Charity and philanthropy update - January 2022

Welcome to our charity and philanthropy update, in which we discuss issues affecting charities and philanthropy and highlight some of the recent developments which impact the third sector.

In this edition, we:

• look at the Charities Bill, currently making its way through Parliament, which aims to streamline certain processes and remove various bureaucratic hurdles currently faced by charity trustees;
• consider some practical points arising out of a recent case involving the mismanagement of a grant-making charity;
• report on a Jersey case where the court blessed a trust distribution, ultimately destined for charity, which was deliberately structured so as to incur a tax charge; and
• set out practical points which charity trustees should consider and discuss with the charity's investment managers when implementing a responsible investment strategy.

If you would like further information or advice on any of the topics mentioned in this update, please contact a member of the charities team.

The Charities Bill

In September 2017, the Law Commission published a report entitled "Technical Issues in Charity Law", setting out some of the legal issues which cause difficulties for charities and suggesting legal reforms to improve the position.

Given the intervention of Brexit and Covid-19, it is perhaps unsurprising that the Government did not find time to respond until March last year. However, the government then accepted 36 of the Law Commission's 46 recommendations and introduced a bill into the House of Lords in May 2021 to implement the recommendations. The Charities Bill (the "Bill") received its third and final reading in the House of Lords on 10 January and is now making its way through the House of Commons.

While the Bill does not introduce any seismic changes to charity law, it does propose focused amendments to make life easier for charity trustees. These cover a wide variety of topics, but we have picked out some key points.

Disposals of charity land

At present, trustees who wish to dispose of land are generally required to obtain a detailed surveyor's report providing advice on the sale. The intention behind the law is to prevent charities selling assets at an undervalue and wasting charitable funds.

Obtaining a report can be expensive and time-consuming, both because the report must be prepared by a member of the Royal Institute of Chartered Surveyors and because regulations set out a long list of detailed matters that must be included.

While this may be appropriate when trustees are selling valuable land, it is less so when the charity's interest in the land is of low value. We have been involved in advising a charity trying to dispose of the long lease of a hut, where the cost of the surveyor's report exceeds the value of the land.

The Bill amends the current requirements so that charities will be able to obtain a report from a wider range of professionals, which will include fellows of the National Association of Estate Agents and the Central Association of Agricultural Valuers. These professionals can provide the report even if they are trustees or employees of the charity. The Government has also confirmed that it intends to amend the (lengthy) regulations on the required contents of the report, so that reports can be more succinct and focus on the important points.

While charities selling a valuable piece of land will still likely want a full surveyor's report to give them comfort that the sale price is reflective of market value, these reforms will enable charities selling lower value land to do so more quickly and cost effectively.

Permanent endowment

Many charities hold funds on permanent endowment - defined in the Bill as property subject to a restriction on being expended which distinguishes between income and capital, i.e. the trustees can spend the income but not the capital of the fund.

While some donors wish to give funds on permanent endowment so that the gift will continue to benefit the charity in perpetuity, this does restrict the flexibility of trustees to spend capital where necessary for charitable purposes. This can become particularly problematic where most of the charity's funds are held on permanent endowment, so that the charity is wealthy from a balance sheet perspective but struggles to meet its day-to-day expenditure from the income of the endowment.

The Bill seeks to help trustees access the capital of a permanent endowment where appropriate. The trustees will be able to pass a resolution to release the restrictions on any permanent endowment up to £25,000 (previously, this was restricted to funds up to £10,000 or with up to £1,000 annual income). Further, the trustees will be able to borrow up to 25% of the permanent endowment to use on charitable expenditure, provided the sums are repaid within 20 years.

Failed charity appeals

Charities which undertake fundraising appeals for specific charitable projects can find themselves in difficulty if the project does not go ahead. For example, we have been advising a charity client which raised funds to finance a medical research trial which could not proceed.

The starting point is that funds should be returned to donors unless the donors disclaim the funds or one of the following applies:

• the charity has published advertisements in a prescribed form and waited three months for any donors to reclaim the funds;
• the donations come from a cash collection, lottery, competition or similar; or
• the Court or Charity Commission considers that it would be unreasonable to incur expense on returning the property given the amounts likely to be returned, or it would be unreasonable for the donors to expect the property to be returned given the circumstances and the lapse of time since the gifts were made.

