Since the mid 1990’s, there have been continuing discussions at a strategic level about the creation of a new kind of legal entity for charities – the Scottish Charitable Incorporated Organisation. The foundations for this were subsequently laid down in the Charities and Trustee Investment (Scotland) Act 2005 (the “Act”). 20 sections of that Act set out the principals behind a SCIO, but then leave it to the Scottish Ministers to make further provisions in what we anticipate to be fairly complex secondary legislation. These sections of the Act will not come into force until the secondary legislation setting out the operational framework has been adopted.
The aim behind SCIOs is to create a structure which is as simple as possible for its users but which still provides the necessary accountability and governance safeguards - SCIOs will allow charities to enjoy the benefits of incorporation without being subject to the “complex apparatus of company law and dual regulation currently imposed on charitable companies”.
A SCIO will have its own legal personality and may therefore own property and enter into contracts in its own name, rather than through the charity’s trustees acting in a personal capacity. A SCIO would be liable for its own debts and will be able to sue and be sued. In addition, the members of a SCIO will have no liability to contriute to the assets of a SCIO in the event of its winding up.
Charitable companies limited by guarantee are required to with company law and must therefore report to both Companies House and OSCR. In contrast, SCIOs will only be regulated by OSCR and will not therefore be subject to the administrative and operational reporting requirements placed on companies.
What does the Act say?
In order for a charity to become a SCIO, an application will need to be made to OSCR. The Act sets out the general requirements which a SCIO must meet, namely that:
- the SCIO must have only charitable purposes;
- the constitution of the SCIO must not permit its property to be used for non-charitable purposes; must not contain in its constitution express powers of direction or control by Ministers; and it must not be a political party or have as its purpose to advance a political party; and
- the SCIO must provide a public benefit in Scotland or elsewhere.
The Act also provides that a SCIO must have:
- a constitution;
- a principal office in Scotland;
- 2 or more members;
- 3 or more trustees;
Once a SCIO is accepted by OSCR then:-
- it goes onto OSCR’s register; and
- is treated as a body corporate.
Certain of the trustees’ duties set out in section 66 of the Act are to apply to members of a SCIO – this means that in exercising their functions as members, they must act in the interests of the SCIO, seeking in good faith to ensure that the SCIO acts in a manner which is consistent with its purpose (failure to so act will be considered misconduct in the administration of the charity). This is different to the position for charities which are companies or unincorporated associations, where this obligation only applies to directors or charity trustees. This seems to us to be a slightly curious change and can only be explained as a quid pro quo of members having no liability in the event of a SCIO’s winding up.
The Scottish Government’s consultation
A Scottish Charitable Incorporated Organisation Working Group was set up to advise the Scottish Government on the implementation of the new legal form and, as a result of those discussions, in November 2009, a consultation paper was published.
At the outset, the Working Group recognised that in producing any form of secondary legislation to govern SCIOs, a balance would need to be struck between – on the one hand - charities seeking a simpler form of regulation, and - on the other hand - funders, lenders and professional advisers looking for assurances similar to those offered by the structure of a company limited by guarantee –(we will touch on this later in this article).
The Working Group also spent time considering if the SCIO regime should provide a very detailed regulatory framework (providing certainty but little flexibility, which could deter charities from seeking SCIO status), or basic regulations (which would provide greater flexibility but less certainty).
The consultation paper focuses on the policy principles which will “determine the structure of the SCIO and the design of the regulatory framework within which it will operate”. The consultation paper is set out in 5 parts:
- Part 1 sets out the background to the development of the SCIO and design questions
- Part 2 sets out three potential models for the SCIO
- Part 3 discusses technical aspects of the SCIO regulatory framework
- Part 4 focuses on the issues of associated with winding up and dissolution
- Part 5 sets out the next steps
The three models
The Preferred SCIO Model
This is the option which was preferred by the Working Group. In essence, this option is based on Scottish charity law with some specific SCIO ‘add-ons’. This model sets a basic level for a SCIO but would be flexible enough to allow a SCIO to go further if so desired. Trustees (and to some extent members) will be bound by the provisions of the Act which deal with good governance. The Group considered whether regulations to introduce this model should include model constitutions (as is the case in England). The conclusion reached on this point was that the regulations should list the requirements to be included in a constitution, but not to provide actual clauses or a model constitution as such (while it was recognised that a model constitution would help smaller SCIOs, providing models could be inflexible for larger charities and could also inadvertently encourage complacency in the sense that charities might become SCIOs without really understanding what their constitutions provide for).
