- Despite the 'switching off' of provisions relating to director's duties for directors of not-for-profit companies also registered as charities with the ACNC, it is recommended that directors adopt best practice and operate as if the provisions still applied.
- Directors of not-for-profits must now observe the five governance standards prescribed by the ACNC Act.
- To fulfil the duty of good faith under the Corporations Act directors must exercise independent judgment.
In the past, many people, without hesitation, would volunteer to be a director or board member of a not-for-profit organisation. However, we are in uncertain times, as recent litigation has caused concern for some volunteer directors and many more are now seeking some form of protection from their notfor-profit organisations for their potential exposure in these roles.
The concern generally speaking, arises from the disparity between the level of comfort a not-for-profit organisation can provide a volunteer director and the level of comfort that the volunteer director seeks.
For the most part, the duties of a volunteer director are the same as those under the common law, which, are also those of any company director under the Corporations Act 2001 (the Act), consisting namely of the duty:
- to avoid allowing the company to trade while insolvent
- to act in good faith
- to act honestly
- to act with reasonable care and diligence
- not to misuse position or information obtained while acting as a director
- to disclose any material personal interest or conflict.
However, if a director of a not-for-profit company under the Act and if the company is also registered as a charity with the Australian Charities and Not-for-profit Commission (ACNC) (but not as a basic religious charity), then the Act provisions (180–183) relating to director's duties have been 'switched off'. While the common law duties still extend to directors of registered charities, additionally, the director must now observe the five governance standards, prescribed by the Australian Charities and Not-for-profits Commission Act 2012 (ACNC Act). In particular, a director must ensure that the financial affairs of the charity are managed responsibly.
The ACNC sets out a brief overview of the five governance standards as follows:
Standard 1: Purposes and not-for-profit nature
'Charities must be not-for-profit and work towards their charitable purpose. They must be able to demonstrate this and provide information about their purposes to the public.'
Standard 2: Accountability to members
Standard 3: Compliance with Australian laws
'Charities must not commit a serious offence (such as fraud) under any Australian law or breach a law that may result in a penalty of 60 penalty units (currently $10,200.00) or more.'
Standard 4: Suitability of responsible persons
'Charities must take reasonable steps to:
- be satisfied that its responsible persons (such as board or committee members or trustees) are not disqualified from managing a corporation under the Corporations Act or disqualified from being a responsible person of a registered charity by the ACNC Commissioner, and
- remove any responsible person who does not meet those requirements.'
Standard 5: Duties of responsible persons
'Charities must take reasonable steps to make sure that responsible persons are subject to understand and carry out the duties set in this standard.'
The ACNC prescribes that:
'As minimum, responsible persons should have good processes to prevent problems and to manage money responsibly', such as 'reading financial statements' as well has 'having a process to ask questions if they don't understand.'
The types of processes for risk management to be implemented will depend on the size of the charity and the nature of its financial affairs.
For example, to ensure uniform observance of the five governance standards throughout all the operations of the charity, it is recommended that the employment contracts or handbook of non-director officers and committee members (whether they are volunteers or paid employees) of an entity impose these same obligations on such persons.
Where a charity, registered with the ACNC, is not a company incorporated under the Act, but is a legally recognised entity (such as an incorporated association) the governing body must also adhere to the five governance standards.
Notwithstanding the 'switching off' of sections of the Act for corporations which are registered charities, as the common law still extends to these entities, and the Act still applies to noncharitable, not-for-profit corporations, we recommend all not-for-profits should adopt best practice and operate as if those provisions still applied.
To that end the following comments apply across all types of not-for-profits.
Importantly, to fulfil the duty of good faith under the Act directors must exercise 'independent judgment'. In the case of Blackwell v Moray (1991) 5 ACSR 255 the Supreme Court found that a director who simply adopted the preferences of the company's majority shareholder, without exercising independent judgment, had breached their duty of good faith, namely, to act bona fide in the exercise of the discretion required of a director so as to act for the benefit of the entity.
