Social Enterprise Derby and Derbyshire

Legal Status Pros and Cons

Why Bother about Legal Status?

Anyone can get together and agree to start a group without legal formalities. In law, this is called “an unincorporated association” i.e. it is not a corporate body or company. There are other kinds of legal structures which you may wish to choose.

The following list gives the advantages and disadvantages of the main types. Please note you can be A and B or B and C! You are then subject to both sets of requirements. The recent review of Charity Law is proposing many alterations - see sections at end of page.

A. Unincorporated Association

The advantages of this kind of group are:

flexible, quick and cheap to set up
can have any aims and rules – easy to change these from time to time
members can have a say in day-to-day decisions
paid staff can be on the committee
no limits on political activity
no limits on trading
no rules re format of accounts or where they have to be submitted
easy to wind up

The disadvantages of this kind of group are:

the groups is not a legal identity
property cannot be held in the group’s name
there is no limit to the financial liability of individual members
no automatic relief from Corporation Tax
no automatic relief from business rates
may not impress funders or donors
individual members of the committee are jointly and severally liable for contracts
people may be unclear about liabilities

B. Charities

The advantages of this kind of group are:

automatic relief of 80% business rates
usually automatic relief from Corporation Tax
more respectable in the eyes of the public
may be easier to raise money from many different types of funders and donors
some charitable trusts will only fund charities
easier to attract committee members
support from Charities Commission

The disadvantages of this kind of group are:

objects and activities must be exclusively charitable
must register with the Charity Commission if turnover above £1,000
paid staff cannot be on the committee
committee members (trustees) cannot be paid
constitution must follow charity rules
accounts must be in a prescribed format & submitted to the Charity Commission
limits on political activity & campaigning
limits on who can be a trustee

C. Incorporation (Limited Company)

The advantages of this kind of group are:

the organisation is a legal entity
can enter into contracts, rent or own property in own right, no need for holding trustees
limited liability for members & governing body
paid staff can be on the committee (not if also a charity)
no limits on political activity (not if also a charity)
no limits on trading (not if also a charity)
transparency – details of directors public
written models of Memorandum of Agreement and Articles of Association
company status is respected by public and funders
Company Secretary can be a member of staff or a Board member
Company accounts format provides structure
permanent succession – no need to transfer contracts or leases when someone leaves who signed originally
permanent – company exists until dissolved even if dormant

The disadvantages of this kind of group are:

false sense of security e.g. limited liability disappears if technically insolvent
company directors are still personally liable if negligent
in practice, most landlords require named individuals to be liable for leases
most lenders would required named sureties
details of directors and members public
language of “Memo and Arts” not user friendly
restrictions on who can be a company director
need a Company Secretary 1/5
administration requirements heavy
company law requirements: registered number and where registered must be on publicity, must hold an AGM, submit annual accounts, company returns and resolutions
risk of fines and imprisonment if company requirements not followed – over 200 criminal offences within company law
formal process needed to bring it to an end –
cannot just pass a resolution to dissolve.

D. Charitable Company

This has the advantages and disadvantages of B and C combined with the added complication of having to follow two different sets of rules, charity law and company law.; two registration processes with two different bodies – the Charity Commission and Companies House – two returns to be submitted each year. The Review of Charity Law seeks to remedy this (see Appendix A).

E. Charitable Trusts

These are usually set up to raise and/or distribute funds. There will be a trustee board with no beneficiary involvement. They are regulated by the Charity Commission and are unincorporated bodies. This makes administration and governance less complicated. However, this also means individual members can be held liable for debts. They lack the structure and assurance for large scale activities or funding.

F. Trustee Incorporation

This is not frequently used. It enables the governing body of a charitable trust or charitable association to incorporate itself. This gives the trustee body a legal entity and enables them to enter into contracts, own property and take action as a corporate body without giving the trustees limited liability.

G. Industrial and Provident Societies (IPS)

This structure is suited to bona fide (genuine) co-operatives and to voluntary organisations trading or carrying on an industry or business for the benefit of the community. Members agree to purchase one or more shares in the IPS and their liability is limited to the amount unpaid on the purchase of the shares. It is unlawful for an IPS to say it is a registered charity even if was set up for charitable purposes: it can say it is “a charity exempt from registration” and/or use its Inland Revenue charity reference numbers.

