Winding Up Your NFP: Navigating Legal & Dispute Risks

Introduction

Winding up your charity or not-for-profit organisation is a significant step that brings complex legal and dispute risks, especially around asset distribution when ending a charity. Whether the decision is driven by insolvency, a change in purpose, or other challenges, the process requires strict adherence to charity law and your organisation’s legal structure to ensure compliance and protect all parties involved.

Disputes can arise over surplus assets, governance, or the interpretation of your constitution, making it essential to seek guidance from a not-for-profit lawyer. Careful planning and professional advice are crucial to avoid costly litigation and ensure that your organisation’s legacy is preserved according to its intended charitable purposes.

Winding Up vs Deregistration: Understanding the Key Dispute Risks

Deregistration: The Faster Path & Its Limitations

Deregistration, also known as cancellation of incorporation, is generally a cheaper and faster method for closing a not-for-profit organisation. In certain situations, a deregistered entity may be reregistered, which is not possible once an organisation has been formally wound up.

However, this approach comes with significant limitations, often involving threshold limits that can become contentious if not properly assessed. For example, an incorporated association may only be eligible for deregistration if its assets are below a certain value. This can create potential disputes if the organisation’s assets are not accurately valued.

Winding Up: The Formal Process for Complex Charities

In contrast, winding up is a more formal and definitive process for ending your organisation. It typically involves appointing a liquidator to manage the charity’s affairs and may even require a court application.

This process is usually necessary for charities that have:

• Higher-value assets
• More complex financial affairs
• Are facing insolvency

The complexity in these situations means there is a greater risk of disputes arising over the management and distribution of assets.

Key Legal Differences Under the Corporations Act & Associations Act

The legal framework that governs the process of ending your organisation depends entirely on its legal structure, which can lead to different types of legal challenges. The specific legislation determines both the duties of the board and the procedures that must be followed.

If you are running a not-for-profit company limited by guarantee, it is regulated by the Commonwealth Corporations Act 2001 (Cth). On the other hand, an incorporated association in New South Wales is governed by the Associations Incorporation Act 2009 (NSW).

These distinct legal frameworks create:

• Different compliance obligations
• Potential liabilities for board members

The Role of Your Charity’s Constitution in Winding Up Disputes

How a Flawed or Ambiguous Winding Up Clause Creates Legal Challenges

Any ambiguity in your charity’s winding up clause can create significant legal challenges. The New South Wales Supreme Court case concerning the Maitland Benevolent Society provides a clear example of how a lack of clarity can lead to disputes between potential recipients of surplus assets.

In that case, the court had to strictly interpret the charity’s constitution to resolve competing claims from two different organisations. This demonstrates that courts will meticulously analyse the wording of a governing document.

If the criteria for a recipient organisation are not precisely defined, it can result in outcomes that do not align with the charity’s original intentions. Such ambiguity often complicates the winding up process, leading to:

• Costly and time-consuming legal battles to determine the rightful destination of the organisation’s remaining assets
• Outcomes that may not reflect the charity’s intended legacy

Ensuring Your Governing Document is Clear on Asset Distribution

The governing document of your charity plays a critical role in guiding how assets are handled during the winding up process. It is essential that the responsible people within the organisation follow this document precisely to avoid disputes.

A clearly worded winding up clause is the most effective tool for ensuring a smooth and legally compliant asset distribution when ending your organisation. Many governing documents for registered charities include a specific ‘winding up clause’ or ‘dissolution clause’. This clause typically dictates that:

• Surplus assets must be transferred to another charity with similar purposes
• A specific procedure for selecting the recipient charity is outlined
• Legal guidance is provided for the proper distribution of all remaining assets

The importance of a clear and unambiguous winding up clause cannot be overstated, as it directs the entire process of asset transfer. Consulting and adhering to your organisation’s governing document is a crucial first step in preventing disputes and ensuring the charity’s legacy is preserved as intended.

The Primary Dispute Who Receives Surplus Assets When Winding Up Your Charity

The Strict Prohibition on Distributing Assets to Members Under NSW Law

A fundamental principle of charity law in New South Wales is that the assets of a not-for-profit organisation must be used for its charitable purposes, not for the private benefit of its members. This rule is strictly enforced when winding up an organisation, whether because of insolvency or any other reason.

The Associations Incorporation Act 2009 (NSW) explicitly prohibits the distribution of any surplus property to members or former members. Consequently, once all debts and liabilities are settled, the remaining assets must be directed toward other charitable work, avoiding internal disputes over the organisation’s final funds.

Transferring Assets to a Similar Charity Under Commonwealth Law

For charities registered with the Australian Charities and Not-for-profits Commission (ACNC), specific requirements govern the distribution of surplus assets when the organisation ends. The governing document—usually a constitution—must be followed precisely.

Most governing documents for registered charities contain a ‘winding up clause’ or ‘dissolution clause’. This clause typically mandates that any surplus assets remaining after settling debts be transferred to another registered charity with similar charitable purposes.

In practice, a typical winding up clause will require the organisation to: 

• settle all outstanding debts and liabilities in full; 
• transfer any remaining assets to a registered charity whose objects closely align with those of the dissolving organisation.

DGR Charities: Special Asset Distribution Rules & Conflicts

Charities with Deductible Gift Recipient (DGR) status face additional and stricter requirements for asset distribution, which can spark conflict if mishandled. The Australian Taxation Office (ATO) requires that the governing document of a DGR-endorsed organisation include a specific winding up clause.