This means that merely turning up to meetings of the board is not sufficient to meet the requirements of acting as a director; a director must be actively involved in exercising independent judgment when it comes to voting on resolutions of the meeting including as a minimum 'considering the views of the relevant materials' (Per Cohen J) not just follow the majority decision because it is the 'popular' opinion.
A test of whether a director has used the degree of care and diligence required can be measured against the business judgment rule. Under that rule the director is found to have acted with the degree of care and diligence required if they make a business judgment in good faith and for a proper purpose, without any material personal interest in the subject matter, having informed themselves about the subject matter to the extent they reasonably believed was appropriate and provided they rationally believed the judgment is in the best interest of the company. The belief is deemed to be rational unless it is a belief that no reasonable person in the director's position would hold (180(2) of the Act).
This rule is limited to a defence of s180 of the Act (duty to exercise care and diligence), but not to any other duty provision of the Act (duty to act in good faith, for proper purpose, for best interests of the company; duty not to improperly use position or information; not to act recklessly or be intentionally dishonest).
If the business judgment test depends on whether it was reasonable for the director to rely on information provided by others, if the director:
- relies on information provided by an employee whom the director believes on reasonable grounds to be reliable and competent, or a professional adviser or expert whom the director believes on reasonable grounds to have the relevant expertise or another director in relation to matters within the director's or officer's authority, or a committee of directors in relation to matters within the committee's authority
- the reliance was made in good faith and after the director made an independent assessment of the information or advice relevant to the director's knowledge of the company.
Unless the contrary is proved, the director's reliance on the information is taken to be reasonable.
Volunteer directors must always declare perceived or actual conflicts of interest.
ACNC offers volunteer directors this advice 'Don't be embarrassed to declare a conflict of interest!'
Failure of a director to declare a conflict can, as the ACNC has correctly pointed out on its website, 'damage your charity's reputation', and will constitute a breach of the Act.
For example, recently the UK equivalent of the ACNC, the Charity Commission, announced a statutory inquiry into the Manchester based charity 'My Community UK' for an alleged failure to manage conflicts of interest.
In another instance earlier this year the Charity Commission advised the Tate Britain to 'follow its policies and processes concerning the management of conflicts of interest' after the gallery displayed artworks of Tomma Abts, who was also one of the Tate's trustees.
Of the 23 investigations undertaken by the UK Commission in 2013 nine involved 'unmanaged conflicts of interest'. Directors should ensure that there are adequate procedures in place as to how to deal with conflicts of interest, if and when they arise.
Directors should take extreme care not to allow their company or not-for-profit organisation to trade while insolvent. Where an entity continues to trade while insolvent, and it is found by a court that the director has not acted with appropriate care and diligence the directors may lose the protection of the corporate veil and be found personally liable for the company's debts. Additionally, these directors may be the subject of criminal proceedings for their breaches of the Act (s588G of the Act) — a director will be found to have breached their duties if they are aware that there are grounds for suspecting the company of being insolvent and/or a reasonable person in a similar situation in the company's circumstances would have been so aware.
In the 1991 National Safety Case (1991) 9 ACLC 946 the chairman of a not-for-profit organisation was held personally liable for the losses incurred after he signed an annual financial statement attesting that the company was solvent when in fact it was not.
All companies and not-for-profit organisations that can afford to do so should maintain Directors & Officers Liability insurance. Most constitutions provide that the entity must at all times maintain such cover. If such cover is unaffordable, entities may indemnify their directors by deed.
Insurance and indemnities cannot assist a director who is guilty of any criminal offence or reckless act.
It was noted in the Federal Parliamentary Standing Committee on Economics, the ACNC Act endeavours to 'ensure that the individuals do not seek to hide behind the protection of a corporate veil to protect themselves from acts of deliberate misconduct'.
Justice Tadgell said in the National Safety Case at 1012:
Every effort should be made to inform volunteer directors about their real exposure, without unnecessarily alarming them, to ensure their work continues for the benefit of the charity. In particular, volunteer directors should be steered towards the ACNC website which provides an abundance of useful and accessible plain English advice on good governance and tips as well as warnings about common traps for directors.
The duties of the directors under the Act although not binding on the governing group of all not-for-profit entities may be used as a reference point and benchmark to achieve best practice.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.