A model mutual

Those considering the mutual model for delivering public services will have to choose between a number of different legal structures. Making sure that they pick the right one will be essential, writes David Wall.

There are several legal structures that lend themselves to a mutual organisation, provided their constitutional documents incorporate the necessary features. Among the factors which will influence the choice of structure are the following:

• For a complex service entailing a variety of risks, you may wish to create a separate legal entity to hold, manage and protect the organisation’s assets, employ people, enter into contracts, leases and raise finance – this would require an incorporated vehicle for the mutual.
• Alternative structures offer varying levels of flexibility as to how an organisation operates, and how its management and membership is organised.
• Some structures are subject to more formal reporting requirements and may need to file annual returns and accounts which can be accessed by the general public.
• The mutual will be more credible both internally and externally if it has a clearly defined purpose and a recognisable structure, with a constitution that ensures adequate and appropriate control systems to safeguard funds and assets.

The first decision to be made is whether to use an incorporated or an unincorporated vehicle for the mutual.

Incorporated Options

Industrial and Provident Societies

Industrial and Provident Societies (IPSs) have their origins in social philanthropy, self-help and the cooperative movement. Perhaps the most prevalent example of this form is housing associations, of which more than 1,000 are set up as IPSs. Depending on when new legislation comes into force, IPSs will soon be renamed as either ‘Co-operative Societies’ or ‘Community Benefit Societies’ depending on their aims.
IPSs have a separate legal personality and limited liability for participants. They fall into two categories:

The 'Bona Fide Cooperative' mutual model (to be renamed ‘Co-operative Societies’). Such a society is formed for the benefit of its members, rather than society at large, and respects the core values of a cooperative. There is scope for distributing dividends amongst society members, although this might not be suitable for some mutuals. Membership could comprise entirely the mutual’s employees who will determine how the organisation is run;

The ‘Society for the Benefit of the Community’ (to be renamed ‘Community Benefit Societies’). Such a society pursues a wider public good, rather than just its members' interests. It cannot distribute profits to members. Membership is generally open to all persons able to use their services and willing to accept the responsibilities of membership, subject to limited qualifying criteria.

The flexibility of an IPS makes it well-suited to being a vehicle for mutuals. Members can actively control the organisation by setting policies and making decisions. Members have equal voting rights regardless of their shareholding and benefit from limited liability. Members usually subscribe for nominal shares in the society (typically £1 each).

A society’s members agree to be bound by a set of Rules which represent the constitution of the society. All IPSs are currently regulated by the Mutual Societies Registration division of the Financial Services Authority (FSA) – all Rules must be registered with the FSA on incorporation.

The management structure is essentially two-tier with a committee or 'board' accountable to a wider membership. Unlike the company structure, there is very little statutory interference in the role of the board and membership. The detailed distribution of powers and functions between the board and the membership is highly flexible and a matter for the IPS’s Rules; they can therefore be tailored to particular circumstances. An IPS is required to file an annual return, revenue accounts and balance sheet with the FSA within 7 months after the end of its accounting period.

The FSA can be described as a fairly light touch regulator in respect of IPSs, in that it makes an initial check on the Rules of a society at the time of registration and, thereafter requires an annual return of board members and shareholders, but otherwise leaves the participants to their own devices. However, if the FSA has reason to investigate an IPS, it has the power to cancel registration if the society does not adhere to its stated purposes.

It is possible for community benefit societies (but not co-operatives) to apply a statutory 'asset-lock' which prevents any assets or cash from being distributed other than to creditors on a winding up or to another asset-locked body, such as a charity or a community interest company (see below). The inclusion of an asset-lock may well be appropriate for a mutual and can add credibility because it guarantees to third parties that the society’s assets will only be applied as determined by the asset-lock. Some social enterprise funders may require this.

A community benefit society can also raise finance by issuing shares to the public on favourable terms. This may be an attractive route for philanthropic investors to invest in socially worthwhile projects in future. One current drawback of the IPS format is that it does not benefit from the ability to use the administration procedure to fend off creditors and avoid insolvency.

Limited Companies

A Limited Company is an organisational structure which confers limited liability on its members. It exists as a separate legal entity – the company is able to borrow money, enter into contracts and hold assets in its own name. Limited companies are governed primarily by the Companies Act 2006 and exist in two forms:

The Company Limited by Guarantee - the members of the company give a guarantee for a nominal sum such as £10, which will be the maximum amount that they will be liable to contribute if the company is wound up.

The Company Limited by Shares - the members own shares in the company which they either purchase or may be given (for example, through an employee share scheme). If the company is wound up, the maximum amount that they will be liable for is the amount payable for the shares. If a company becomes a public limited company (plc), it may offer its shares for sale to the public. Issuing shares is one way in which a company may raise capital, but there are strict rules governing the offer of shares and investments to the public.

A company operates with a two-tier management and governance system: members will decide the most important decisions regarding the company such as changing the governing documents and winding up, whilst the directors will carry out the day-to-day running of the company.

A company’s directors owe a duty to the company to act in its best interests and to exercise reasonable care. They may be liable to third parties if they carry on trading when the company is insolvent. Liability insurance can be taken out to cover directors for some risks.