This clause must ensure that, upon winding up your charity or having its DGR endorsement revoked, all surplus assets are transferred to another DGR. These assets include: 

• gifts of money or property received for the organisation’s principal purpose; 
• deductible contributions made in relation to eligible fundraising events; 
• any money received by the organisation as a result of such gifts and contributions.

The recipient organisation must be another eligible DGR fund, authority, or institution with a similar primary purpose. Failure to adhere to these rules can lead to regulatory action and disputes over the final distribution of assets.

Litigation Scenarios How Winding Up Plans for an Organisation Get Challenged

When Members or Other Parties Can Legally Challenge the Board

Under the Associations Incorporation Act 2009 (NSW), there is a direct legal path for stakeholders to challenge the handling of a charity’s final assets. Any person who feels aggrieved by the distribution of surplus assets during the winding up of an organisation can apply to the NSW Supreme Court.

This provision creates a formal avenue for legal challenges from disgruntled members or other affected parties who believe the asset distribution was improper.

Case Study: Disputes Over Charitable Property & Trustee Duties

The NSW Supreme Court plays a crucial role in resolving disputes over property held on trust for charitable purposes, as seen in the case of Chaina v Presbyterian Church (NSW) Property Trust [2015] NSWCA 66. In this matter, a property purchased for a church was found to be property held on charitable trust for the organisation’s religious purposes, even though the church was an unincorporated association without a formal constitution.

Trustees of a charity have a significant duty to act in the best interests of the organisation. In the Chaina v Presbyterian Church Property Trust case, a trustee breached this duty by:

• Transferring the church’s property into his and his sons’ names
• Mortgaging it for personal business interests

This misappropriation of a charitable asset was challenged by members of the charity. The court found this to be a severe breach of the trustee’s obligations and ordered the defendants to:

• Restore the property to the church by transferring the title back to the rightful trustees
• Indemnify the plaintiffs against any claims made by the mortgagee
• Pay the plaintiffs’ legal costs

Case Study: Competing Claims for Surplus Assets in the NSW Supreme Court

The case of In the matter of Maitland Benevolent Society Limited (In liquidation) [2020] NSWSC 1284 illustrates how an ambiguous winding up clause can result in a court battle. When the Maitland Benevolent Society, a not-for-profit aged care facility, was wound up, its liquidator sought directions from the NSW Supreme Court on how to distribute surplus funds.

The dispute centred on the interpretation of Maitland’s constitution, which set out specific criteria for any organisation that could receive its assets. Two charities, the Royal Freemasons’ Benevolent Institution and the United Protestant Association, made competing claims for the funds.

The court had to meticulously examine the constitutions of both potential recipients against Maitland’s strict requirements. Ultimately, the court found that:

• Only the Royal Freemasons’ constitution met all the criteria
• The entire surplus was directed to that organisation

The Role of Regulators & Courts in Winding Up Disputes

The ACNC’s Role in Approving Final Asset Distribution

If your organisation is a charity registered with the ACNC, you must apply to have your registration revoked as part of the winding up process. Before approving the cancellation, the ACNC Commissioner will assess whether your charity has managed its assets correctly.

The ACNC must be satisfied that any remaining assets will be distributed in a manner consistent with your organisation’s charitable purposes and its governing document. This typically involves:

• Ensuring that all surplus assets are transferred to another registered charity with similar objectives
• Confirming that the asset distribution plan is compliant with both the charity’s purposes and its governing document

The ACNC will not finalise the deregistration until it is confident that these requirements have been met.

The NSW Supreme Court & Fair Trading’s Powers Over Asset Distribution

The NSW Supreme Court has significant authority to oversee the assets of a charity, especially during disputes or insolvency. Under the Charitable Trusts Act 1993 (NSW), the Court can intervene in cases of mismanagement to:

• Protect trust property and ensure it is used for its intended charitable purpose
• Make various orders, including appointing a receiver to manage the charity’s property

Additionally, the Associations Incorporation Act 2009 (NSW) allows any person who feels aggrieved by the distribution of surplus assets during a winding up to apply to the Supreme Court for a final determination.

In other circumstances, such as an involuntary cancellation of an incorporated association’s registration, NSW Fair Trading assumes control of the organisation’s property and is responsible for:

• Deciding on the distribution of any surplus assets
• Ensuring that the distribution is handled in accordance with legal and regulatory requirements

Board’s Guide to a Legally Defensible & Orderly Winding Up

A Checklist for a Legally Defensible Wind-Up Process for Your Organisation

To ensure the closure of your not-for-profit organisation is properly managed and documented, your board should follow a structured process. This means passing formal resolutions at both board and member levels to approve the decision and the asset-distribution plan.

A legally defensible wind-up process generally involves several key actions:

• Special resolution – formally approve the wind-up as required by your governing document.
• Independent liquidator – in complex cases or where insolvency looms, appoint a professional to manage affairs.
• Pay all debts and liabilities – clear outstanding loans, employee entitlements and contractual obligations.
• Distribute surplus assets correctly – follow the winding-up clause and transfer remaining assets to a charity with similar purposes.
• Complete administrative tasks – close bank accounts, end supplier contracts and formally disband the committee.
• Notify relevant regulators – inform ASIC or your state body, the ACNC (to revoke registration) and the ATO (to cancel ABN and tax concessions).

Conclusion

Winding up a charity involves significant legal risks, with disputes often arising from the distribution of surplus assets and the interpretation of the organisation’s governing document. Adhering to strict regulatory requirements and understanding the legal structure are essential to ensure compliance and protect the board from liability.

To effectively manage these responsibilities and ensure a compliant process, contact the expert not-for-profit lawyers at LawBridge for trusted legal advice tailored to your organisation’s unique challenges when winding up.

Frequently Asked Questions