legal

Legal

Legal Obligations of NFP Directors


Published: August 19, 2022

Read Time: 21 minutes

In this highly engaging presentation Sophie McNamara gives an overview of the various legal obligations NFP Directors have.

Sophie: I just want to say what a great event this has been. I’ve only been here for the afternoon, but I just want to congratulate Better Boards and Raf. It’s such a great idea. I gave a talk last year about managing difficult directors, and in my research for that found out that the average age of a director in Australia is 68 years old, and they are definitely a white man. And this is just a really great initiative, I think, to get more diversity on boards and particularly more young people on board, so it’s great. Congratulations to Raf and everyone.

Sophie: So after such an inspiring morning, I’m going to talk about something fairly boring, and that’s the law and what can go wrong. I’ve personally had to sit through variations of this talk many times, and my main criticism is usually that it’s all sort of doom and gloom and what can go wrong, and basically you just leave feeling a bit more terrified than you did before. My aim for today is that you will not feel terrified, but you’ll feel informed, and you’ll go back to your boards and be champions of good governance, and you’ll never ever find yourself in some of the situations which we’ll be discussing today.

Sophie: In complete knowledge of how boring my topic is, I’ve tried to put Lego in every slide, and if you learn nothing else today, let it be that if you type Lego and then pretty much anything into Google, someone somewhere in the world has made a Lego picture of that. It’s kind of amazing. Anyway, we’ll get the bad stuff out of the way. If you seriously, seriously breach your obligations as a director, there are pretty significant personal, civil, and criminal penalties for that. So our friend here has breached his obligations as a director, and he has been fined. He’s been fined up to $200,000. He’s had a compensation award made against him personally. There’s been an injunction with its associated legal fees to stop him being so rubbish, and he has been disqualified from managing companies for up to 10 years.

Sophie: So as you can imagine, that can have quite serious implications for your day job as well, if you are barred from management positions. There are also criminal liabilities. Now, you have to work really hard to attract a criminal liability, so don’t let this terrify you. And even if you end up in jail, that guy’s enjoying it by the looks of it. You can really only end up in jail if you have been extremely reckless or pretty dishonest and misused your position. So you’ve either discharged your duties in an incredibly irresponsible way, or you’ve used your position to advantage yourself or disadvantage your organisation, or you’ve failed to prepare accurate finances, or you’ve been dishonest in failing to prevent insolvency. So it’s only in the very most extreme cases that you’ll find yourself or anyone attracting criminal liability.

Sophie: Here is an overview of the director’s duties I’m going to cover today. Some of my clients have this slide pinned in their toilet. If you feel your fellow directors do their best thinking there, then I suggest you also hang it up there. So I’m going to cover the key duties, the first of which is due care and diligence. So the standard of due care and diligence when you’re on a board, you must exercise a degree of care and diligence that a reasonable director or officer in your position would exercise. So it’s an objective test, it’s what a reasonable person would’ve done.

Sophie: Now, what does that look like in effect? At a bare minimum, I would describe it as you have to take an active interest in the affairs of your organisation. It’s really common, particularly on not-for-profits, to come across sleeping directors, or people who are legacy directors who founded it 20 years ago and now just come to the AGM for a wine. Those people are breaching their obligations as directors, and if that reminds you of anyone on your board, I recommend that you take steps to rectify that. Every director has to understand the core business, or the core operations, and you have to be ready to question anything that appears suspicious or potentially detrimental. So you just can’t be asleep at the wheel. Once you assume that position, it’s a very real and alive responsibility.

Sophie: The other thing that I’ll add is that if you’ve held yourself out to have specialist skills, so if you are an accountant or a lawyer, then that attracts an additional standard. So you’re then judged as was your behaviour reasonable, considering the skills that you had or said that you had. I will also add, sorry, just building on what Joanne said, your constitution can really protect you in terms of care and diligence. If you have a director on your board who is not coming to enough meetings, you can amend your constitution or your code of conduct to say directors are expected to come to 10 out of 12 meetings or something like that, and you can really use your documents to support a culture that forces directors to govern in a diligent way.

