Restricted funds – a reminder for charities

In this article, we explore what to do – and, more importantly, what not to do – if the purposes of one or more of your charity's restricted funds have become impracticable or impossible to fulfil for some reason. It's a subject that we covered in our previous article but, given the potential repercussions for charities of getting it wrong, we thought it would be helpful to have a reminder of the rules.

What is a restricted fund?

When money is donated to a charity free of restrictions, its trustees will usually be able to apply the funds in whatever way they see fit, provided that the intention is to further the objects for which the charity was established. Such funds are generally known as "unrestricted funds".

Restricted funds, on the other hand, are funds that must be spent in a particular way because of one or more conditions that have been set out by the donor – that the funds are to be put towards a particular project, for example, or used in a particular part of the country.

Some restricted funds come about as a result of lifetime giving, where a donor has made a conditional gift or a grant to the charity or the charity has carried out a fundraising appeal for a specified purpose, but most of them originate from gifts in wills. Whatever their origin, having accepted restricted funds, the charity's trustees are duty bound to spend them in accordance with the stated purpose.

Unrestricted v restricted legacies

Legacy income is of fundamental importance to charities: according to a report by Legacy Insight at the end of 2024, legacy income across the sector during the preceding year totalled over £4 billion. It is expected to remain at that level for the next three years but rise to an annual figure of £10 billion by 2050.

Most legacies are made without specific instructions about how they are to be used. This is clearly preferable as, in these cases, the trustees will have discretion as to how the funds are applied. Many charities work closely with potential donors to ensure that legacies are made free from restrictions or at least that, if the donor does have a particular purpose in mind, it is expressed in such a way as not to be legally binding – an expression of wishes, rather than a direction – or that the wording of the gift provides for an alternative use of the funds should circumstances change.

Because of the potential for legacies to be received some time after the will is made, there is no guarantee that the charity will be able to carry out the terms of the gift once it has been received – particularly if the focus of its activities has altered over the ensuing years.

However, legacies are not always made with the charity beneficiary's knowledge, and some testators are keen to ensure that – notwithstanding the fact that their chosen charity has purposes that are already in some way restricted – the legacy will be used to benefit the organisation in a more specific way. Inevitably, some of these legacies risk failing on the grounds that the terms of the gift are – or may become – impossible or impracticable to carry out.

Initial failure – legacies that fall at the first hurdle

Some charitable legacies fail at the outset. This may happen because the intended beneficiary has been misdescribed, has never existed or has ceased to exist between the date of the will and the testator's death.

Other so-called "initial failures" occur because, by the date of death, it has already become impossible for the charity to meet the conditions of the gift. In some cases – and sometimes depending on how they are worded – such gifts can be saved for charity in some way but, in others, they must be returned to the estate, and it will be for the personal representatives to determine how they should be distributed.

Subsequent failure – legacies that fail later on

But what about legacies that were made subject to conditions that could be – and were initially – met at the date of death but have since become difficult to comply with? This might occur, for example, in respect of a legacy that was intended to be used to fund a particular service that the recipient charity has ceased to provide, or to support beneficiaries in an area in which there is no longer sufficient demand for the charity's services.

In cases such as these – sometimes referred to as "subsequent failures" – charities can end up sitting on potentially large sums of money that they can no longer spend in accordance with the testator's instructions. Situations such as these can be problematic for charities because their trustees may not have power to use the funds for anything else.

The difficulty arises because, to all intents and purposes, a restricted fund is a charity in its own right, with objects that fall within – but are narrower than – the general purposes of the organisation as a whole. If any part of the fund is applied otherwise than in furtherance of those narrower purposes, a breach of trust occurs, whether or not the charity would have been able to apply the funds in that manner had the restrictions not existed. In short, the narrower purposes of a restricted fund do not fall away simply because they have become difficult or impossible to fulfil.

Potential consequences of a breach of trust

A breach of trust – even if inadvertent – can be a serious matter for trustees because the Charity Commission will treat it as evidence of either mismanagement or misconduct within the charity. The Charities Act 2011 gives the Commission a wide range of powers to investigate and, if appropriate, tackle apparent mismanagement or misconduct, including the power to open a statutory inquiry, which the Commission has recently done in respect of a well-known charity.

As well as being a considerable drain on resources, a statutory inquiry can lead in the most serious cases to the disqualification of trustees and even the closure of a charity. It is therefore important that charities have controls in place to ensure that expenditure from restricted funds is limited to the purposes for which they were given.

Avoiding breaches of trust

Luckily, where the terms of a restricted legacy have become impossible or impractical to fulfil, there are steps that trustees may be able to take to enable a wider application of the funds concerned. Depending on the nature of the fund, the trustees might be able to resolve under a provision of the Charities Act that its purposes should be changed to something less restrictive, thereby allowing it to be spent more effectively.

Alternatively, they might be able to apply to the Charity Commission for a scheme – a legal document that can bring about changes to the purposes of a charity or one of its restricted funds in certain circumstances. In fact, under such circumstances it is likely that the trustees will have a statutory duty to make such an application.

However, the appropriate course of action is not always clear, and the rules are different where the testator intended the gift itself to be retained indefinitely, with only the income being expendable on the recipient charity's purposes. Consequently, we would advise trustees to seek our advice before proceeding down any of these routes – and certainly before spending any of the funds in question.

Get in touch

If your charity has one or more restricted funds that it is having difficulty spending and you would like our support, please contact a member of the team.