Compliance and Creativity: the strategic obligations of directors

One of the main roles of a not-for-profit (NFP) board of directors is to develop and cultivate a long-term strategy for the organisation, which furthers the objects of that organisation.¹

Despite the fact that directors appreciate that strategic planning forms part of their role on the board, directors often err on the side of caution when strategizing, or avoid developing a strategic vision for their organisation entirely. Reasons for this include:

• Concern that poor business decisions may result in a director being civilly or criminally liable for breach of their duties;
• A fear of change;
• Previous frustrations with management when implementing strategy; or
• A lack of accountability for not strategizing.

This brief article will explore directors’ duties of acting in good faith, as well as the duty of care and diligence, encourages directors to be brave in formulating a strategic plan for their organisation.

Whilst it is true that the standards imposed on directors are significant and require directors to make carefully balanced decisions, directors should be comforted by the fact that some of their duties require them to develop strategy and take risks. The two main directors’ duties that relate to strategic thinking include the duty to act in good faith in the best interests of the organisation, and the duty to act with care and diligence. Both of these duties require directors to be concerned with the long-term future of the organisation, which involves strategizing. Hence, directors should view strategizing and risk taking as an integral part of their duties.

Duty to act in good faith

Directors must act in good faith in the best interest of their organisations. One way to act in the best interests of the organisation is through strategic planning. This is due to the fact that strategic planning is known to increase revenue², increase member satisfaction, attract both a motivated Chief Executive Officer (CEO) and talented directors, and prepare an organisation for changing environments. Directors of NFPs must ensure that their organisation acts according to its objects, in order to fulfil its purposes. This usually involves acting in the best interests of beneficiaries and clients.

In the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Banking Commission) Final Report, Commissioner Kenneth Hayne commented on how some for-profit organisations chose to prioritise making profit over the interests of their customers.³ Hayne suggested that the interests of an organisation’s customers fall within the purview of the interests of the organisation. Organisations must become ‘customer-centric.’ Similar findings have been alluded to in the Royal Commission into Aged Care Quality and Safety Interim Report.

As NFPs are unable to pursue profit, following the Banking Commission, directors of NFPs are reminded that their organisation and practices should be customer-centric, in order to satisfy their duty to act in good faith. This is because acting in the best interests of the organisation involves considering the interests of the beneficiaries and clients.

Duty of care and diligence

The duty of care and diligence also provides directors with some flexibility in order to make informed strategic decisions for their organisation. Within this duty lies the ‘business judgment rule’ (Rule) which may be used as a defence for directors develop and implement a strategy, which in hindsight appears to have been a poor decision. The Rule was established to ensure that innovation was not stifled by directors not wishing to take any risks, in fear of personal liability. The courts appreciate that directors will often make decisions with incomplete or limited information and in tight time constraints.⁴ The Rule therefore acts as a ‘safety-net’ to protect honest directors from the risks which are inherent to making business decisions.

A ‘business judgment’ is any decision in respect of a matter relevant to the business operations of an organisation. This means that the Rule can only be applied as a defence by a director who has made a business judgment.⁵ For example, in Gold Ribbon (Accountants) Pty Ltd (in liq) v Sheers [2006] QCA 335, a director could not rely on the Rule as a defence for not participating in board decisions because he did not wish to disagree or challenge the status quo.

In Australian Securities and Investment Commission v Mariner Corporation Limited [2015] FCA 589, whilst the directors were held to have not breached their duty of care, the Federal Court held that the Rule could have been used as a successful defence. This was because each director had a reasonable belief that the business judgment would be in the best interests of the company, each director had considerable corporate law experience, legal advice was received on the business judgment, and the potential benefits far outweighed the potential risks.

In light of this, what should directors consider when strategizing? Directors must create a transparent culture where risk and strategy are discussed and embraced. The board should also not be seen as a ‘rubber stamp’; rather directors should have a complete understanding to make informed decisions. Directors will also have difficulty breaching their duties if they act within their organisation’s objects.

Further, directors are able to strategize and limit their liability for breach of duties by:

• Recording detailed minutes when making business judgments which demonstrate how a decision was made;
• Having a clear understanding of the financial position of the organisation;
• Considering the rights and any responsibilities owed to various stakeholders, and developing a ‘customer-centric’ attitude which is reflected in governing documents;
• Considering the impact of any decisions made on the organisation in the coming months and years, including the impact of not making that decision; and
• Ensuring management understands their role in implementing strategy.

Ultimately directors should not be so cautious as to never take justified risks or formulate and implement a strategic plan for their organisation. Whilst directors must be aware of the risk of liability if they breach their duties, so long as directors act in good faith in the best interests of their organisation and with care and diligence, they will remain compliant with the law.

This article was first published in the Better Boards Conference magazine, July 2020