policy for reserves. For the SORP definition of reserves please see section 3. In some cases a pension liability may exceed the amount of reserves of a charity. This has raised questions as to the impact this may have on the ‘going concern’ of certain charities.

The Charity Finance Directors’ Group (CFDG) in an earlier version of its publication Navigating the charity pensions maze highlighted the need for charities with defined benefit pension schemes to consider the implications and legal liabilities that follow from such schemes. It provided options as to how such risks might be managed with the help of professional advice. This guidance looks at the immediate legal and other implications on a charity having a defined benefit pension scheme.

The operation of a defined benefit scheme by a charity creates financial risk which in some cases may, if not managed, become a major risk to the charity and its future activities. This guidance also explores how the identification and management of such risk may be addressed in the context of a risk management framework.

2. Consideration of going concern

The Audit and Assurance Faculty of the Institute of Chartered Accountants in England and Wales has provided guidance in Technical Release Audit 1/02 for auditors on how they should approach the question of pension liabilities when assessing the going concern of an entity. Although this guidance is directed at auditors, it is relevant to charities wishing to understand how pension liabilities may affect solvency. In the view of the Pensions Regulator, and consistent with that of the Audit and Assurance faculty, an FRS17 deficit does not of itself automatically raise an issue over the going concern of the charity.

FRS17 does not, of itself, affect the cash flows of a charity. The contributions made by an employer charity into a defined benefit pension scheme are usually arrived at in accordance with the terms of the pension scheme, in light of advice from its actuary based on the results of an actuarial valuation of the pension scheme and through statutory requirements. Changes in these statutory requirements mean that pension schemes are likely to be more prudently funded as a result of actuarial valuations occurring on and after 23 September 2005.

These requirements may involve measuring surpluses or deficits of the pension scheme on a different basis to that required by FRS17. In the context of under funded schemes, increases in contribution rates would arise irrespective of the accounting disclosure provided in the financial accounts.

Charitable companies are ‘legal persons’, can incur liabilities, and can become ‘insolvent’. Such charities can be deemed insolvent in accordance with s.123 of the Insolvency Act 1986, as amended, for example when they are unable to pay debts as they fall due. See the commission’s guidance Managing financial difficulties and insolvency in charities.

When considering the appropriateness of the going concern concept, trustee directors of charitable companies need to consider the cash flow effects of the agreed pension contributions arising under the scheme irrespective of whether any FRS 17 deficit is disclosed on or off balance sheet. The impact of contributions would normally be considered as part of a charity’s budgetary process and would focus on the ability of the charity to meet contributions as they fall due, together with consideration of the impact such payments have on the planned programme of charitable activities. In addition trustees/directors will also consider the impact funding deficits may have on existing borrowing arrangements, and compliance with loan covenants, together with the potential impact on the charity’s ability to raise funding in the future.

Unincorporated charities are not ‘legal persons’ and cannot technically incur liabilities, which are instead incurred by their trustees, acting on behalf of beneficiaries. Unincorporated charities cannot, strictly speaking, become insolvent. However, a charity may reach a financial state where the value of the assets in its trust which are available to the trustees to settle the liabilities of the charity are insufficient. In the context of unincorporated charities the term ‘insolvency’ is used informally to describe this situation.

Trustees normally have a right of recourse to the trust assets for reimbursement of liabilities properly incurred. The concern for trustees is that (unless the debts and liabilities have been incurred on the basis that they will only have to be met if there are sufficient funds in the trust to do so) they may have to meet the debts and liabilities personally if there are insufficient funds in the trust. (See Appendix B for more on the contractual liabilities of trustees).

3. Reserves

The Charities SORP recommends that trustees provide a statement of their reserves policy in their trustees’ annual report. Trustees will need to consider explaining to the charity’s stakeholders the effects of the inclusion of any pension asset or liability on the charity, particularly any impact on its reserves policy; paying particular attention to explaining clearly and simply how the accounting disclosures should be interpreted in the context of the charity’s finances. Trustees will also need to consider direct communication with major funders, explaining the impact on cash flows.

