A charity is insolvent if it cannot pay its debts as and when they become due and payable.
Insolvency is determined by looking at the financial position of an organisation as a whole. A charity that is experiencing an irregular or temporary shortage of cash isn't necessarily insolvent. However if this issue becomes ongoing, or a charity has debts or invoices for goods it can't pay when they fall due, it may be insolvent.
Under Governance Standard 5, a charity’s Responsible People have a duty to not allow their charity to operate while insolvent.
Responsibility to not operate while insolvent
ACNC Governance Standard 5 requires a charity's Responsible People to ensure their charity is not allowed to operate while insolvent.
A charity must take reasonable steps to ensure its Responsible People fulfil the duties set out in Governance Standard 5.
For a charity that is a company, in addition to the ACNC’s Governance Standard 5, there are duties set out in the Corporations Act 2001 that still apply to Responsible People (directors), including the duty to prevent insolvent trading. If a charity that is a company continues to operate while insolvent, its directors may be subject to legal action under the Corporations Act 2001.
For a charity that is an incorporated association, in addition to the ACNC’s Governance Standard 5, office holders may have responsibilities to the charity’s state or territory regulator.
For more information about specific requirements, check with the relevant state or territory regulator of incorporated associations.
Signs of insolvency
There are various warning signs that might indicate a charity is facing financial trouble. Be aware of them and know when they may indicate that your charity could be in danger of insolvency.
It is important to know remember that there are many factors that contribute to a charity’s overall financial health. Temporary problems with cash flow or similar issues are not necessarily a sign that a charity is in danger of becoming insolvent.
Consider the warning signs in the context of your charity’s circumstances.
Some warning signs may include:
- difficulty paying bills or for goods and services
- a history of financial losses in consecutive financial periods
- trouble producing accurate and timely information about your charity's performance and financial position
- overdue tax debts (for example, superannuation guarantee contributions, PAYG withholding or GST)
- late payments to creditors that have resulted in stricter credit terms or creditors now requiring cash on delivery payment
- payments being declined (for example, payments by credit card or cheques)
- loan applications being declined
- trouble paying staff on time
- loss of a major income source or significant funding
- relying on funding from unreliable sources
- a noticeable increase in costs or decrease in income compared to budget projections
- creditors threatening or commencing legal action for unpaid debts
- board members or staff raising concerns about the charity’s financial situation.
Guarding against insolvency
A charity and its Responsible People should take a range of steps to guard against insolvency.
These steps may include:
- not taking on debt that the charity cannot expect to pay back comfortably
- seeking contracts for goods and services that provide value for money
- keeping costs and expenditure reasonable
- seeking funding from a range of sources so the charity is not reliant on a single source (or small number of sources)
- ensuring balance sheets and cash flow statements are kept accurate and up to date
- ensuring budgets are accurate, and financial forecasts are realistic and well considered
- presenting financial reportsand providing updates at all committee or board meetings
- maintaining open and transparent decision-making processes about finances and expenditure
- developing a clear approvals process for charity expenditure involving Responsible People or the appropriate level of charity management
- identifying, disclosing and managing conflicts of interest to ensure financial dealings are transparent
- emphasising the importance of ACNC Governance Standard 5 and the duties it sets out for Responsible People about financial management
- making the duties of Responsible People a part of the charity's induction and handover processes
- creating a culture of open disclosure within the charity
- having a clear process for Responsible People and staff to raise concerns about the charity's financial situation.
The Responsible People of a charity should speak up early and ask questions if they think there might be a problem with their charity’s solvency. They have a responsibility to do so, and it may be the difference between they charity surviving or folding.
What to do if your charity is facing insolvency
A charity's Responsible People have a duty to act if they believe their charity is facing insolvency.
If you believe your charity may be facing insolvency, you should:
- talk to an appropriate person in your charity (for example, one of your charity's Responsible People, a manager, a finance officer) about your concerns
- seek professional advice from outside your charity (for example, from a financial advisor, accountant or lawyer)
- examine your charity’s finances to see if you can increase income or cash flow. This might include:
- calling in outstanding debts or fees owed to the charity
- looking at ways to cut costs
- looking for additional funding sources
- holding a fundraising appeal or seeking financial support from members
- negotiate payment plans with institutions your charity owes money to.
Voluntary administration is an option available to some charities. This is where an independent administrator is put in charge of the charity with a view to either:
- restructuring it so that it can continue to operate, or
- liquidating its assets and winding it up.
But if your charity is facing insolvency, getting help and advice from a professional with experience in handling insolvency is a good idea.
What to do if your charity is insolvent
If your charity becomes insolvent, it will need to appoint an administrator or liquidator to manage its affairs. In some cases, this will result in the charity being wound up.
It is important your charity gets this help early to ensure its operations do not continue while insolvent.
If a charity is insolvent and has not acted to appoint an administrator or liquidator, an unpaid creditor of the charity may commence legal action to request a court to order that the charity be wound up.
When a charity is wound up, it ends its operations and ceases to exist. Winding up a charity is permanent and cannot be reversed.
In winding up, a charity must follow its rules, as well as any relevant legal requirements. These requirements will depend on the structure of the organisation.
For example, state or territory regulators have requirements for winding up an incorporated association and the Australian Securities and Investments Commission (ASIC) has requirements for winding up a company limited by guarantee.
As part of the winding up process, a charity must also apply to have its charity registration revoked by the ACNC. Do this by filling out the online form available in the ACNC Charity Portal.
There have been changes to the ATO's insolvency framework to help more small businesses, including some charities, restructure and survive the economic effects of COVID-19. Read more information about the insolvency reforms from the ATO.
The consequences of operating while insolvent
For charities that are incorporated associations, the state or territory regulator may issue penalties for Responsible People who breach their duties by allowing their charity to operate while insolvent. Legislation governing incorporated associations differs in each state and territory and it is important to check the details of consequences for operating while insolvent with the relevant regulator.
For charities that are companies, continuing to operate while insolvent may be considered an offence or contravention under the Corporations Act 2001. The main types of legal action that can be taken against directors for insolvent trading include:
- compensation proceedings
- criminal charges
- civil penalties.
The Australian Taxation Office (ATO) may also issue a Director Penalty Notice against a director for outstanding tax and superannuation obligations linked to their charity.
- More information on winding up a charity
- The ACNC's two-part Charity Chat podcast looking at charities and how they can deal with financial difficulties, including insolvency.
- Insolvency factsheet from NFPLaw @ Justice Connect (PDF download, 369 KB)