Sophie: The main one that attracts the attention of the courts is insolvent trading. So you all have a duty to ensure that your organisation is able to meet all its debts as and when it falls due. Now, this requires you to understand basically the incomings and outgoings financially of your organisation. You are risking liability if there are reasonable grounds for suspecting insolvency and directors are aware, or a reasonable person in that position would’ve been aware. This is the area that the courts have been most vocal about. It’s been addressed as a core responsibility, so that means you cannot delegate it to anybody. Everyone must be Batman.

Sophie: This is the one thing I really struggle to get a Lego analogy happening with, but I put Batman there, because Batman’s like, the buck stops with Batman. He’s not like, “Oh, I’m not doing it today.” So think of Batman. You must read and understand all the finances for your organisation, have to understand when money’s coming in, when money’s going out. You have to keep an eye on money that might be due in the future, so what tends to trip people up is things like long service leave. A lot of organisations don’t put aside money for long service leave or superannuation. We’ve had a lot of clients who just forget to pay superannuation.

Sophie: So these are the kinds of things you need to stay on top of. It does require a degree of financial literacy, which I’ll talk about more in a minute, but this duty cannot be delegated. You can’t just say, “Well, the treasurer handles that,” and take their word for it. The court has said that is unacceptable. You likewise cannot outsource it. So you can’t send it to an accounting firm, you can’t send it to an auditor and wash your hands of it and sign off on it not reading it. Everyone personally has to read and understand the finances. Have I said that enough? Yeah? Okay.

Sophie: You wouldn’t believe how many directors that I speak to, half the board says, “Oh, numbers.” And I’m speaking as someone whose mother did my tax return until… She’s probably doing it today. I’m not a financially enthusiastic person. I don’t like maths, but when you are sitting on a board, please, please, please, just make yourself do it.

Sophie: And that brings us to the only case that I will talk about today, because law is boring. This is the Centro case, so this was a big case a few years ago, and it’s probably the leading case in relation to directors duties in Australia. It was in the papers, but Centro is a large retail chain and their directors got into some pretty hot water, basically, on signing off on finances that left them $2.1 billion in shortfall.

Sophie: So it’s unlikely that we’re all sitting on boards that have billions of dollars to misplace, but it is still the leading authority and it affects all of us. So these directors signed off on these accounts, not realising that they were wrong, and then ASIC pulled them, charged them, and the directors argued a bunch of things. One was that they relied on their accountants. So they had briefed, I won’t say their name, but one of the top four accounting firms globally to do their books, and they had signed off on the reports. So they relied on that, and the court said that’s not enough. It’s not enough to rely on even experts. You personally have to turn your mind to it.

Sophie: The other thing that they said in their defence was that they got so much information as board directors, every meeting they had a pile this high of documents. How could they have possibly found this needle in a financial haystack when they were being given so much information? And likewise, the court said it is the duty of the directors of the board to control what information comes before you. If you are receiving information that you can’t use, that you can’t understand, then that is your obligation to go back to either your auditors or your accountants or your organisation or the CEO or the treasurer, and say, “You have to give me the information in a way that we can understand and use.” So that again was rejected.

Sophie: The other one, which I found quite interesting, was two of the directors argued, “But this wasn’t my area. So I came onto this board as a human resources consultant. I came onto this board to give marketing advice. I never said I was a financially savvy person. We have financial people on the board, this is out of my wheelhouse.” And the court said, it doesn’t matter. If you’re on the board, you need enough financial literacy to understand the financial documents of your board.

Sophie: This comes into the not-for-profit sector in a few interesting ways, because I think lawyers had a lot of questions after this case. So do we need to understand multi-billion dollar financial documents before we can be on a board? And there’s disagreement among lawyers and even among my colleagues about this, but my colleagues aren’t here, so you’re getting my spin. You need to have enough financial literacy to understand the books of your organisation. You don’t need to understand Centro’s, but you need to understand your organisation. So if it’s a big organisation, you need quite a high level of financial literacy. If you’re discharging complicated grants, if you have complicated employment awards, then that’s again a bit higher. But if you’re managing a graveyard or an op shop, arguably, you probably just need to understand money in, money out, read a spreadsheet.