Where material, the reserves policy statement is likely to differentiate the pension asset/liability from other reserves of the charity. It might explain the actuarial valuation resulting in the pension reserve/deficit and that the corresponding asset/liability does not result in an immediate cash flow impact on the charity, ie that it is not an asset that can be immediately drawn down or a liability that must be settled immediately. A brief indication of the cash flow effects (ie increase or decrease in contributions to the scheme) would put this situation into context.

The definition of reserves in the SORP is ‘that part of a charity’s income funds that is freely available for its general purposes’. This definition of reserves therefore normally excludes:

• permanent endowment funds
• expendable endowment funds
• restricted income funds
• any part of unrestricted funds not readily available for spending, specifically income funds which could only be realised by disposing of fixed assets held for charitable use

‘Reserves’ are therefore the resources the charity has or can make available to spend for any or all of the charity’s purposes once it has met its commitments and covered its other planned expenditure. More specifically ‘reserves’ are income which becomes available to the charity and is to be spent at the trustees’ discretion in furtherance of any of the charity’s objects (sometimes referred to as ‘general purpose’ income) but which is not yet spent, committed or designated (ie is ‘free’). Where designations are made as part of a charity’s reserves policy, both their purpose and the likely timing of their expenditure should be explained.

Where, under FRS17, a charity discloses a significant pension fund deficit, this does not mean that an immediate liability for this amount crystallises. Similarly, where a pension surplus is disclosed this does not create an immediately realisable asset that can be released straight away and expended on the purposes of the charity. In particular, the disclosure of a pension liability does not mean that the equivalent amount is already committed and is no longer available to the trustees to further the charity’s objectives.

The funding position of a pension scheme will result in a cash flow effect in terms of an increase or decrease in contributions over a period of years. The charity needs to revisit its business plans and budgets and ascertain how this outflow might impact on future operational plans and budgets. If increased contributions can be met through budgeted inflows then the impact on reserves policy is marginal. In other cases, it might be necessary to set aside resources currently held to help fund anticipated increases in cash flows.

In looking at cash flow forecasts generally, it is probable that pension contributions are likely to increase at a faster rate than charitable income. Trustees may need to revisit their reserves policy sooner than they might otherwise have done, particularly with the advent of the statutory scheme specific funding requirement (replacing the minimum funding requirement for defined benefit schemes).

4. How to set a reserves policy

In so far as an FRS17 calculated pension deficit does not result in an immediate equivalent cash commitment, it would not generally be appropriate for trustees to regard an equivalent amount as a designation of charitable funds. This would indicate an intention to apply the amount designated to make good the full amount of any reported pension liability and indicate that such funds were unavailable to spend on the charity’s general purposes.

A good starting point is for a charity to exclude the FRS17 calculated asset or liability when calculating free reserves but then to give careful consideration to the cash flow implications that may arise from the accounting disclosure in terms of increased or reduced contributions.

Where a charity is confident that it can meet contributions from projected future income without significant impact on its planned levels of charitable activity then it is unlikely that trustees will need to designate any of their existing funds to meet future pension commitments.

Where contribution increases create uncertainty as to the charity’s ability to meet them from projected future income, or would result in a significant curtailment of charitable activities, then urgent consideration by the trustees is required. Immediate actuarial and legal advice is likely to be appropriate; it would be prudent to create a designation in so far as it is anticipated that the ability to make future contributions is dependent upon the assets currently held by the charity.

Additional contributions could result in a situation where designations of currently held resources and future incoming cash flows are insufficient to fund future contributions, or the impact of funding the scheme is such that it would have an unacceptable impact on charitable activities. In such situations issues of viability arise and formal professional advice is essential.

5. Risk management

The SORP recommends trustees provide a statement within the charity annual report confirming that ‘the major risks to which the charity is exposed, as identified by the trustees, have been reviewed and systems have been established to mitigate those risks’.

‘Major risks’ are those risks which have a high likelihood of occurring and would, if they occurred, have a severe impact on operational performance, achievement of aims and objectives or could damage the reputation of the charity. Such risks could change the way trustees, supporters or beneficiaries might deal with the charity.

