How to deal with insolvency in higher education

Higher education is now provided by a range of new and private providers alongside older universities. Funding has moved away from direct government provision to a tuition fee model, increasing competition in the market. Students now demand more from their HEI, which has led to an increase in the number of complaints.

Brexit adds another level of uncertainty to the sector. Whilst the long-term impact on the two core functions of universities, teaching and research, is yet to be seen, the decision to leave the EU is already starting to affect the way HEIs operate. The number of students applying to study in the UK from EU countries is falling, and EU research funding could be under threat.

Will the UK government set up similar funds using monies saved by Brexit? Will UK universities continue to be able to apply for EU funding? What about funding that has already been agreed with the European Commission? Such uncertainty is likely to cause significant headaches for university leaders.

Some HEIs will thrive in this market, and some will struggle or fail. In a recent white paper, the government has even gone so far as accepting this, stating that “the government should not be in the business of rescuing failing institutions”.

A university failing will affect students, staff and will involve complex factors such as public sector pensions and a variety of corporate structures.

Duties of directors and trustees

Whether the Insolvency Act 1986 (IA 1986) applies to HEIs will depend on their constitutional make-up and it is hard to know how courts will apply the law to insolvent HEIs given the limited number of examples of HEIs entering into formal insolvency processes.

The majority of HEIs have been established under royal charter. It is likely that the IA 1986 will apply to HEIs established by royal charter even though they may be unincorporated entities rather than registered companies. The majority of HEIs do not constitute unregistered companies for the purposes of the Companies Act 2006 because they do not operate for profit.

The IA 1986 sets out detailed responsibilities for those in charge of entities approaching or suffering insolvency. Many of these responsibilities are stated to apply only to directors and so arguably do not apply to the governing body of a HEI. However, it would be prudent for the governing bodies of HEIs to treat the overarching principles of the IA 1986, particularly the rules on the conduct of directors, as applicable because:

• the considerations that will be taken into account in determining whether action should be taken against members of a governing body in respect of their conduct as charitable trustees and fiduciaries are derived from and informed by the provisions of the IA 1986;
• the majority of the provisions of the IA 1986 constitute a codification of historic case law which could be applied by the courts to an entity established by royal charter and its officers in appropriate circumstances; and
• given the current financial concerns for HEIs, it is anticipated that further legislation will be required in the near future to address HEIs in financial distress. It is likely that any such legislation will either apply the existing provisions of the IA 1986 or, at the very least, use the IA 1986 as a framework for such legislation.

In practice, there is little difference between the duties of a trustee in law and those of a director. Members of a HEI’s governing body are charity trustees and will have all the obligations imposed by charities law, including:

• to act for the benefit of the HEI (and its beneficiaries);
• to make their own decisions and to act independently;
• to exercise reasonable care and skill and diligence in carrying out their role on the HEI’s behalf. What is reasonable depends upon any special knowledge or experience of the trustee and so this will vary for each trustee;
• to take full responsibility for the HEI. To meet regularly and act in person; only delegating as set out in the governing documents;
• to act strictly in accordance with the HEI’s governing documents and ensure that they use the income and property of the HEI only for the purposes set out in those documents;
• to act in the HEI’s interests without regard to their own personal interests and not to obtain any personal benefit or gain from the charity;
• to manage prudently the HEI’s affairs avoiding undue risk; and
• to reach balanced and informed decisions taking account of both the long and short term and taking professional advice on matters they are not competent to deal with.

Restricted funds

An IP may find that an HEI is not free to use its assets or funds as it might wish. For example, an asset may be a permanent endowment such as a gift or bequest of money or property that was intended to be held by the HEI forever; as the use of such an asset will be subject to the terms of the original endowment, the trustees will be unable to use it as if it were income.

This may be an important consideration for banks, particularly if the status or conditions attaching to an asset have not been fully understood by the present trustees and, therefore, explained to the bank and its advisors. It is also likely to be a breach of trust by the trustees/directors to use endowed property or restricted funds for a purpose other than for which they were intended.

Real estate and enforcement of security

When selling property owned by an HEI – whether the sale is pre or post insolvency – an important consideration is whether the property in question is subject to a trust, for example as a permanent endowment or whether the HEI is the beneficial owner and able to sell.