In those circumstances, the donations will be applicable cy-près, i.e. for other charitable purposes.

The Bill simplifies the requirements, so that donations of up to £120 (including any other donations made that year by the donor) will automatically be applicable cy-près. The Bill also removes the complex rules about advertising and instead allows the charity to take reasonable steps to contact donors as agreed with the Charity Commission.

The charity will then generally need an order from the Charity Commission to confirm what alternative charitable purposes the funds can be applied towards. However, there is a new power for trustees to take this decision (without the permission of the Charity Commission) where the funds are up to £1,000.

While this is helpful, we would always recommend that charities make clear that any funds donated can be applied towards the charity's general charitable purposes. This gives the charity much more flexibility and avoids the costs and administrative complexity of trying to repurpose funds raised for a failed project.

Payment of charity trustees for goods

At present, there is a general statutory power for a charity to pay a trustee for providing services to the charity (unless the charity's constitution expressly forbids this). This is subject to strict requirements - there must be a written agreement between the trustee and the charity, the fee must be reasonable, the trustees must consider it in the best interests of the charity and only a minority of trustees can be paid.

The power is being extended, so that trustees can be paid for goods as well as services, and the same restrictions will apply. This will provide flexibility for charities where trustees can provide goods - often on better terms than a third-party supplier.

Mismanagement of a grant-making charity - a cautionary tale

In a recent judgment (Knightland Foundation v Charity Commission [2021] UKFTT 0365), the First-tier Tribunal (Charity) upheld a Charity Commission decision to appoint interim managers for the Knightland Foundation (the "Foundation"), due to serious concerns surrounding the charity's governance and finances.

The Foundation was established in 2011 as a charitable company for the relief of hardship in the Jewish community, the advancement of the Jewish religion and the education of Jewish pupils, and is funded from donations made by companies which are owned by one of the trustees, Mr Friedman. The Charity Commission has engaged with the Foundation since 2016, after the charity failed to file certain accounting information and various governance concerns emerged. In March 2017, the Commission issued the trustees with an "action plan" and continued to monitor the Foundation. Due to ongoing concerns, it opened a statutory inquiry and appointed interim managers to oversee the Foundation's affairs in early 2021.

The Foundation challenged the appointment of interim managers; however the Tribunal concluded that there had been mismanagement by the trustees in the administration of the Foundation and so the appointment of interim managers should be upheld. The Tribunal based this decision on two key issues:

• a "long standing failure to document decisions and decision-making processes in relation to the investment and other use of the charity's funds"; and
• Mr Friedman's dominance over the operation of the Foundation and the unwillingness or inability of the other trustees to exert any control.

Examples of mismanagement are as follows.

• The transfer of charitable funds to a company owned and controlled by Mr Friedman: whilst the Tribunal accepted that there had been no misapplication of funds (as the transfers were made to enable the Foundation to make use of the company's online banking facility and to provide proof of funds to purchase a property), the trustees "did not take reasonable and proper precautions to ensure that they fully understood the level of risk to the funds once those funds had been transferred out of their control". They did not take any legal advice on the basis on which the funds were held by the company for the Foundation, nor did they create a paper trail with the appropriate documentation and minutes recording the trustees' decision. Indeed, there is some evidence that one of the transfers of funds to Mr Friedman's company took place without the involvement of the other trustees.
• Interest free, unsecured loans to the Foundation's subsidiaries (of which Mr Friedman is the sole director): Charity Commission guidance notes that loans which are not secured and not on commercial terms may be deemed as non-charitable expenditure by HMRC (which could affect the availability of tax exemptions to the charity), and so such loans put the Foundation's funds at risk. Furthermore, the trustees failed to document the loans when they were originally made, and there are no minutes of any meetings at which the decisions to make the loans were discussed and approved. There is also no evidence that potential conflicts of interest were discussed.
• Payment of a developer fee (regarding a property development carried out by one of the Foundation's subsidiaries) to a company owned and controlled by Mr Friedman: various issues were identified in relation to this payment, including in particular the lack of management of the clear conflict of interest between the Foundation and Mr Friedman and the fact that the trustees did not consider the fee until after Mr Friedman had authorised its payment.