In the context of the pension scheme, trustees are encouraged actively to manage any liability by:

• identifying the funding position from the scheme’s actuarial valuation
• using subsequent FRS17 valuations which are updated to reflect changing conditions to monitor trends in the funding position
• identifying the cash flow requirements
• identifying how to deal with it (short, medium, or long term)
• reviewing the benefits provided by the existing pension scheme
• where circumstances require, taking professional advice as to options available to limit the charity’s exposure to increasing liabilities accruing under the scheme

Risk management should therefore not be seen purely as a compliance issue or as being solely focused on the prevention of a ‘disaster’. The process will enable trustees to focus on the mitigation of risks that would prevent the charity achieving its strategic objectives. In so doing, charities will be able to take opportunities and develop them with an understanding of the risks faced, and with confidence that reasonable steps have been taken to mitigate those risks.

The reputational risk to a sizeable charity from not honouring pension promises, particularly when it is relying on a large number of employees to fulfil its objectives, could be substantial.

The commission’s guidance on risk management identifies financial risks such as accuracy and timeliness of financial information, adequacy of reserves and cash flow.

6. Role of regulators

6.1 Charity Commission

The commission registers and regulates charities in England and Wales. It fulfils this role by:

• registering eligible organisations in England and Wales which are established for only charitable purposes
• taking enforcement action when there is malpractice or misconduct
• ensuring charities meet their legal requirements, including providing information on their activities each year
• making appropriate information about each registered charity widely available
• providing online services and guidance to help charities run as effectively as possible

6.2 Pensions Regulator

The Pensions Regulator is the UK regulator of work-based pension schemes. It works with trustees, employers, pension specialists and business advisers, giving guidance on what is expected of them.

The Pensions Act 2004 gives the Pensions Regulator objectives to:

• protect the benefits of members of work-based pension schemes
• promote good administration of work-based pension schemes
• reduce the risk of situations arising that may lead to claims for compensation from the Pension Protection Fund

For further information see The Pension Regulator’s website.

6.3 HM Revenue and Customs

In so far as pensions are concerned, HMRC’s role is to protect the valuable tax reliefs on offer, through the granting and monitoring of tax approved status for retirement benefit schemes.

For further information see Pension scheme administration.

7. Appendix A: Reserve policy scenarios

This appendix considers a number of possible scenarios setting out how a defined benefit pension scheme funding requirement might impact on a charity’s reserves policy. In all cases the assessment necessary in setting a reserves policy goes beyond simply looking at the FRS 17 liability disclosure. It involves looking at the scheme’s funding requirements and in particular at the impact of increased contributions on planned activity level and resulting cash flow.

The scenarios presented in this appendix are for illustrative purposes only. As explained in section 4, actuarial and legal advice is likely to be appropriate where uncertainty exists as to the ability of a charity to meet future contributions to the scheme from projected income or where to do so would result in a significant curtailment of charitable activity.

Asset	Scenario 1 (£1m)	Scenario 2 (£m)	Scenario 3 (£m)
Tangible fixed assets	10.0	10.0	10.0
Investments	5.0	5.0	5.0
Net current assets	5.0	5.0	5.0
Net assets excluding pension liability	20.0	20.0	20.0
Pension liability	(10.0)	(17.5)	(22.5)
Net assets/(liabilities) including pension liability	10.0	2.5	(2.5)

Funds of the charity	Scenario 1 (£1m)	Scenario 2 (£m)	Scenario 3 (£m)
Restricted funds	5.0	5.0	5.0

Unrestricted funds	Scenario 1 (£1m)	Scenario 2 (£m)	Scenario 3 (£m)
General	5.0	2.0	0
Pension	-	3.0	5.0
Property	10.0	10.0	10.0
Unrestricted funds excluding pension liability	15.0	15.0	15.0
Total charity funds excluding pension reserve	20.0	20.0	20.0
Pension reserve	(10.0)	(17.5)	(22.5)
Total charity funds	10.0	2.5	(2.5)

7.1 Scenario 1

Financial position

In this example, the charity’s restricted funds of £5million are fully committed to meet a planned project funded by a number of restricted grants. The restricted funds’ assets are held as gilt-edged securities within fixed asset investments pending commencement of the project. The investment would be disclosed as a current asset if expenditure was anticipated in the next accounting period. The accounts disclose unrestricted funds of £15million including tangible fixed assets, used operationally, with a book value of £10million. The remaining unrestricted funds of £5million are held in liquid form as current assets.