Sophie: So it’s on a sliding scale. What a lot of people say to me when I give variations of this advice is, “But we’re volunteers. These were paid directors. What court is going to penalise us when we were doing this for free in our own time?” And the answer to that is that the case doesn’t specifically mention that this doesn’t apply to volunteers. The language they use is very broad. So until another case comes to them, and I suggest no one here is so negligent that they get there, we don’t know. But the court would’ve had in their mind that there are hundreds of thousands of not-for-profits. Likewise, the people who have drafted and amended the Corporations Act would’ve turned their minds to the fact that a lot of corporations are not-for-profits, a lot of directors are volunteers, and none of them have seen fit to draught any kind of exception. So we have to assume that even though you’re a volunteer, this all applies to you as well.

Sophie: Another issue that can sometimes come up is when you have a stakeholder on a board. So I’ve worked with an organisation that was an Indigenous organisation, and it was important to them to have a lot of community members on the board, including community members affected by addiction and community members affected by foetal alcohol syndrome. So they felt that was very important to inform the direction of their board. Those board members, sadly, did not have the mental capacity to understand the governance of the organisation or the financial documents. So in that case, we advised them to look at different positions that those people could assume. You should absolutely not disregard the important role that those people can play in your organisation, but in that case, it was inappropriate to have them on the board, and it made them vulnerable too, because they were personally liable for decisions that they didn’t understand.

Sophie: So we shifted their structure a little bit. One of those members became an ambassador for the organisation and did a lot of public speaking really well. Some other people became a consumer advisory group. So before every second board meeting, the consumers would meet with the board, and they would have a chat about issues that were affecting them and what they thought the organisation should be doing. So in that way, they were able to utilise their input and make sure that they were contributing to the aims of the organisation, but without making them vulnerable as directors.

Sophie: The last duty we’ll talk about is you must discharge your duties with good faith and for proper purpose. So this is basically, I think, about loyalty to the organisation. The most common breaches that I’ve seen are misusing information or misuse of a position, and also not managing a conflict of interest. So… Oh wait, hang on. I’ve got a trick. Excellent. Topical. I’m not implying that Bronwyn Bishop is a bad director. So an organisation I’ve worked with, the… I won’t say. I won’t give any identifying information, but this organisation decided to buy a bus. So they bought a bus for the organisation. When we chatted to them about this bus, it turned out the organisation used the bus maybe three times a year. The bus was getting a lot of work on the weekends, because two of the directors were using it to take camping trips and drive their mates to festivals and to drive their kids’ soccer team to practise.

Sophie: Does anyone want to jump in? What’s wrong with that picture? They were absolutely misusing their position for personal gain. And it’s a problem not just because of the money they spent on the bus, but they’re spending money insuring it, they were driving the organization’s petrol. It would’ve been much cheaper for that organisation to rent a bus three times a year when they needed it, and all in all, it was fairly poor conduct.

Sophie: So it’s just important to be mindful of your own conduct and your fellow director’s conduct. I find it’s especially common in very small not-for-profits where people have been involved for a long time. They get a bit of a family business kind of feel and the lines get quite blurred, and sometimes they start to treat the property in the office as their own, and that’s absolutely something that you need to stay on top of.

Sophie: The other common thing would be a misuse of information, so it’s particularly common in the not-for-profit sector. You might be involved in that sector for your day job, and then at night volunteer on a not-for-profit board. Perhaps it’s the peak body of your sector. And while you’re sitting on the peak body board, you might hear that one of the other service providers is in danger of losing a grant. You then can’t bring that information back to your employer and say, “Hey, we hear the people across the road are about to lose their grant. They’re not complying with it. Why don’t we make a pitch for that same grant?” That’s again a misuse of information, and there’s a lot of overlap between that and a conflict of interest.