The governing documents of a company are known as the articles of association. The company’s articles of association give details of the company’s internal management affairs, the running of the company and its liability. To operate as a mutual, the articles of association would need to adhere to the principles of a mutual, whereby the membership community ‘owns’ the mutual collectively, a democratic voting system is in place and stakeholders can play an appropriate role.

Companies represent a universally-recognised structure for a mutual, and provide for transparency since company documents are available for public inspection. A company will have a duty each year to file annual accounts (containing the directors’ report) as well as an annual return detailing membership and directors, and other key information. Filings are administered by Companies House – the registrar of companies within the UK. Copies of any special, extraordinary or certain types of ordinary resolution of the members must also be sent to Companies House.

Mutuals formed as limited companies must be able to deal with the administrative requirements, such as the various forms that have to be signed and filed if there is a change in the company structure. Smaller organisations may find this too cumbersome and consider that it outweighs the benefits that limited liability brings.

Community Interest Companies

The Community Interest Company (CIC) was launched as a ‘custom-made’ vehicle for social enterprises in 2005. It was a new type of company designed for social enterprises that want to use their profits and assets for the public good. It is a business with primarily social objectives, where the surpluses are reinvested in the business or the community rather than being driven by the need to make profits for the benefit of the members. As such, they are a potentially suitable vehicle for a mutual.

CICs are subject to dual regulation by both the CIC Regulator and Companies House. They have the same governing documents as a normal company and are generally subject to the same procedures. A CIC exists as a separate legal entity and has the same two-tier management as a normal company.

CICs may be limited by either shares or guarantee; in the case of a CIC limited by shares, dividend payments are possible - but restricted by a dividend cap. This means that there is a maximum amount that can be paid on each share regardless of how well the CIC is performing.

A main principle of a CIC is the ‘asset lock’ – assets, cash and property can only be used for the stated community purpose. Organisations must name another ‘asset-locked’ body to receive any surplus assets upon winding up. If no such body is named, the CIC Regulator will award the assets to an asset-locked body which has the most similar objects.

CICs must satisfy the ‘Community Interest Test’, demonstrating that a reasonable person would perceive their activities as being in the interests of the community. The relevant community must not be an unduly restricted group or have political motives. As such, being a CIC may be viewed as a badge of commendation: the title proves the company will use its profits and assets for the public good and is a reassuring brand which third parties can feel confident in engaging with. However, some groups may find the additional regulatory burden unattractive as compared with another type of company.

Limited Liability Partnerships

A Limited Liability Partnership (LLP) might be described as halfway between a company and a simple partnership. With its own corporate identity and limited liability for its partners, an LLP has the advantages of a company, but provides the flexibility to allow the partners to tailor its internal workings. An LLP is taxed as a partnership, rather than as a company – meaning the partners individually pay income tax rather than the organisation paying corporation tax.

There is no legal requirement for an LLP to have a formal constitution, although it is common to set down at least basic organisational rules within an ‘LLP agreement’ which can be kept private if so wished.
Regulated by Companies House, LLPs must be run to make a profit and might be considered an unconventional model for a mutual. However, their flexibility and potential tax advantages could make the LLP a viable alternative.

Charitable Incorporated Organisations

The Charitable Incorporated Organisation (CIO) is a new legal structure, still yet to be launched. Organisations with charitable objectives may wish to utilise this vehicle as a relatively simple alternative to the other incorporated options. CIOs have been designed so they can adopt straightforward constitutions clearly setting out the charitable duties of their trustees and members.

As a corporate body, a CIO has a separate legal personality but would only have one regulatory body in the Charity Commission. Simpler reporting requirements and potentially low start-up and running costs will make the CIO a potentially appealing option when it finally becomes available. However, as an untested model it remains to be seen just how suitable the CIO could be for a mutual organisation.

The Unincorporated Option

An unincorporated association is a group of individuals who have come together to pursue a shared goal, whether that be to benefit the members only or for the wider public benefit. As with incorporated vehicles, an unincorporated association would need rules that adhere to the principles of a mutual, i.e. the mutual is ‘owned’ collectively by the membership community, there is a democratic voting system in place and stakeholders can play an appropriate role.

An unincorporated mutual provides the most flexibility in terms of structure and the way it operates because it is not subject to any regulation by company law. There are no applicable regulators, unless the organisation is registered as a charity – in which case the Charity Commission will be the regulator. An unincorporated mutual may be relatively simple and inexpensive to set up.

However, an unincorporated mutual has no legal personality of its own, so it cannot enter into contracts or hold property in its own name and may find it difficult to borrow money. An unincorporated mutual would also have unlimited liability, meaning the individual committee members may be pursued for any outstanding debts or liabilities run up by the organisation. As such, it is not likely to be an attractive option for running a significant trading enterprise.

Choosing the right legal structure for your mutual is an important part of the development process and should be approached with care. Choosing the wrong structure can inhibit the appetite of investors and lenders and can be costly to unwind later. Specialist advice should be sought at an early stage.

David Wall is a solicitor at TPP Law

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