In line with FRS 17 requirements, the charity has obtained an actuarial valuation and recognised a pension liability of £10million in its accounts arising from the pension scheme’s actuarial deficit measured using the principles of the accounting standard. The pension liability of £10million reported in the accounts is less than the charity’s total unrestricted funds of £15million reported, however, the pension liability does exceed the undesignated general funds of £5million.

Reserves policy

In setting their reserves policy the charity trustees would identify that restricted funds were fully committed to meet planned expenditure and explain their policy for designating tangible fixed assets. In this example, the charity operates a number of care homes with long term residents. A strategy of freehold ownership is adopted to help ensure long term care commitments are met. The trustees would also give consideration to whether the £5million held as current assets was sufficient to provide for working capital needs and to meet budgeted activity levels.

In setting a reserves policy, consideration would be given to the pension liability reported in the accounts. Although the reported liability does not exceed the amount held by the charity as unrestricted funds, it will still be necessary to consider the cash flow impact that may arise from the reported pension deficit.

Cash flow impact on reserves policy

The FRS 17 calculated pension liability does not result in any immediate liability to pay this amount to the pension scheme and hence a designation of unrestricted funds to match the FRS 17 calculated liability will not normally be necessary where any resulting increase in contributions will be met from anticipated future income streams.

Increased contributions may arise where, for example, the pension scheme’s valuation presents a funding deficit. The contribution rate will be arrived at in accordance with the terms of the pension scheme, in the light of advice from its actuary, based on the results of a pension scheme’s valuation and through statutory requirements. Both of these will involve measuring surpluses or deficits on a different basis to that required by FRS 17.

In setting a reserves policy, the charity trustees should give particular attention to the impact any increase in pension contributions will have on cash flow forecasts and planned activity levels. In the case of an open scheme, a designation would normally only be made in the accounts where the cash flow effect of increased contributions is such that it may become necessary to earmark funds held at the balance sheet date in order to meet future contributions.

In this scenario, it is assumed that the pension scheme actuary undertook a valuation of the pension scheme and discussions were entered into resulting in agreement with the pension scheme trustees to increase employer’s contribution to the pension scheme by £1million in each of the next five years. The charity trustees have given consideration to the impact of these additional costs on their planned activity levels and cash flow budgets and have concluded that these additional costs can be absorbed within existing budgets without jeopardising existing activity levels.

The trustees have therefore concluded that no designation of funds held at the balance sheet date to meet future contributions is necessary, despite the FRS 17 liability disclosed of £10million exceeding undesignated general funds of £5million.

Had the view been taken that the increase in pension contributions over the next five years could not be fully met from anticipated cash flows, all or part of the £5million held as undesignated general funds could be designated where it is anticipated that the assets of this fund will be needed to meet increased contributions. A charity clearly cannot create a designation in excess of its unrestricted funds; to do so would indicate insufficient funding to deliver planned activities.

7.2 Scenario 2

Financial position

In this example, the charity’s restricted funds of £5million are again fully committed to meet a planned project funded by a number of restricted grants. The assets of the restricted fund are again held as investments pending commencement of the project. The accounts again disclose unrestricted funds of £15million including tangible fixed assets, used operationally, with a book value of £10million. The remaining £5million of unrestricted funds are held as liquid current assets. The FRS 17 liability reported, in this scenario, of £17.5million exceeds the unrestricted fund balance of £15million.

Whilst the pension liability (calculated under FRS 17 principles) exceeds the amount of unrestricted funds of the charity, this should not automatically be interpreted as creating a state of insolvency. It will however act as a trigger for a detailed review of the impact of pension contributions on the charity’s cash flow position and ability of the charity to meet its debts as they fall due.