The Company Model
The regulations for this model would draw significantly from company law (such as in relation to the execution of documents; publication requirements for charges etc). It is anticipated that this model would require more administration than the other two models. The Working Group concluded that this model would not serve the needs of the target market for SCIOs – the smaller to medium sized unincorporated charities, where significant regulatory requirements would be a burden.
The Minimalist Model
The third model which was considered was the Minimalist Model. This would take the provisions of the Act which already deal with the creation of SCIOs (see the paragraphs above summarising the provisions of the Act which specifically deal with SCIOs) and then do the absolute minimum in terms of the drafting of secondary legislation. The Group felt that this approach would lead to more uncertainty and the degree to which third parties would be confident in engaging with such a loosely regulated entity was questioned.
Borrowing and Accounts
The consultation paper also touched on a SCIO’s borrowing powers – the Act provides that a SCIO is empowered to do anything which is calculated to further its purposes (subject to anything which is contained in its constitution). So, the view is that this means that a SCIO can borrow. Of course, this assumes that lenders will be willing to lend to a SCIO.
Often, lenders require a borrower to grant some sort of security (such as a standard security over property, or a floating charge over assets). This gives the lender greater protection in the event that the loan is not repaid, or the borrower gets into financial difficulties. As explained in the consultation paper, most of these charges are registered at Companies House, which gives potential lenders the opportunity to check what existing charges are registered against a specific entity. The consultation paper asked if the SCIO regime should follow a similar procedure, and if it did not, asks if this may impact on a lender’s willingness to lend.
It is worth noting here that SCIOs will not be able to grant floating charges. This is because floating charges can only be granted by companies (and a SCIO is not a company).
For smaller charities which are not companies, the Act permits the preparation of ‘receipts and payments accounts’ (unless the charity’s constitution requires otherwise). For charitable companies, accounts must be prepared on an accrued basis. The paper asks if SCIOs should be subject to a blanket approach that all SCIOs are to produce SORP-compliant accrued accounts, or whether a proportionate approach should be followed which sets out different requirements for SCIOs with different levels of income. The Group were minded to follow the approach currently taken in relation to charities, but welcomed views.
The Working Group was (perhaps unsurprisingly) exercised by what should happen in the event that a SCIO goes into solvent or insolvent liquidation. Little (if any) detail about liquidation is set out in the Act, so it was left to the Working Group to come up with some options for discussion. This section forms the largest part of the consultation paper, where a number of options are set out for further consideration.
A solvent dissolution is where a SCIO is to be wound up but is able to pay its debts.
Option 1 – the basic option – this would follow a process similar to that currently used where an unincorporated association applies to OSCR to be dissolved. Would this process be sufficient given a SCIOs incorporated status? Potential creditors (including those contracting with a SCIO and lenders) might well expect a more formal dissolution process.
Option 2 – striking off – this process would be broadly equivalent to the process currently used to strike a company off the Registrar of Companies. The SCIO may be required to satisfy certain conditions before OSCR could approve of such a striking off.
Option 3 – members’ voluntary liquidation process – again, this would be similar to the current process for companies. A liquidator would need to be appointed, so there would inevitably be a cost associated with this (but greater comfort for creditors perhaps?).
Option 4 – only allow a solvent SCIO to follow the insolvent dissolution process – this would mean all SCIOs could only use one process, which would bring consistency, however there would be associated costs (which would disadvantage the smaller SCIOs which have limited or no funds available to them).
This is where a SCIO is to be wound up but is unable to pay its debts. Factors which the Working Group considered here were:-
- the costs involved in any such process, and whether such expense is a good or appropriate use of charitable funds; and
- the length of time each option would take to develop (hence the suggestion of a temporary option – see Option 5).
Option 1 – apply the current corporate insolvency regime – the perceived advantages with following this option are that the process is familiar and established and offers a range of options to creditors. Disadvantages are that the regime may be disproportionate for smaller SCIOs, and cost. Drawing out the relevant legislation to apply to SCIOs would take time and in the Working Group’s opinion would delay the introduction of the SCIO.
Option 2 – apply the current insolvency regime with modifications – this would be based on the current corporate insolvency regime with elements considered inappropriate for SCIOs being stripped out.