ALL IPSs register with Mutual Societies Registration, part of the Financial Services Authority. The Registry of Friendly Societies has a supervisory responsibility for IPSs.

From April 1st 2004 the very strict rules voiding all acts outside the I&PS's or committee powers were eased. From the same date, where the name of a charitable I&PS does not include the word "charity" or "charitable", the fact that it is charitable must be stated on business letters, notices, advertisement, cheques, orders, invoices, receipts etc. From 20th October 2003 I&PSs no longer need to have a seal.

From 6th April 2006 non-charitable community benefit industrial and provident societies can pass a special resolution to amen their rules, "locking in" assets so they cannot be distributed to members, but must always be used for the benefit of the community. This does not apply to charitable community benefit I&PSs, which are already subject to an asset lock under charity law, and registered social landlords.

H. Co-operatives

Co-operatives are democratically run by the members with each member having one vote at general meetings. It is quite common for workers to be members (workers co-ops). Some co-ops allow profits to be distributed to members; others are set up on a not-for-profit basis where the profit is put back into the business.

The advantages of this type of group are:

worker and community member control
the advantages of incorporation: limited liability, legal personality, permanent succession, right to own property
less legislative requirements
less public disclosure
less risk of fines and prosecution than in company law
don’t need to send accounts to each member therefore costs are lower
model rules available
charitable IPSs have tax advantages without having to register with the Charity Commission (register with Inland Revenue - quicker) ¨ ICOM – the Industrial Common Ownership Movement – publishes models of different forms of governing document for co-operatives

The disadvantages of this type of group are:

conflict of interest between workers needs and those of the co-op
high structural complexity and difficult to get advice on procedures from voluntary sector advisers or lawyers
IPS not a structure familiar to funders
must have three members
must be democratic - no places for outside bodies on governing body
slow, cumbersome registration process & more expensive than for companies
co-ops have variable history of success
charitable status not familiar to funders who expect charities to be registered with the Charities Commission and have a registered charity number

I. Development Trusts, Village Development Companies, Civic Trusts, Community Regeneration Companies

These will take one of the forms under A-G. The Development Trusts Association says, “The legal structure of development trusts is most frequently that of a company limited by guarantee….As the activities of development trusts are frequently charitable, many development trusts apply for charitable status, so that they are operating through a charitable company….However, since development trusts also aim to earn income through trading activities – and there may be limited on what they can do as a charity – they frequently set us subsidiary trading companies which can covenant profits back to the main charitable company”.

J. Partnerships

Some partnerships are loose informal structures without any specific legal status. Others may have working rules, protocols, or even “constitutions”. Those with very detailed rules may be classified as unincorporated associations. Partnerships concerned with regeneration or strategic partnership often use a separate limited company or local authority as an accountable body through which funds may pass.

K. Community Interest Companies

Community Interest Companies are specially designed for social enterprises and the not-for-profit sector. They register with Companies House as a company limited by guarantee or a company limited by shares, then apply for CIC status to the new Regulator of Community Interest Companies. The regulator will need to be satisfied that the organisation meets "a community interest test" and will genuinely operate for the benefit of the public.

Community Interest Company must be included in the title, limited cannot be used in its name.

CICs must produce an annual community interest company report with information relevant to CIC

The constitution must contain an asset-lock clause, which ensures that its assets can never be distributed to private individuals or companies.

Community Interest Companies can pay their directors salaries providing they are not trustees.

The Community Interest Companies Regulator imposes strict rules and organisations will be monitored on a regular basis.

A charitable company based in England or Wales can convert to a CIC, but only if the Charity commission agrees that it is in the charity's interest. Social Enterprises may use this as the most appropriate legal structure.

