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Home / News and Insights / Blogs / Charity Law / 27: Charity trustees and director disqualification – what does the Kids Company decision mean for charities?

On 12 February 2021, the High Court gave judgment in the Kids Company trial, in which seven directors and the chief executive of the former charity defended a claim by the Official Receiver that they be disqualified under the company director disqualification regime. The judge found comprehensively for the defendants – she was ‘wholly satisfied’ that no disqualification order was necessary. The case raises important questions about the expectations placed on volunteer charity trustees and the respective roles of the charity board and its executive.

Background

Amid a mass of media interest, the charity Keeping Kids Company (Kids Company) closed suddenly in August 2015 and went into insolvent liquidation after unfounded allegations of serious criminal conduct were made against the charity, causing would-be backers to withdraw.

Where a company is involved in insolvency proceedings, the Insolvency Service may investigate the conduct of directors of the company. If the Insolvency Service thinks they are ‘unfit to be concerned in the management of a company’, so that the public should be protected from such conduct, they may seek a disqualification order under the Company Director Disqualification Act 1986 (the Act).

The Act applies to charitable companies, such as Kids Company, as well as to CIOs, so charity trustees can be susceptible to these investigations. Charity trustees have been disqualified under the Act before (eg re the Public Safety Charitable Trust after the former charity’s involvement in a business rates relief scheme). A charity chief executive can also be disqualified as a ‘de facto’ director (as in the case of Lifeline Projects in 2019). However, in these cases, the accused director (or de facto director) accepted disqualification undertakings rather than go to trial. The tests of ‘unfitness’ in respect of a volunteer charity trustee, and when a charity chief executive may be a ‘de facto’ director, had not been tried in court before the Kids Company case.

The Kids Company case came to trial in October 2021 after years of investigation and pre-trial preparation. The trial ran for 10 weeks with witness evidence and cross-examination backed up by several thousand pages of written evidence. It is perhaps, unsurprising, therefore that the judgment runs to a hefty 221 pages, setting out a mass of detail from that evidence. The gist and some points to highlight from the decision are set out below.

The case against the Kids Company directors

There were no claims of dishonesty, breach of duty or wrongful trading in the conduct of the defendants. The single allegation, made collectively against the charity trustees, was of unfitness due to incompetence. This claim was based on the trustees having ‘caused and / or allowed Kids Company to operate an unsustainable business model’ and that by November 2014 they ‘knew or ought to have known that failure was inevitable without immediate material change’.

The gist of the basis for the charge was in the charity’s operation of a ‘demand-led’ model of ‘self-referral’ and a policy of ‘never turning a child away’, whilst being dependent on ‘ad hoc’ grants, donations and loans, without sufficient reserves. This was exacerbated by the rapid growth and geographical expansion of the charity. The charity trustees were alleged to have taken an overly optimistic approach to prospective funding and to have had inadequate control of the charity’s governance, risk management and its CEO.

The judge noted that an allegation based solely on incompetence must be shown to be ‘of a high degree’. The court must also be careful ‘not to fall into the trap of being too wise after the event’ and judging the case with the benefit of hindsight, knowing that the charity went into liquidation. The charity context was also relevant, including the non-executive roles of the directors here.

In those circumstances, the judge was unpersuaded by the Official Receiver’s case. The central allegation of unsustainability was hard to fathom when the charity had been operating the same model for 17 years. The trustees should not be criticised for running on a demand-led self-referral basis, as many charities, especially aid charities, do. Likewise, it was common for charities to be dependent on donations – that did not make the model unsustainable. In the judge’s view, absent the unfounded criminal allegations, it was more likely than not that the restructuring of the charity in 2015 would have succeeded.

The judge acknowledged some validity in the criticism of the lack of liquid reserves, but ‘creating them was much easier said than done’ and the decision to prioritise spending on charitable objects was one that the trustees could reasonably reach. The judge also had no criticism of the level of scrutiny applied by the board.

The Official Receiver had not demonstrated that decisions that the trustees took, or failed to take, in the factual context were ‘outside a range of reasonable decision-making’. The trustees’ conduct did not amount to incompetence of a high degree. The judge concluded that the public ‘need no protection’ from these charity trustees:

‘On the contrary, this is a group of highly impressive and dedicated individuals who selflessly gave enormous amounts of their time to what was clearly a highly challenging trusteeship’.

The case against the chief executive

The charity’s chief executive, Camila Batmanghelidjh, was not a director of the charity. However, the claim was that she should be disqualified as a director on the basis that she acted as a ‘de facto’ director of the charity and her actions as such made her ‘unfit’.

Remarkably, the basis for the claims that the CEO was a ‘de facto’ director included such factors as:

  • reliance on the job title of ‘chief executive’;
  • her overall responsibility for the day to day running of the charity; and
  • given the non-executive nature of the board, that ‘if the CEO of a charity was in substance doing what could be characterised as the same job as a CEO of a commercial company then they were likely to be a director’.