Reserves policy

The factors identified in scenario 1 relating to restricted funds and property designations would once more be relevant and explained as part of the reserves policy statement. Again, the cash flow implications arising from any pension scheme deficit would impact directly on the reserves policy set by the charity.

Cash flow impact on reserves policy

In this scenario, it is again assumed that, following a valuation of the pension scheme, agreement was reached with the pension scheme trustees to increase employer’s contributions on this occasion by £1.3million in each of the next five years. In addition, in order to meet the scheme’s minimum funding requirement (which is to be replaced in relation to actuarial valuations occurring on and after 23 September 2005 by a prudent, statutory scheme specific funding requirement), an additional one-off single payment into the pension scheme of £1.5million is required in the next financial year.

The charity trustees have taken the view that £1million of the increase in contributions rates is sustainable in the medium term without jeopardising the planned levels of charitable activity. However, the cash flow impact is such that it will be necessary to earmark £300,000 of the increased annual contributions together with the one-off contribution of £1.5million in order to sustain planned activity levels.

The designation made in the accounts of £3million represents a one off payment of £1.5million to meet the minimum funding requirement and £300,000 of additional contributions over each of the next 5 years which cannot be met from anticipated income streams if planned activity levels are to be maintained. The trustees, in addition to explaining the designation set aside for future pension contribution, would consider the adequacy of the undesignated general fund of £2million now reported.

7.3 Scenario 3

Financial position

In this example, the charity’s restricted funds of £5million are again fully committed to meet planned project expenditure funded by a number of restricted grants. The accounts again disclose unrestricted funds of £15million including tangible fixed assets, used operationally, with a book value of £10million. The remaining £5million of unrestricted funds are held as liquid current assets. The FRS 17 liability reported of £22.5million exceeds both the unrestricted fund balance of £15million and the total assets of the charity before the pension liability of £20million. The net liability position of the charity including the pension liability is £2.5million.

Whilst the pension liability (calculated under FRS 17 principles) exceeds the net assets of the charity, this should not automatically be interpreted as creating a state of insolvency. It will however act as a trigger for a very detailed review of the impact of pension contributions on the charity’s cash flow situation and ability of the charity to meet its debts as they fall due.

Reserves policy

Again, in setting a reserves policy, the charity trustees have identified that restricted funds were fully committed to meet planned expenditure and explain their policy for designating tangible fixed assets. The charity trustees have given consideration to whether the £5million held as current assets is sufficient for working capital needs and to meet budgeted future needs. In looking at future budgeted needs, the cash flow impact of any increase in pension contribution would have been particularly relevant.

Cash flow impact on reserves policy

In this scenario it is again assumed that, following a valuation, the pension scheme trustees have advised the charity that an increase in employer’s contributions is necessary to reduce the pension scheme deficit which would result in the charity’s contribution increasing by £1.5million in each of the next five years. In addition, in order to meet the scheme’s minimum funding requirement (which is to be replaced in relation to valuations occurring on and after 23 September 2005 by a prudent, statutory scheme specific funding requirement), a one-off single payment into the pension scheme of £5million is required in the next financial year.

The charity trustees have given consideration to the impact of these cash outflows on planned activity levels and the sustainability of these increased payments. In forming their view, the trustees have decided to take legal and actuarial advice on other options available in relation to the pension scheme to reduce its deficit and future contributions.

For example, the view may be taken that the increased contributions are only sustainable if the terms of the pension scheme are changed to incorporate an increase in employees’ contributions to the scheme. It is assumed that, with an increase in employees’ contribution, the on-going funding of the scheme is sustainable.

The cash flow impact is such that the one-off payment of £5million can only be met by a combination of curtailing certain budgeted activities and through earmarking of funds currently held at the balance sheet date. The full amount of the £5million one-off contribution can be designated since undesignated general reserves stand at £5million. This would indicate that no free reserves were held at the balance sheet date. Trustees would therefore review budgets and cash flow forecasts carefully to ensure future income streams were sufficient to meet working capital requirements.

In this scenario, had it not proved possible to increase employees’ contributions to the scheme, the increase in future contributions could only be met from future income streams or by reducing future budgeted expenditure. It would not be possible to increase the pension designation above £5million and create a negative balance on undesignated general funds. The trustees could in such circumstances review the need for other designations if, for example, the policy of retaining freehold property was not central to operational objectives.