Despite its decision, the Tribunal accepted that Mr Friedman and the other trustees "genuinely believe that they have, at all times, acted in the interests of the Charity and that each has a genuine desire to continue to do so". It noted that "one can well understand Mr Friedman exercising control of the governance of the Charity because it is his generosity and business know how which has made the Charity such a success". Nevertheless, it emphasised the importance of maintaining transparency and openness in the Foundation's operations, procedures and decisions (particularly given the close relationship between the Foundation and Mr Friedman's private business operations) so that the Charity Commission could ensure that the Foundation is complying with the regulatory framework.

This case is a cautionary tale for wealthy individuals who wish to establish their own charity to channel their philanthropic aims, serving as a reminder that they must maintain a clear separation between the charity and their personal finances, as well as ensuring that proper decision-making processes (with a paper trail and proper management of any conflicts of interest) are in place.

The May Trust - distribution structured intentionally to incur UK tax for the broader social benefit

The Royal Court of Jersey recently confirmed in the case of IQEQ (Jersey) Ltd re the May Trust [2021] JRC 137, that a trustee could make a distribution which the beneficiary intended to use to (unnecessarily) incur UK tax.

The trust was established for the benefit of a family and for charity, but since 2014 the trustee had distributed over £8m to charity and less than £100,000 to the family. The trustee was now seeking the court's blessing to distribute nearly half the trust fund, £75m, to a UK resident beneficiary to enable him to make a charitable donation.

This in itself might have warranted an application for a blessing of a "momentous" decision, but the unusual point was that the beneficiary intended to structure the charitable donation to ensure an effective rate of 25% tax to HMRC, compared to the nil tax that would have been payable had the trustee made the donation directly.

The family had carefully considered their plan for their family wealth and had requested this distribution as part of their wider plan for charitable and philanthropic giving. They considered it important as part of their principles to pay tax, notwithstanding that it was legally unnecessary and notwithstanding decades of case law which confirm that there is no moral obligation to pay tax, only a legal one.

The court concluded that this could be for the benefit of the beneficiary and approved the distribution. This was on the basis that "benefit" has a wide meaning and is not limited to financial benefit; trustees can consider social benefits and perceived moral obligations of the beneficiary. It was reasonable for the trustee to make the distribution, given "the social justice aspiration of the Family".

The English case law on this is narrower, and the Jersey courts expressly decided to depart from the English case of X and another v A and others [2006] 1 WLR 741, which quoted the older case of Re Clore's Settlement Trusts [1966] 1 WLR 955, itself built on the Lords' ruling about the meaning of "benefit" in Pilkington v IRC [1964] AC 612. In X v A, the trustees sought the court's approval for a proposed distribution to charity for the benefit of an individual beneficiary, to relieve her of a moral obligation to give to charity. The court refused as the beneficiary would not have had the funds to make the charitable donation personally, so the trustees were not "relieving" her of a financial burden she would otherwise have had: a telling observation in para 41 of the judgment reflects that the arguments put forward for the distribution "place a greater weight on the personal views of the beneficiary than is justified by the authorities". The Jersey courts confirmed that this approach would not apply in Jersey, because they have a wider view of "benefit" to a beneficiary.

This Jersey case is a notable example of a recent trend of wealthy individuals having broader aims than tax mitigation. Many individuals and families now have a focus on ESG issues. In some cases, whether out of a feeling of personal commitment or a concern to guard against reputational damage, this will include a commitment to pay what they perceive as a "reasonable" amount of tax. It demonstrates the need for advisers to seek to understand their clients' aims, rather than assume that an unbending strategy of tax mitigation will be appropriate for all clients.

Responsible investment and charities - practical steps for charity trustees to engage with their investment managers

Last year, we discussed the Charity Commission's consultation on draft guidance for charities that wish to adopt ESG-integrated investing strategies which are aligned with their charitable purpose. Here, we consider some of the issues that charity trustees face when considering responsible investment strategies and provide some practical steps to consider.

