Mergers and incorporations: managing the risk of losing legacy income

Gareth Roy, Senior associate in the Russell-Cooke Solicitors, charity law and not for profit team. Chris Rowse, Partner in the Russell-Cooke Solicitors, charity law and not for profit team.
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Gareth Roy, Chris Rowse

The value of legacies

Legacy Foresight, analysts of the legacy sector, recently forecasted 23% growth in the number of charitable legacies over the next decade and 16% growth in value in real terms. This suggests legacies could become increasingly important to the sector.

Legacies are often considered particularly important to large charities, but small charities can sometimes be surprised by an unexpected, or unexpectedly large, legacy, which can sometimes be transformative.

What happens to legacies after the merger or incorporation of a charity?

Incorporations proceed by a new, corporate, entity being set up and the assets and liabilities of the unincorporated charity (Charity A) being transferred to that incorporated organisation (Charity B). Mergers also often involve a transfer of assets from Charity A (the transferring organisation) to Charity B (the receiving organisation). After such a transfer (in either case), Charity A will often be dissolved either automatically, by operation of law, or following a dissolution process, depending on the legal structure of the charity.

Where a legacy is left in a will to a specific charity that has ceased to exist at the testator's death, the default position is that the legacy will fail.

To protect against this risk, it is possible to register the merger or incorporation of a charity on the Charity Commission's register of mergers. The effect of making such an entry is that most gifts left to Charity A will automatically pass to Charity B after Charity A has ceased to exist.

However, whilst this automatic transfer will usually happen, there is a risk that some types of legacies may still fail, even where an entry has been made in the register of mergers. This is because the section of the Charities Act 2011 setting out the effect of making such a registration may not cover legacies which name an alternative charity as the recipient of a legacy if the first-named charity has ceased to exist. For example, a legacy which is drafted to "Charity A provided it is in existence as at the date of my death" would very likely fail if Charity A had ceased to exist after transferring its assets to Charity B, notwithstanding any entry in the register of mergers.

The use of "shell" charities to protect legacy income

Given this risk and to protect legacy income in a more comprehensive way, some charities decide to retain Charity A as a 'shell' charity after the merger or incorporation has taken place.

As Charity A continues to exist it can continue to receive legacy income. Upon receipt of any such income, Charity A will typically transfer the funds to Charity B, in accordance with the terms of an agreement between the two charities.

Whilst this course of action can help protect legacy income, it has drawbacks. As Charity A continues to exist as a charity it will need a constitution and trustees and it will have ongoing administrative and compliance obligations and incur corresponding costs.

In the case of incorporations, it is also possible that the retention of the old unincorporated charity can cause other difficulties. If the unincorporated charity continues to exist and the charity's administration is less than perfect, it is not impossible that the charity inadvertently starts operating, or partly operating, through the old organisation. Corporate memory can also fade over time and the charity can forget why there are two charities in existence which may cause problems.

The future

For now, trustee boards need to consider the pros and cons and make a judgement call on their preferred approach when merging or incorporating, balancing the risk of losing some future legacies against the administrative and other burdens associated with retaining a shell charity.

In future, it is possible that the law will be changed and the protection offered by the Charity Commission's register of mergers strengthened – this was the recommendation of Law Commission's 2017 report, "Technical Issues in Charity Law".

However, with Parliamentary time likely to be at a premium for the foreseeable future, no change is presently on the horizon.

Briefings Charities Mergers Charity law Gareth Roy Chris Rowse