INCORPORATION EXPLAINED IN PLAIN ENGLISH - PART 2

Here in the second part of this comprehensive article, on 'Incorporation', we take a look at the pros and cons of incorporation and when and when not to incorporate, all written in plain English.

ADVANTAGES OF INCORPORATION

Liability

Members of the governing body of an unincorporated organisation have unlimited liability and usually that liability is joint and several. What that means is that should the organisation fail to meet its debts, those individuals may be required to meet them: and that burden may well fall on those most able to pay rather than on all members equally. While it is relatively rare for individuals to be held personally liable for organisational debts in non-profit organisations, it does happen occasionally. It may be possible to take out insurance to protect against some potential risks, and a well-run organisation should in any case not find itself in a position of having liabilities which it cannot meet.

All members of a corporate body, by contrast, are protected by limited liability. For example, members of a company limited by guarantee commit themselves to paying a fixed sum in the event of the company being wound up with outstanding debts. This sum guaranteed is commonly a nominal ￡1.00 in a not-for-profit organisation. Members of a company limited by shares stand to lose the value of the shares they have bought but should face no further liability for the company’s debts.

There are rare occasions when members of the governing body may be held personally liable for some or all of the debts of the corporate body, but only where one or more members of the board have acted fraudulently or with gross irresponsibility. Generally the protection provided by incorporation is sound.

Ownership of property and entering into contracts

Because an unincorporated organisation does not technically exist in law as a separate entity, it stands to reason that it cannot own property or enter into contracts. Thus one or more members will usually have to own or contract on behalf of the association. With major assets like property, this will be done by appointing certain people as holding or custodian trustees (sometimes called nominees) who are named as owners of the asset on behalf of the association.

In this arrangement there should be a written trust deed (or nominee agreement) detailing how holding trustees are appointed and the terms on which they hold the property. For instance, it should clarify that they mustn’t do anything with the property (such as selling it) without the permission of the organisation’s governing body; and equally if the governing body directs them to do something with the property, they must do it.

It is necessary to regularly review the holding trustees and replace them if they wish to retire or if one should die. Problems arise when an organisation wishes to sell its property, only to discover that it is technically owned by people who died years previously – this happens quite frequently.

With lesser assets, like cash, the organisation may acquire something without any stipulation about who actually owns it. The law governing this area is complex and the true situation is not always entirely clear.

An unincorporated organisation technically cannot enter into contracts (such as a lease or a contract of employment), though the paperwork may often indicate that it has done so. Difficulties can arise, for example in employment disputes when it may not be clear who the employer is in law. A court may decide that individual members of the governing body are responsible for discharging the employer’s responsibilities, not the organisation as a whole.

A corporate body, being a distinct legal entity, may own property and enter into contracts in its own right. Because a corporate body retains a continuous, stable existence until it is finally wound up, then ownership issues also remain stable. There is no need to appoint holding trustees and the corporate body can be signatory to all contractual documents.

Clarity of relationships

Generally the precise roles, rights and responsibilities of members and officers are clearer in a corporate body. Companies and co-operative and community benefit societies are governed by comprehensive statutes (Acts of Parliament) while unincorporated bodies are governed by a complex hotchpotch of case law, specific statutes and – crucially – by the contents of the governing document, which is often inadequate.

DISADVANTAGES OF INCORPORATION

Cost

There are additional costs involved with being a corporate body rather than an unincorporated body. There is the cost of getting registered (often several hundred pounds) plus there may be an annual ‘filing fee’ to remain on the register (up to ￡40 for a limited company). Historically, one of the main cost considerations, especially for smaller organisations, was the need to have a professional audit (independent scrutiny) of the financial accounts each year. However, in recent years the regulations have been relaxed for smaller corporate bodies. For instance, a company with an annual turnover of less than ￡10.2 million does not require a professional audit. Charities continue to need a full professional audit at a lower threshold than this, and it will often be a condition of grant funding to provide audited accounts, regardless of the law or legal status.

Jurisdiction

There are strict rules about the records which a corporate body must keep and their form, and information which must be submitted to the regulator (Companies House in the case of a limited company). Such discipline in record keeping need not be a bad thing in itself, and the task of administering a corporate body is not all that onerous, but penalties can be stiff if records are not kept up to date.

An organisation which does not have paid staff or a permanent office may find it particularly easy to fall foul of the regulator’s requirements with regards to record-keeping and filing. A question to ask any organisation considering incorporation is therefore: do you have the capacity to keep all the paperwork up to date?

Privacy

The ‘price’ paid for limited liability is loss of privacy. The regulator must be kept informed about the identity of members of the governing body, finances, indebtedness and so on, and this information is readily in the public domain. However, especially in the case of a body receiving public funds, this may not always seem such a bad thing. Anyone can demand to inspect a company’s register of members though this may not apply to other legal forms.

WHEN TO INCORPORATE

There are no hard-and-fast rules as to when it becomes appropriate for an organisation to consider incorporation. In part it will depend on the motive for seeking corporate status.

If the primary aim is to limit the liability of the governing body, then the guide as to when to incorporate will be their degree of exposure to financial risk: such factors as employing staff on a permanent basis, entering into contracts, or engaging in speculative trading ventures will increase the potential liabilities of the governing body and thus tend to make incorporation more attractive.

Increasingly social enterprises and not-for-profit organisations are being encouraged to consider taking loans rather than seeking grants exclusively. Many lenders will only deal with corporate bodies; and members of the governing body of an unincorporated organisation may be liable to repay a loan if their organisation defaults.

Incorporation may well be considered if a major piece of property (such as a building or lease) is to be purchased and it would be more desirable to have such property held by a corporate body than by holding trustees.

Groups sometimes opt for corporate status to demonstrate their credibility. The unincorporated structures are really quite informal in many ways; for example, an association can dissolve spontaneously simply if the governing body stops meeting, whereas a corporate body must go through formal winding up procedures. The more regulated corporate structure can be reassuring to potential funders. Similarly, projects that have been part of some larger organisation and are now becoming independent may incorporate to demonstrate their autonomy and maturity.

Occasionally funders may insist upon a project becoming incorporated as a condition of grant aid or – especially – when awarding a contract.

WHEN NOT TO INCORPORATE

The main reason for discouraging groups from incorporating is if they don’t appear to have the capacity (whether in terms of volunteers, staff or premises) to keep up with the detailed administrative requirements of being a corporate body.

Incorporation may also be inappropriate for a relatively short-term project.

It is also important to note that if an existing unincorporated body is insolvent (i.e. it cannot pay its debts), then incorporation will not protect the governing body from liabilities incurred prior to incorporation.

Understanding the unfamiliar terminology (jargon) used in legal processes can be bewildering and time-consuming - that's why here at Charlie Cattell Consultancy, we try to provide you with clear and concise facts and information.

Have a good day!