As the judge pointed out, the argument here ‘would throw into doubt the status not only of many individuals with executive functions who work in the charitable sector, but that of many in the commercial world as well’. Happily, the judge was clear in rejecting it – neither the ‘label nor functions of a CEO role are, by themselves, indicators that the holder has assumed to act as a director’ and this was ‘particularly so for incorporated charities, which with narrow exceptions must have Boards comprised entirely of volunteer directors’. The judge felt it ‘worth emphasising’ that ‘there is nothing inherently ‘wrong’ in a structure which includes a CEO role with the executive functions that Ms Batmanghelidjh had’.

While Camila Batmanghelidjh was the founder and ‘face’ of the charity and had significant influence, she was ‘not part of the ultimate decision-making structure’. The Official Receiver’s argument failed to distinguish between decision-making at director level and making decisions under delegated authority, subject to supervision. In this case, the CEO was carrying out her role under delegated authority from, and the supervision of, the board of charity trustees.

The judge was clear that the CEO was not a ‘de facto’ director. As such, the question of ‘unfitness’ was irrelevant, but in any case the judge would not have found her ‘unfit’.

Reserves

As noted above, the judge acknowledged that there was validity in the criticism of the charity’s lack of liquid reserves. The judge also recognised the difficulty for the charity in creating such reserves. This was not only due to the demand-led nature of the charity’s operations, but also to the difficulty of persuading donors to give towards reserves – even the government was unwilling to allow its grants to be used to build reserves. If a charity has built up reserves, it can also impact negatively on fundraising – as the judge noted, ‘The unfortunate reality is that a charity with cash set aside for the proverbial rainy day is less obviously in need’.

These sorts of issues have been brought into sharper focus by the pandemic, which has been a very long period of ‘rainy days’ so that charities’ reserves have been significantly diminished and often spent entirely. The ray of sunshine in this may be that it will also have changed donors’ and funders’ perspectives, so that they are more willing to recognise the importance of funding reserves.

Charities are different

The Official Receiver had sought to run the case on the basis that Kids Company’s status as a charity was ultimately irrelevant. The judge disagreed, accepting that the courts have long taken a more benevolent approach towards charity trustees where (as here) no dishonesty or wilful misconduct was alleged. The judge suggested that ‘incompetent 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 different, charitable, context’.

One of the striking aspects of the judgment is that the judge highlighted the apparent ‘lack of experience’ of charities within the Official Receiver’s department. This extended to a lack of knowledge about charities’ business models (‘the failure to give full recognition to the fact that it is common for charities to be heavily dependent on donations’) and management structure (‘the apparent difficulties that [they] had with the concept of wholly non-executive boards of directors’). In the judge’s view, this lack of experience affected the Official Receiver’s approach, eg leading to some ‘inappropriate assumptions being made as to what should have been done’ by the trustees.

To determine if a director’s conduct is ‘unfit’, you have to understand what conduct would be ‘fit’. If a public body tasked with making such decisions has unreasonable expectations of the conduct expected of charity trustees, that is worrying and could have wider consequences. As the judge noted:

‘The charity sector depends on there being capable individuals with a range of different skills who are prepared to take on trusteeship roles. 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. 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.’

Time for some guidance from the Insolvency Service?

While the decision brings some welcome commentary on how the disqualification regime should apply to charities, more clarity is needed on how decisions to seek disqualification will be made in future cases involving volunteer charity trustees (and charity chief executives). It should not be underestimated how much stress will have been felt by the individuals involved over the five and half years, and ten weeks in court, of this case. As the judge noted, the ‘existence of the proceedings themselves can have extremely significant consequences for defendants’ and in ‘many cases there will also be no review by the court, because the defendant chooses to accept a disqualification undertaking’.

In the absence of further clarity here, the risk of a chilling effect on charity trustee recruitment remains. The judge highlighted the risk:

‘The result of proceedings being brought in other than the clearest of cases is likely to … deter many talented individuals who take the trouble to understand and appreciate the risks either from charitable trusteeship at all, or at least from all but the most wealthy, well endowed, charities which are likely to have least need of their skills.’

This is all the more important at present, when so many charities are in financial distress.

What next?

It is feasible that the Official Receiver will seek to appeal the decision. In the meantime, the case is not over for the charity trustees (and their CEO), as they need to turn their minds to the Charity Commission’s statutory inquiry, which was put on hold pending the result of the Insolvency Service action.

Third Sector has reported that the Charity Commission has decided not to take any regulatory action against any of the charity trustees. However, the Commission will produce an inquiry report setting out lessons learned and it will be interesting to see its approach, in particular on questions such as the model adopted by the charity and the approach to reserves. This is likely to be especially important given the context of the pandemic and the financial distress currently being felt by many charities.

The judge noted in this respect that, although the company director disqualification regime applies to charities, ‘it might be thought that the primary means of regulating trustees’ behaviour, at least in practice, is and should be via the standards set by, and the enforcement powers of, the Charity Commission, being the regulator that has the most appropriate expertise. At the least, this might in practice reduce the risk of charity trustees being held to inappropriately different standards depending on whether the charity in question happens to be incorporated’.

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