As explained in section 4, where designations of currently held resources and future incoming cash flows are insufficient to fund future contributions, or the impact of funding the scheme is such that it would have an unacceptable impact on charitable activity, then issues of viability arise and formal professional advice is essential.

8. Appendix B: Role of charity and pension trustees (legal obligations and liabilities)

8.1 Role of charity trustees

The role and responsibilities of charity trustees generally are set out in the commission’s guidance The essential trustee.

For trustees of a charity to have set up a defined benefit pension scheme, they will have taken a decision that the scheme in question is expedient in the interests of the charity. Trustees are fiduciaries and can only exercise their powers for the legitimate purposes of the charity and not for any ulterior purposes. Trustees cannot generally make moral or benevolent gestures in the administration of their trusts which are unconnected (directly or indirectly) with the achievement of the charity’s objects. Neither can the court or the commission sanction such gestures (except where the trustees regard themselves as being under a moral obligation).

It may be the case that salaries in the charitable sector have been lower than in the private sector and that a relatively generous pension scheme has been seen as a way of attracting staff of a suitable calibre and commitment. Alternatively, it may be necessary for a charity’s pension scheme to be comparable to the public sector in order to recruit suitable staff from that background. In such a case the scheme may be justified by the benefits to the charity from recruiting and retaining staff.

The charity trustees will need periodically to consider whether continuing the level of funding required by such a scheme remains in all the circumstances in the interests of the charity.

The range of options for the charity with regard to the pension scheme will depend on the employment contract, the terms of the pension scheme, the agreed level of contribution by the charity, and any statutory provisions affecting these. In particular, statutory provisions regarding the financial provision to be made on the winding up of a scheme, and other statutory changes, have tended to make the provision of a defined benefit pension scheme a more onerous and expensive option to pursue than previously. Some employers have adopted the policy of closing defined benefit pension schemes to new employees.

There have also been cases of employers seeking to close defined benefit schemes in relation to the future service of current members. Whether this can be challenged by those members in any particular case will depend on the precise terms of the employment contract, the terms of the pension scheme, and any relevant statutory provisions. The Court of Appeal has held that, where a contract of employment provides for membership of arrangements like a pension scheme, there is an implied obligation upon the employer to discharge their functions in good faith and, so far as lies within their power, to procure the benefits under that arrangement for the employee (Mihlenstedt v Barclays Bank International [1989] IRLR 522). Accordingly, charity trustees considering closing a scheme should obtain legal advice before taking any action.

8.2 Role of pension scheme trustees

The role of pension scheme trustees is to ensure that the pension scheme is administered in the best way for the members of the scheme and to safeguard their interests. In addition, the pension scheme trustees must understand the employer’s financial situation and its commitment to the pension scheme. They must also comprehend the position of the pension scheme and its funding.

8.3 Legal obligations of charity trustees of unincorporated charities with a defined benefit pension scheme

This type of pension scheme is usually established by a trust deed and a set of rules. The charity trustees are not necessarily also trustees of the pension scheme but they do have certain obligations in respect of the pension scheme which will vary depending on the exact terms of the pension scheme’s trust deed and rules. The liability of the charity trustees in respect of the pension scheme is likely to be based in trust law and contract but with some overriding statutory requirements.

The charity trustees will be required to make contributions at a rate to be agreed between the charity trustees and the pension scheme trustees in accordance with the terms of the pension scheme’s trust deed and rules. The level of these contributions will be determined in the light of advice from its actuary based on the results of an actuarial valuation of the pension scheme and in accordance with overriding statutory requirements. There is also likely to be a power to reduce or to suspend the contributions to the pension scheme.

The aim should be to put the pension scheme in the position where it holds sufficient assets to cover its liabilities, both of which are calculated prudently. It is likely that the terms of the pension scheme and the overriding statutory obligations will require the employer to pay sufficient contributions to ensure this. So long as the charity trustees are able to do so out of the funds expendable for that purpose, no difficulty arises.

