The COVID-19 pandemic is placing significant pressure on the existing and future resources of some not-for-profit (NFP) organisations. With resources typically stretched in NFPs in a regular environment, many NFP organisations may have serious financial issues to address during these times.
Ultimately, an NFP organisation exists to carry out the particular purpose of the organisation, whether it be through the provision of services or furthering a cause. In this article, we outline the options available to NFPs to ensure an organisation can continue its operations. If, however, continuing operations is not commercially viable, we also provide an overview of the options available for the dissolution or wind-down of an NFP.
Survival through hibernation
The concept of “hibernation” has primarily come about as a consequence of the Government’s measures to support businesses and NFP organisations throughout the COVID-19 financial fallout.
It is important to consider preparing and reviewing a cash flow forecast to determine if hibernation is a viable option. For hibernation to be a viable option for an NFP organisation, the cash flow forecast should show that there are sufficient cash reserves, or an ability to generate sufficient cash, to place the organisation into “hibernation” or a state of limited operation. The cash flow forecast should demonstrate that the organisation will be able to sustain its debts once ordinary operations recommence.
Some steps an organisation may take in a hibernation period include:
- contacting landlords to renegotiate rent obligations
- contacting financiers and other creditors to defer or renegotiate debt repayments
- standing down all non-essential employees
- preparing a plan for payment of debts that have been deferred during the hibernation period
- minimising cash outlays and regularly monitoring cash flow forecasting.
Organisations should also monitor day-to-day cash flow against their forecast. If cash flow deteriorates over a hibernation period, the organisation should consider whether it is still viable.
The Government’s relaxation of insolvent trading provisions
One of the Government’s measures to support businesses through this crisis was to relax insolvent trading provisions by suspending the operation of section 588G(2) of the Corporations Act 2001 (Cth) for six months commencing on 25 March 2020. These provisions set out a director’s duty to prevent insolvent trading by an organisation where:
- he or she is a director of the organisation at the time it incurs a debt; and
- the organisation is insolvent at that time (or becomes insolvent by incurring that debt or by incurring at that time debts including that debt); and
- at that time there are reasonable grounds for suspecting the company is insolvent or would become insolvent.
An organisation is deemed to be insolvent when it cannot pay its debts as and when they fall due. If it is established that an organisation incurred debts at a time when it was insolvent, the director/s may be personally liable. It is important to note that the operation of s.588G(2) of the Corporations Act 2001 (Cth) will only be suspended if debts being incurred are “in the ordinary course” of the organisation’s business. Protection will not be afforded if debts are incurred in a reckless fashion. Directors may still be at risk of personal liability in the current environment under other provisions, including common law and statutory duties of directors (including those owed to creditors upon insolvency).
NFPs must plan for what happens next, and a plan to repay debts needs to be in place well before the end of any hibernation period. This is the point when the existing “safe harbour” protections may be relied upon for those with a business capable of being saved.
This, unfortunately, may lead to an ironic scenario where individuals who are motivated to take on volunteer roles as officeholders of NFP organisations face potential personal financial exposure if the financial position of the organisation deteriorates.
Options if an NFP’s operations are no longer commercially viable
For NFPs facing the reality that its operations are no longer commercially viable, there are two key options available – active wind-down and a range of insolvency options.
It may become evident following analysis of the organisation’s financial position that the organisation may need to be terminated or wound down. This decision may need to be considered if the business has insufficient cash reserves, inability to generate sufficient cash over the next six to 12 months, or if a long-term improvement strategy is not possible.
It is important to complete an assessment of whether the organisation may be able to conduct an active wind-down over a period of three to six months, as opposed to an immediate shut down of the organisation. Winding down over three to six months may provide organisations with time to sell down assets and pay out creditors, or consider integration with another organisation with a like-minded purpose.
If there is no prospect of sufficient capital being made from the sale of the organisation’s assets or through funding avenues, then the organisation may need to consider entering voluntary administration or liquidation.
Many NFP organisations are operated through structures such as an incorporated association or company limited by guarantee. These structures can be problematic if an NFP organisation enters into voluntary administration.
The voluntary administration process generally does not have regard to the wishes of the members of an organisation. It is the directors or board who are empowered to appoint voluntary administrators and the voluntary administration process is primarily concerned with protecting the interests of creditors.
Before any decisions are made to wind-down operations, NFPs need to consult the Constitution of the organisation to determine next steps such as approval of its members to move forward with voluntary administration or liquidation.
A key consideration, however, in the voluntary administration or liquidation of an NFP is the considerable engagement required with the membership base throughout the process. This engagement may include regular “Town Hall” meetings plus other activities and decision-making processes mandated in the organisation’s Constitution.
The other complication of the voluntary administration or liquidation process for an NFP is that the Corporations Act 2001 does not specifically recognise that the voluntary administration and liquidation provisions apply to NFP organisations.
The voluntary administration or liquidation of an NFP organisation in Victoria is enabled through the Associations Incorporation Reform Act 2012 (Vic), which amends some of the provisions in the Corporations Act 2001 that specifically relate to incorporated associations.
Previous experience with insolvency administrations involving NFP organisations has demonstrated that major liabilities generally relate to employee entitlements and landlords. The Federal Government, through its Fair Entitlements Guarantee, provides financial assistance to cover certain unpaid employment entitlements to eligible employees who lose their job due to the liquidation of their employer. The organisation needs to enter into liquidation for this financial assistance to be available.
How a Victorian NFP addressed debt and continued its operations
The case study below outlines how a Victorian NFP was able to address debts and engage with key stakeholders throughout the administration process, ultimately continuing its operations through a new provider.
Case Study – Voluntary administration of Moonya Community Services Inc.
MCSI was a disability service provider based in Wonthaggi, the only one of its kind in the region. The organisation operated for over 50 years, offering day support services and supported employment for disabled adults.
At the time of appointment of the Administrators, the organisation provided day services for 59 clients and employment for 27 disabled staff. With debts nearing $1 million and over 20 care and administration staff, the key risk for the community was the loss of a valuable local service and potential unemployment for the staff and supported employees. Closure would have placed significant stress on the clients and their families, who would be forced to travel long distances to access services of a similar nature.
Pitcher Partners worked closely with the Federal and State Governments to find a sustainable long term solution and navigated consultations with Government representatives, employees, financiers, creditors, union representatives and previous management, as well as managing the expectations of the clients and their parents and carers. Considerable engagement was undertaken with the membership base to obtain support for the continuation of the operation by a different operator.
Over a two-month period, Pitcher Partners was able to maintain ongoing operations and successfully negotiated for the assets and operations to be sold to a respected and accredited similar service provider.
Connecting Skills Australia, a major Victorian not-for-profit organisation, took over the assets and operations of MCSI, retaining the organisation name and maintaining the presence of this valuable community service provider in Wonthaggi.
In addition to the provision of the ongoing services, continued employment was secured for all the Australian Disability Enterprise staff of MCSI, as well as most of the care and administration staff.
Consider your NFP’s commercial viability and explore your options
While it can be difficult to come to the realisation that your organisation’s operations are no longer commercially viable, it does not mean the organisation needs to immediately close its doors. By taking the time to step back to review your cash flow forecasts and the range of wind-down and insolvency options available, there is potential that your NFP can still deliver its purpose-driven activities.