The Charities Act 2011 restriction on dispositions of land under section 119 does not apply to exempt charities such as HEIs.

Complex funding structures

Prior to the 2008 credit crunch the higher education sector used some complex funding structures, including long-dated structured debt. Some of these in the form of structured bonds have in turn been packaged up for the capital debt markets and guaranteed by the monoline insurers. Often the university staff who put together these structures have long left the university. One potential danger area is the inflexibility of listed debt and the possibility, in any scenario of financial distress, of a large payment becoming due to repay the bonds early. This can be a substantial sum, running to millions.

Similarly, some HEIs have needed to fund ambitious growth plans for their accommodation. Last year, the student accommodation of Aston University was sold after its joint venture scheme, funded by the Bank of Scotland, faced difficulties. Unite Students and GIC, the Singaporean sovereign wealth fund, purchased the 3,000 beds for £227 million, leaving the university’s accommodation stock in the hands of the private sector.

Takeovers

One rescue procedure that may become more readily available to HEIs is the possibility of a takeover by private sector organisations. The University of Law, formerly known as the College of Law, is an institution that offers law courses to prospective lawyers across various cities in England. In 2012, it was sold to a private equity firm for a sum in the region of £200 million. The college’s legal education and training businesses were subsequently separated from its charitable activities. This involved the sale proceeds being settled into a separate charitable trust established for the charitable purpose of advancing legal education.

Although the sale attracted much public criticism, there is an expectation that private equity firms and other investors remain tempted by the possibility of acquiring HEIs or parts of HEIs. The opportunity to own an institution with degree-awarding powers and the possibility of focusing on its more profitable aspects is a tempting proposition, but further takeovers will inevitably be met with resistance from a large proportion of the public who are reluctant to see public institutions and public assets fall into private hands. The University of Law was re-sold to Global University Systems in 2015. Global University Systems also acquired Arden University the following year, within 12 months of that institution acquiring the university title.

Mergers

There have been a number of mergers between HEIs including that between the Institute of Education and University College London in 2014; the merger of the School of Pharmacy and University College London in 2012, and the merger between Manchester University and the University of Manchester Institute of Science and Technology in 2004.

The most common method used for mergers of HEIs involves the dissolution of one institution following the transfer of its property, rights and liabilities to the other institution. It is also possible to create a new institution to which the two merging institutions transfer their property, rights and liabilities.

Practical steps

Whether dealing with the solvent winding down of a HEI or its insolvent winding up, there are some important practical issues that an IP will need to bear in mind, including:

• the requirement to report serious incidents affecting the HEI to the Higher Education Funding Council for England (HEFCE) as principal charity regulator. The HEFCE accountable officer at the HEI is required to inform the HEFCE immediately if there are any material changes which could affect the HEI’s financial sustainability, management or governance. This includes “any adverse variance in the financial position material to the institution’s financial sustainability”. The HEI’s memorandum of assurance and accountability sets out what constitutes a serious incident requiring reporting;
• the novation of any contractual arrangements, for example where the HEI is a party to a research collaboration with multiple other parties where the insolvency of one party may have an impact on the wider collaboration;
• managing the transfer of students to other institutions so that they can complete their studies and receive an award;
• restricted funds or endowments; and
• destruction of records. There may be a difficult balance to achieve between, on the one hand, a HEI or an IP wishing to destroy records falling within the definition of personal data under the Data Protection Act 1988 as soon as reasonably practical in order to avoid having to deal with potentially expensive and time-consuming information requests whilst, on the other hand, wishing to preserve the academic records of students.

What does the future hold for HEIs?

There is no doubt that HEIs are in a period of significant uncertainty, which has been fuelled by major developments such as the UK's decision to leave the EU; increased pensions deficits, and an increase in vocational courses and training.

There will be significant restructuring activity in the higher education sphere in the future but the restructuring processes themselves will not be simple given the high profile nature of these organisations; the complex legal and regulatory framework in which they operate, and the political repercussions that such processes would inevitably have on any incumbent government.

Tom Withyman is a restructuring expert and Gayle Ditchburn is an education expert at Pinsent Masons, the law firm behind Out-Law.com