Any debt due from the charity trustees for which they are entitled to an indemnity from the charity can usually be paid from the assets of the charity. If the charity trustees are required to transfer an amount to the pension scheme which is more than the value of the assets of the charity, the charity trustees could be personally liable for any shortfall.

The first call for any debt is on the general funds of the charity (unless incurred in the administration of any restricted fund of the charity). Assets held on special trusts including endowed funds can usually be used to make up any deficiency except where they constitute a distinct charity. Where special trusts are income funds they will be included in SORP compliant accounts as restricted income funds.

There may be a specific requirement under the pension scheme’s trust deed and rules that the rate of contributions must not fall below the minimum required to ensure that, over the lifetime of the pension scheme, the liabilities of the pension scheme do not exceed its assets. Otherwise there will be overriding statutory duties to comply with to ensure that the pension scheme is prudently funded.

Under changes to the pensions legislation, if the pension scheme trustees are particularly concerned about the pension scheme’s funding position and the ability of its sponsoring employer to resolve the problem, they are able to apply to the Pensions Regulator to see if it can use any of its powers to help ensure that the pension scheme is being properly supported financially.

It may also be possible for them to cut back members’ future benefits in the pension scheme or even close the pension scheme completely. Ultimately they may need to consider whether to wind it up. A winding up will have the result of crystallising the whole of the pension scheme’s liabilities and triggering, as a result of section 75 of the Pensions Act 1995 (as amended by the Pensions Act 2004) a statutory debt due from the pension scheme’s sponsoring employer. This will be calculated on the basis of paying all the actual expenses of winding up the pension scheme and securing all members’ benefits with annuities purchased from an insurance company. If a pension scheme’s sponsoring employer is not able to do this then the trustees of the pension scheme may ultimately be able to approach the new Pension Protection Fund for assistance.

8.4 Liabilities of charity trustees of an unincorporated charity under a contract

Liabilities may also arise from contractual arrangements existing between the charity trustees and the trustees of the pension scheme. The contractual liability arising falls on those charity trustees who are parties to the contract. They will be entitled to be reimbursed from the funds of the charity for any liabilities properly incurred under a contract which has been properly entered into. If the assets of the charity are not sufficient to meet the liability, the charity trustees will be personally responsible for the shortfall unless the document imposing the obligation provides that the charity trustees shall only be responsible to the extent of the charity’s assets. If there is such a provision, the charity trustees will not be personally liable.

A person, who has ceased to be a charity trustee but who, as charity trustee, was a party to the contract, is still liable under that contract unless that liability is limited as indicated above or novation occurs. A novation is the substitution of a new contract in place of an old one. It involves an agreement between the original contracting parties and a new contracting party. Thus an agreement between the trustees of the pension scheme, the original charity trustees, and the new charity trustee could substitute the new trustee as one of the contracting parties and release the retiring trustee from future liability under the contract. Such a novation can be express or inferred.

An inferred novation is where the actions of the parties to the contract and any of their successors indicate that a new contract has been substituted for the old contract and the terms of the old contract do not prevent this. Thus in a partnership case, the acceptance by other parties of payments from the new partners was considered to give rise to a novation of the liabilities of the original partners (Bilborough v Holmes (1876) 5 Ch.D 255).

In any event the former charity trustee will continue to be entitled to an indemnity from the funds of the charity for liabilities properly incurred by him or her.

It is possible that, after a person has ceased to be a charity trustee, the charity funds are unduly depleted by the actions of the successor charity trustees. If there has been a novation, the former charity trustee will have no liability arising after the date of the novation.

If the pension trustees were aware of the changes in the charity trustees and have accepted payments made by the new charity trustees, it is likely that there will be an inferred novation of the liabilities of the original trustees (see Bilborough v Holmes above).

If there is no express or inferred novation, and if a former charity trustee has been given an express indemnity from the continuing trustees, s/he will have a claim against those trustees. If no express indemnity has been given, the former charity trustee will have a claim on the charity and not against the continuing trustees.

If there are insufficient funds to satisfy the indemnity to which the former trustee is entitled from the charity as a result of the continuing trustees having acted in breach of trust, the continuing trustees may be personally liable to the charity to make up the shortfall.

