Understanding Restricted Funds in Third Sector Organisations

Restricted funds can be a real problem if a 3rd sector organisation that uses them runs into financial difficulties. It’s vital that they are handled properly at all times and that is particularly important if insolvency is likely.

What Are Restricted Funds?

Restricted funds are donations, grants, or other financial contributions given to a charity or third-sector organisation with specific conditions on how they can be used. As a rule, this means they will be ring-fenced for specific purposes and therefore restricted in use.

Restricted funds differ from other sources of funding such as:

Unrestricted funds – These are for general use and how they are used is at your discretion.

Endowment funds - which may be invested and only the income generated can be used for charitable purposes

Restricted funds are subject to some very clear and rather strict legal and ethical procedures during insolvency and they must be handled correctly or there is a danger that Trustees and other stakeholders could be held liable for their misuse.

Which Organisations May Have Restricted Funds?

Restricted funds are quite common in third-sector organisations. The organisations that may have them include:

• Charities – Many charities receive restricted grants from government bodies, trusts, or individual donors. These could well be only for specific projects.
• Community Interest Companies (CICs) – CICs often receive public funding with conditions attached.
• Non-Profit Organisations – Some non-profits operate with grants that specify how funds should be used.
• Social Enterprises – If funded by grants rather than commercial income, these organisations may have restrictions on spending.

The chances are that if you rely on grants, donor contributions, or public funding, you may need to manage specific restricted funds. Proper financial governance is essential to ensure compliance with donor conditions and legal requirements. Should there be a financial crisis, you cannot divert or use these funds except for the purpose for which they were donated or granted.

How Should Restricted Funds Be Handled During Insolvency?

If a third-sector organisation faces insolvency, handling restricted funds correctly is critical.

• Restricted funds cannot be used to pay creditors
• Funds must be returned or transferred
• Trustees and administrators must comply with legal obligations
• Proper documentation is essential

What these rules will mean to you and your organisation will be down to the way the funds were donated, what their purpose was, how they can be returned or transferred, and potentially several other factors. It’s important you contact us as soon as possible so we can discuss how this will work for you.

Restricted Funds and Insolvency

It really is vital you take professional advice if you are looking at financial difficulties and your organisation uses restricted funds. Failing to handle them properly could mean trouble with charity law and funding agreements. Trustees have a duty to ensure that funds are used appropriately, and misusing restricted funds could result in legal action, regulatory fines, or personal liability for those responsible.

Restricted funds are a vital part of third-sector funding. They also help ensure that donor contributions are used for their intended purpose. During insolvency, handling these funds correctly is not just a legal obligation but also an ethical necessity. Trustees and financial managers must be fully aware of their responsibilities to prevent legal repercussions and protect the integrity of the organisation.

If you are involved in managing a third-sector organisation facing insolvency, then as your insolvency practitioners we can help ensure that restricted funds are handled correctly and compliantly.

Your first consultation is free, so, if you are worried about insolvency, press the red button on the banner and let’s talk.