Restricted funds: What are they and what are the pitfalls?

For the purpose of this article, we will refer to both as ‘charities’. Such assets are referred to as ‘unrestricted funds’.

In some cases, special arrangements are made in respect of certain charitable assets and, in the event that those arrangements amount to a separate charitable trust being established, a ‘restricted fund’ is created. These special arrangements are usually a result of donor requests but also come about where a charity fundraises for a specific purpose.

It is worth noting that charities can allocate certain assets towards a particular use for administrative purposes and that such an allocation will usually only create a separate fund in administrative terms as opposed to a separate trust being established by law, such funds being a charity’s ‘designated funds’. The distinction between designated funds and restricted funds is that the charity can simply re-allocate the proposed use of the assets in a designated fund (provided that such action is in the best interests of the charity) whereas departing from the special arrangements that apply to restricted funds is a more complicated process (see further below).

Restricted funds are commonly sub-divided into ‘restricted income funds’ and ‘endowment funds’, broadly: the term ‘restricted income funds’ is used for funds whose use is restricted by a particular purpose and where the assets must be used in a reasonable period from their receipt (e.g. where a charity is given money by a third party further to a bequest where the bequest specifies that the monies are to be used to purchase certain assets for which the charity has a need);

‘endowment funds’ are funds whose restrictions relate to the capital element of the assets in question. Endowment funds can be further sub-divided into:

(a) ‘permanent endowment funds’, where there is no power granted to the charity in the terms of the trust to convert the capital element of the asset to income. An example of this would be where a third party makes a bequest that monies are left to a charity on the basis that the capital sum is invested and that only the income is used for the charity’s purposes; and (b) ‘expendable endowment funds’, where there is a power granted to the charity in the terms of the trust to convert either all or part of the capital element of the asset to income. An example of this would be where a capital sum of money is left to the charity to be spent in its entirety on the charity’s purposes but where there is no requirement that the capital be spent in a reasonable period.

RESTRICTED FUNDS – WHAT ARE THE PITFALLS?

The main pitfall associated with restricted funds is the charity and its trustees/members being subject to liabilities arising from being in breach of trust as a result of not adhering to the trusts of the relevant restricted fund in question. To explain, whenever a new trust (such as a restricted fund) is created, the charity trustees in question become subject to a further set of duties and obligations in respect of that new trust in addition to the duties and obligations that they hold towards the larger charity.

Unless a specific power for the donor to consent to the assets in question from being freed from the relevant restriction (or giving the charity any discretion in respect of the same) has been incorporated into the trusts of the restricted fund in question, the charity can only deviate from the terms and conditions of the trusts in certain instances as specified by charity law (these ‘legal flexibilities’ are set out below). In the event that a charity deviates from the terms of the trusts of a restricted fund and does not act within the legal flexibilities below then such action is likely to be unlawful.

The legal flexibilities referred to above include:

• where the charity acts within the relevant powers in the Charities Act 2011 – either in the context of a smaller restricted income fund (with an income not exceeding £10,000 where no designated land is involved) where a charity wishes to vary the restricted funds’ purposes or in the context of a smaller endowment fund (with a market value of less than £10,000 and income not exceeding £1,000) where a charity wishes to spend the capital;
• where the charity acts within the relevant powers in the Charities Act 2011 and with Charity Commission consent for larger endowment funds; or
• where the charity obtains specific court or Charity Commission consent.

Another pitfall would be for a charity to misidentify funds and be in breach of accounting regulations: it is a legal requirement that restricted income funds and endowment funds must be separately accounted for within charity accounts and that certain other regulatory requirements are followed in respect of the same.

A final pitfall in respect of restricted funds is a charity misidentifying funds as restricted funds when they are in fact unrestricted funds (such as where a donor leaves monies to a charity with a non-legally binding ‘expression of wishes’ in respect of the use of the monies as opposed to an intention to create a separate trust that amounts to a restricted fund). Here the trustees/members of the charity would be inadvertently restricting the potential of its charitable assets.

Due to the complexity of both the accounting and legal rules in the context of restricted funds, we recommend that all charities seek professional advice in respect of restricted funds on a case by case basis.

If you need any legal advice in respect of fund classification then please do contact Lara Jones at lara.jones@luptonfawcett.law / 01904 561 426 or Mark Honeywell at mark.honeywell@luptonfawcett.law / 01904 561 476.

Lara Jones Senior Solicitor Lupton Fawcett LLP

Mark Honeywell Senior Solicitor Lupton Fawcett LLP

The information contained in this article is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.

The opinions expressed in this document are not necessarily the views held throughout RBC Brewin Dolphin Ltd.