8.5 Trustee liabilities to employees

In the case of employment contracts, section 218(5) of the Employment Rights Act 1996 dealing with continuity of employment states “If there is a change in the partners, personal representatives or trustees who employ any person, the employee’s period of employment at the time of the change counts as a period of employment with the partners, personal representatives or trustees after the change, and the change does not break the continuity of the period of employment.”

Regardless of whether this section in itself means that successor trustees are responsible under the employment contract, a novation is likely to be inferred by the ongoing payment by the trustees of the employees and the work carried out for the benefit of the charity by them.

8.6 Statutory requirements

As explained in section 6, on the role of the Pensions Regulator, in addition to the contractual responsibilities of the charity trustees under the trust deed and rules of a specific pension scheme, the Pensions Acts impose obligations which may have an impact on charity trustees in certain situations. An example of this would be under section 75 of the Pensions Act 1995 (as amended by the Pensions Act 2004) - see also ‘legal obligations of charity trustees’ above.

If section 75 of the Pensions Act 1995 (as amended by the Pensions Act 2004) applies, then, a shortfall in the assets of the pension scheme as against the liabilities of the pension scheme is treated as a debt of the employer owed to the trustees of the pension scheme. In such circumstances the debt will fall (in the case of an unincorporated charity) on the charity trustees as the employers at the time of the shortfall rather than at the time the trust deed or any subsequent deed or act of novation is entered into. Whilst the charity trustees would generally be entitled to an indemnity from the assets of the charity, any limitation expressed in the pension scheme rules that sought to limit their liability to the assets of the charity would be ineffective.

8.7 Conflicts of interest

The position regarding conflicts of interest generally is set out in the commission’s guidance Conflicts of interest: a guide for charity trustees. A trustee is under a duty not to place him or herself in a position where their duty to the charity conflicts with their personal interests unless the conflict is authorised, either expressly or by necessary implication, by the trust instrument (Re Llewellin [1949] Ch 225; Edge v Pensions Ombudsman [2000] Ch. 602).

A pension scheme is usually set up with the trust deed providing for representation among its trustees of various interests, including the employer and the employees. In the Edge case the court took the view that the trustee body as a whole had been set up to take all decisions regarding the pension scheme and that the decisions of that body were not vitiated by the existence of any conflicting interests on the part of a section of the trustees. What mattered was that the decision of the trustees was made properly.

Even where the existence of a conflict of interest is not authorised by the trust deed it does not in all circumstances vitiate the decision made (The Public Trustee v Cooper [2001] WTLR 901). However, where such a conflict exists and cannot be properly managed, charity trustees would be well advised either to apply in advance of any decision for a commission order or to allow any proposed exercise of discretion to be scrutinised in advance by the court.

A decision by trustees must be reached in accordance with their duties. The duties of the trustees in exercising their discretion are as follows:

• to act within the powers conferred upon them to act reasonably i.e. the decision should be within the range of decisions which a reasonable body of trustees could have made (Lee v Showmen’s Guild of Great Britain [1952] 1 All ER 1175; Scott v National Trust [1998] 2 All ER 705)
• to act within the powers conferred upon them and the established rules and procedures for dealing with issues of the kind under consideration ( re Hastings-Bass dec’d (C.A) [1975] Ch 25)
• to act in good faith (see re Hastings-Bass above; Armitage v Nurse [1997] 2 All ER 705)
• to inform themselves adequately in order to make the decision in question (R v Charity Commissioners ex parte Baldwin (2001) 33 HLR 48, QBD; See Scott v National Trust above)
• not to take into consideration any factors which it is not proper for them to take into account (Mettoy Pension Trustees v Evans (Ch.D.) [1990] 1 WLR 1587; Dundee General Hospitals Board of Management v Walker and another [1952] 1 All ER 680
• to consider any factors which they should take into account (Mettoy Pension Trustees v Evans above; See Dundee General Hospitals Board of Management v Walker and another above)

In case law it is accepted that, provided trustees exercise their discretion in accordance with these duties, the decision in question is not capable of being challenged by the courts.