Charities and legally binding documents: managing risk and legal exposure

08 November 2019

Charity trustees have to recognise that managing contractual risk is critical to the success of their charity; failing to do so could put them in breach of their duties and the charity itself in jeopardy. In this article we’re going to consider some of the key issues trustees need to consider when faced with commercial agreements.

In general terms, risk management comes down to identifying risk and taking the action to mitigate its possible effects. Risk, i.e. the possibility of being subject to some form of loss or damage, takes a variety of forms, but possibly the most relevant to charities include: 

  1. economic damage
  2. regulatory enforcement
  3. reputational damage.

When considering commercial opportunities, trustees must be mindful of their duty to act in the best interests of the charity and its beneficiaries. This duty extends to trustees having to take the action required to maintain and protect the charity’s assets, goodwill and reputation. It’s therefore easy to see how failing to properly assess contractual risk could put trustees in breach of this most fundamental duty. 

Identifying risk

Risk management has three broad stages, the first of which is the identification of relevant risks. Each contract will pose different risks, but when considering a contract trustees should ask themselves the following questions.

  1. Is it clear from the contract (ignoring any previous conversations) what it’s actually trying to achieve?
  2. Are the duties of each party clearly set out?
  3. If the contract goes wrong, what’s the worst case scenario?
  4. What’s the charity’s potential exposure if it breaches the contract?
  5. What rights of recovery and enforcement does the charity have against the counterparty if the counterparty doesn’t comply with the contract? 
  6. For how long will the contract run and, if the charity’s circumstances change, can it get out of the contract?
  7. Can the counterparty get out of the contract easily and, if it can, where would that leave the charity?
  8. Could entering in to the contract pose a risk to the charity’s goodwill and reputation?

If there is any uncertainty about the answers to any of these questions, the charity should not be entering in to the contract until the relevant risks have been managed.

Managing risk

Once a risk has been identified, its effects need to be assessed by considering the probability of the risk arising and its potential impact. Once the risk has been assessed, thought needs to turn to how it can be managed. One option is to try and allocate the risk to the counterparty. This should be done where the particular risk is outside the charity’s control. Commonly risks are allocated through the use of indemnities (essentially, a promise by one party to reimburse the other party’s losses on the occurrence of a particular event). Indemnities are very useful tools for allocating liability for specific risks. However, trustees should be wary of giving indemnities to the counterparty, especially where the losses covered by the indemnity are hard to determine (e.g., losses arising from any breach).

Where a charity cannot allocate risks (e.g., where the risk is that the charity itself is subject to a claim for defective performance) the charity needs to limit its liability under the contract. In other words, the charity needs to ensure that if it were to breach the contract, its liability is limited to the greatest, legal, extent possible. Generally, contractual limits on liability operate in two ways: 

  1. to set an overall cap on liability (which may be linked to a relevant insurance policy)
  2. to exclude the counterparty from bringing claims for particular losses, such as loss of profits.

Practical tips for reducing contractual risk

  1. Be very wary of starting to work with a counterparty before the contract is finalised; this creates significant legal uncertainty.
  2. Always scrutinise ‘Memorandums of Understanding’ and ‘Non-disclosure/ Confidentiality Agreements’ closely. By failing to do so and entering into such agreements, a charity is at risk of being bound to potentially onerous terms.
  3. A charity should consider having its own standard form contracts to use when either supplying or procuring goods and/or services. Even if the counterparty tries to negotiate them, at least the charity will be dealing with a contract it’s familiar with.
  4. A charity should have a risk policy so it’s clear about what risks the charity will and will not accept. Any staff that have authority to negotiate contracts must be obliged to stick to the policy.
  5. A charity should routinely undertake due-diligence into any prospective commercial partner. Negotiations shouldn’t be commenced unless the charity is certain the counterparty itself won’t pose a risk to the charity.
  6. Finally, charities should be pro-active, not reactive. Risks should be analysed and dealt with head-on; they shouldn’t be left to arise when damage limitation is the charity’s only option.

The content of this article is for general information only. For further information, please contact Edward Bouckley or another member of the Charities and Social Enterprise Team. Law covered as at November 2019.