The advantages of this kind of group are:

freedom to trade
able to pay Directors
retains benefit within the community
can bring in investment
tax benefits for investors
not having to comply with company & charity law

The disadvantages of this kind of group are:

no tax benefits - rates etc.
Some Charitable Trusts cannot fund
auditing the Community Interest Statement
additional costs
will not necessarily attract investors

L. Other Forms of Legal Status

There are many specialised forms of legal status, some of which are subject to legislative regulation e.g. housing associations and credit unions. Organisations such as the Chamber of Commerce, trades unions and employers federations are part of the “wider voluntary sector”. Talk to Links if you are not sure about any thing.

Social Enterprises

Social enterprises (sometimes called community enterprises or community businesses) are a concept not a legal structure. Any of the structures listed above (unincorporated association, limited company, trading arm of charity, registered charity, IPS, credit union, co-operative or Community Interest Company) can operate a social enterprise. Franchised social enterprises are being developed which replicate successful models, sometimes as satellite projects of the main organisation.

“Social firms” are businesses which provide employment for disabled people.

The “social economy” is a term which encompasses social enterprises, social firms and the whole range of charities, voluntary and community groups.

Latest Proposed Changes to Charity Law

The Prime Minister’s Strategy Unit published its report on the legal and regulatory framework governing charities and the voluntary sector, Private Action, Public Benefit on 25th September 2002. The bill completed its report stages in the House of Lords in November 2005 and has now moved to the House of Commons, but no dates have been set yet for debate. It sets out a range of proposals which aims to:

modernise charity law and status to provide greater clarity and a stronger emphasis on the delivery of public benefit;
improve the range of legal forms enabling organisations to be more effective and entrepreneurial;
develop greater accountability and transparency to build public trust and confidence; and
ensure independent, fair and proportion regulation.

Updating and expanding the list of charitable purposes

The report proposes to redefine a charity as an organisation which provides public benefit and has one or more of the following thirteen purposes:

The prevention and relief of poverty
The advancement of education
The advancement of religion
The advancement of health or the saving of lives
Advancement of citizenship or community development
The advancement of culture, arts, heritage or science
The advance of amateur sport 4/5
The promotion of human rights, conflict resolution and reconciliation or the promotion of religious or racial harmony or equality and diversity
The advancement of environmental protection and improvement
Relief of those in need by reason of youth, age, ill health, disability, financial hardship or other disadvantage
Advancement of animal welfare
Promotion of the efficiency of the armed forces
Other new purposes which are analogous (similar) to another charitable purpose.

These thirteen purposes will replace the existing four “head” of charity: the relief of poverty, the advancement of education, the advancement of religion and any other purposes beneficial to the public. The aim is not to change what purposes are eligible but to clarify the current four “heads” and existing case law. All purposes which are currently charitable will continue to fall within one of these ten purposes.

Clearer focus on public benefit

At present public benefit is only assessed on application for charitable status. The report proposes that every charity will be expected to publish in their annual report an explanation of how they provide public benefit and the Charity Commission will systematically check these. In addition, the Charity Commission will be undertake checks on the “public character” of charities which charge high fees e.g. public schools and private hospitals.

Making trading easier

Charity law currently permits charities to undertake trading that is directly connected with, or is ancillary to, their charitable purposes. Any charity undertaking substantial trading to generate income has to set up a trading company. Although this system has some benefits, the reports says that it is administratively complex, expensive and can inhibit charities from diversifying. The report proposes greater freedoms for charities to trade without establish separate trading arms.

Improving the range of legal forms available to charities and social enterprises

Changes have been made to the law on Industrial and Provident Societies and the new structure Community Interest Companies is available proposals are still in the pipeline for a new legal form of Charitable Incorporated Organisation, avoiding the new for dual registration as charity and company.

The report also proposes greater accountability and transparency for the sector with clearer information being supplied to the Charities Commission; a new fundraising body to develop self regulation and good practice; a new unified licensing scheme for street collections; relaxing the rules of paying charity trustees; and making the role of the Charity Commission more clearly regulatory renaming it the Charity Regulation Authority. A controversial proposal is to increase the threshold of registration from £1,000 income to £5,000 but charities under the threshold will be able to register voluntarily.

Information provided by LINKS - the Chesterfield and North East Derbyshire Council for Voluntary Service and Action Ltd