The challenge presented by "greenwashing": new Government intervention

In June 2021, the Government announced the launch of the Green Taxonomy Advisory Group or GTAG: a new expert group "whose work will support investors, consumers and businesses make financial decisions". Crucially, the group is intended to mitigate "greenwashing - unsubstantiated or exaggerated claims that an investment is environmentally friendly" (ibid.). This is one of several Government initiatives in the green investment management space, perhaps the most influential of which to date has been the Government's declared intention to make corporate disclosures aligned with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations mandatory across the economy. Most recently, we have seen the publication of the Government's Green Finance Roadmap in relation to the implementation of the Sustainable Disclosure Requirements, which has the aim of streamlining disclosure and reporting of sustainability-related issues across the economy under a unified framework. These are clearly welcome developments, but implementation will not happen overnight.

With so many new "sustainable" and "impact" investment funds entering the UK market each year, investors are increasingly able to be specific about the impacts they are seeking to deliver through their application of capital. Many charities have operated investment screening - for example, the screening out of investments in gambling and tobacco - for decades. However, ESG investing poses a new challenge: for example, investing responsibly in the transition to a low carbon economy requires far more engagement than simple divestment and therefore involves complex qualitative analysis to assess impact on a new scale. Similarly, when assessing the social impact of an ESG or impact-labelled investment, this requires radically different techniques than traditional financial analysis tools and will have varied relevance across sectors and geographies. Particularly when investing in the public markets, arguably the only way to have impact is through the harder route of engagement rather than the blunter tool of divestment, which puts an additional burden on trustees.

How should charity trustees respond?

How do trustees know what "good" looks like in the context of their investment aims when they want to factor in non-financial impacts (or, indeed, ensure that their portfolios are adequately protected from systemic risks)? Ensuring that trustees gain a clearer understanding on these areas will be a key part of fulfilling their fiduciary duties in this rapidly changing landscape.

Whilst it may be hoped that the Sustainable Disclosure Requirements and industry bodies will facilitate progress in this area, there are certain key questions which charitable trustees should think about when they consider the adoption of an investment strategy which seeks to be aligned with their charitable purpose.

Whilst far from exhaustive, the following provides a starting point for trustees starting to engage with their managers and advisers on these issues.

1. What ESG benefits are claimed by the product?
   The words "sustainable", "responsible", "ethical" and "impact" often feature in marketing material, but they are subjective terms. Ask providers what they mean by using these terms. Similarly, statements with adjectives like "good governance" also require careful analysis. What features of governance are considered good, and which features are prioritised (for example: decision making at board level? Supply chain transparency?)?
2. How does the provider implement its ESG strategy?
   Does the provider implement negative screening, or does it score potential investments according to a responsible investing metric instead? Does it combine approaches? At what point are responsible investing considerations incorporated into investment decisions? If investments are scored, what are the criteria and can you request a sample?
   Implementation varies widely between providers. The integration of responsible investment considerations into decision-making at several levels is generally to be preferred. If a provider promotes responsible investing via shareholder engagement, consider asking for examples of this.
3. Monitoring and reporting
   What is the monitoring and assessment process for ESG credentials? What ongoing stewardship (e.g. voting at shareholder meetings or supporting activism) is carried out on investments, and how often?
   Larger charities may want bespoke reporting on responsible investment criteria and performance. If so, it should be confirmed with the provider that this can be accommodated.
4. Accreditation
   Frameworks are offered by many, including industry bodies, NGOs, self-imposed standards and regulators. Carefully assess the accreditation that the investor is offering. Is it commented on positively in the market? Will you be notified or consulted if these standards change, or if they are not met? Does the framework have minimum and/or mandatory requirements? Who is monitoring compliance?
   Acronyms are another point to consider. Check what they mean and consider what they represent. Not all acronyms are recognised or respected in the responsible investment community.
5. Market data
   Managers' investment decisions can only ever be as good as the information that they receive. You can ask what their sources of market data are, how it is quality controlled or independently verified and consider how it matches up against that of competitor providers.
6. Personal practice
   How seriously an investment manager takes corporate and social responsibility of its own affairs is a useful indicator for how seriously it will take similar issues into account in its fund investment strategies.
   Annual reports of the investment manager are increasingly a good source of information for assessing their carbon impacts if they are a public company. If a company does not take responsible investment commitments seriously themselves, it is a strong signal that their investment strategy is not seriously committed to responsible investing either. If there is insufficient detail in an annual report, or if it is a private company, you can ask them for information about measures they have taken to mitigate their carbon footprint directly.