Option 3 - appoint an independent third party to manage the more complex insolvency cases – this would involve developing a bespoke form of insolvent dissolution, based on existing provisions but also incorporating elements to reflect the “realities of the charity sector in Scotland”. The Working Group felt that in some circumstances (e.g. where there are employees or where creditors wish to contest a proposed settlement) there may be a need for some sort of independent adjudication, though it accepted that such a process could be lengthy and costly.
Option 4 – the default regime – here, a SCIO would be treated like an unregistered company – the benefits in using this system are that no new legislation would be required, and the costs would be lower. Disadvantages are that a SCIO could not itself petition to be wound up under these arrangements.
Option 5 – apply the default regime in the interim, while a specific regime is developed – the conclusion reached by the Working Group was that Options 1 and 4 are too inflexible. The Working Group was attracted towards Options 2 and 3, but recognised that either of these options would take time to develop and would delay the SCIOs introduction. So, a fifth option was put forward which would apply the default option (Option 4) in the intervening period while a dedicated regime is developed.
On 1 April 2010, the Scottish Government published its summary of the 63 responses it received to the consultation. The majority of the responses agreed with the proposals put forward by the Working Group in terms of the preferred model for the SCIO which “seeks to balance administrative ease and minimal cost for charities with a robust and credible framework in which third parties can transact with confidence”.
The majority of the responses felt that it would be better for the regulations to set out the minimum requirements which a constitution must cover, rather than setting out the exact form and content. There was a divergence of opinion amongst consultees as to whether the SCIO regulations should include model constitutions, though it was accepted that templates would assist smaller charities. The question remains – who should be responsible for producing such models – OSCR or umbrella organisations? The Scottish Government has not reached a final view on this point.
Note that the Government is minded to require a SCIO to maintain a register of members (but would not require this to be made available to the public). Depending on the extent of the membership and the frequency of changes, this could be an adminstrative burden for SCIOs – the Government’s response to such concerns is that if such a requirement is too onerous for an organisation, then it should consider whether another legal structure would be more suitable to it.
The majority of consultees agreed that the accounting requirements for SCIOs should follow those for charities (and not companies).
There was little support for the registration of charges and perhaps due to the technical nature of the proposals, there were few responses on the ‘end of life’ questions which were posed in the consultation paper. Of those that did respond on these specific questions the preference for solvent dissolution was to use the least administratively cumbersome option (somewhere between Options 1 and 2 outlined above). For insolvent dissolutions, there was a split in preferences, but Option 5 (apply the default regime in the interim, while a specific regime is developed) apparently received the most support.
There has been some discussion surrounding the impact of the wording contained in section 55(7) of the Act which states that if a SCIO ceases to be a charity, then it ceases to be a SCIO. In such an event (e.g. if for instance the SCIO strayed – either deliberately or inadvertently - from its charitable purpose), what would happen to its property, its employees, assets and its contracts? What does the SCIO actually become? There is unfortunately no clear answer to this question at this stage, and it remains to be seen how such matters will be addressed in the regulations. We suspect that until the position is made clear, there will be a reluctance on the part of those wishing to incorporate as a SCIO to venture down the SCIO path and those who hope to contract with or lend to SCIOs may be unwilling to commit to lending to such entities or contracting with them.
Similarly it is unfortunate that discussions surrounding insolvent dissolution are not more advanced, and it remains to be seen whether lenders in particular will be interested in funding SCIOs while a specific SCIO insolvency regime is developed.
The Scottish Government will now push on with the development of draft SCIO regulations and these will be the subject of further consultation later in the year, before final regulations are laid before the Scottish Parliament.
Who will use this structure?
The Scottish Government predicts that initially, most applications to become SCIOs will come from unincorporated associations wishing to convert to become a SCIO and that subsequently, there will be interest amongst charitable companies wishing to convert.
What is the position in England?
In England, similar provisions for the creation of CIOs have been incorporated into the Charities Act 2006. The Office of the Third Sector and the Charity Commission for England and Wales are currently developing subordinate legislation to implement CIOs – this was the subject of consultation in 2008. The intention is for CIOs to become available sometime in 2010 – though whether this can be achieved remains to be seen. The Scottish Government has acknowledged that there are significant differences between the Scottish and English legislation – our view is that the creation of two regimes will inevitably cause difficulties (and confusion) for organisations, their advisers and their funders.
To access the Scottish Government’s consultation paper (now closed) go to www.scotland.gov.uk/Resource/Doc/292195/0090094.pdf
To access the Scottish Government’s analysis of the written responses to the consultation paper go to www.scotland.gov.uk/Resource/Doc/308670/0097127.pdf