Sophie: So does anyone want to say what’s wrong with Mr. Burns making this decision on the… It’s a conflict of interest. His personal company is going to benefit from that decision. It would’ve been more appropriate for Mr. Burns, if the organisation was deciding what kind of power they were going to use, it would’ve been appropriate for Mr. Burns to declare a conflict, and then that board would have a procedure for managing that conflict. So it might be that Mr. Burns does just declare the conflict and it’s judged in that situation. That’s fine. Knowing that, we’ll all make the decision anyway.

Sophie: It might be that Mr. Burns has to abstain from voting on any decisions relating to power providers. It might be that Mr. Burns has to leave the room. In very extreme cases, it might be that Mr. Burns can’t sit on an organisation that is so directly in conflict with his personal economic interests. But in 99% of cases, I think particularly not-for-profits, conflicts, shouldn’t be seen as the end of the world. I think we have to expect that they’ll occur. It’s entirely about managing them. And there’s no need to panic if you feel like you have a conflict, it’s absolutely about just having a procedure in place.

Sophie: So that has covered the main duties. My colleagues and I had a brainstorm, these are what we think the common mistakes on not-for-profit boards are. It’s pretty common to see conflicts not being managed properly, particularly in regional areas or if you’re in kind of a niche sector, there’s obviously a lot of overlap. You’re going to know the same people, you’re going to use different providers, you’re going to have mates. You’re going to have probably relatives, even. It’s entirely about managing that, and see the upside of that. If you are really embedded in that sector, it shows what a passion you have for it. So just because somebody has sort of a limb a few pies doesn’t mean that they’re an inappropriate director.

Sophie: Another one that is terrifyingly common is boards that defer to their CEO, particularly if the CEO’s been there for a long time. The CEO works for you, absolutely not the other way around. The CEO should not be hand picking board members. They should be involved in decisions, but the CEO should be reporting to you. Likewise, the chair. I’m personally of the view that no one should be a chair for more than a few years. A lot of not-for-profits get into trouble because they have a chair that’s been there for 20 years and they founded it, and they like things done the one way over and over again, and everyone else on the board tends to defer to them, which might be great. It might run really well, but you’re also running a huge risk because there is a protective mechanism in groups making a decision, and you lose that when you just defer to one person.

Sophie: The other one, relying on experts exclusively. As we discussed, you need to turn your own mind to issues. You can’t rely on anybody else. Not understanding finances, treating property as your own property. Disengaged directors are a huge problem. And these two are kind of the same. A lot of boards get distracted by smaller issues and they don’t focus on the mission anymore, and that’s not really a huge legal breach, but I think it can take away a lot of time and energy from the right issues. Not seeking professional advice.

Sophie: A lot of boards come to us, because I’m a pro bono lawyer, a lot of boards just come to us when everything is on fire. And you just think, why didn’t you call us a year ago? Anyone who looked at your constitution or whatever would’ve anticipated this problem. So I really encourage you to engage with whatever pro bono legal services are available, or any other kind of pro bono advice. It is so much more cost effective to deal with a problem before it’s a crisis.

Sophie: The other one, particularly I think for younger directors, is assuming that your questions are silly. Never assume that your questions are silly. It’s always, always right to ask a question when you don’t understand it. In my experience, usually other people don’t understand either. This is a pop quiz. We’re going to see what you’ve learned. Here are our Lego directors. Starting from the blonde one, does anyone want to say what’s wrong with that?

Audience: [inaudible 00:19:32] deferring to the chair?

Sophie: That’s right, deferring to one person. She’s not turning her own mind to the issue. What about the guy with the aeroplane top? It’s similar, he’s deferring to one person on one issue and he’s failing to undertake due care and diligence in a decision. What about the person in the middle?

Audience: [inaudible 00:19:53].

Sophie: Nepotism? Yep. It’s a huge conflict of interest. She should have excused herself, perhaps, from that decision. What about our friend in the red hat?

Audience: [inaudible 00:20:07].

Sophie: That’s right. Abdicating his responsibility in relation to the finances, also the most likely to end up before the Federal Court. And what about, is he an astronaut?

Audience: [inaudible 00:20:19].

Sophie: Racer? Forgive me. [inaudible 00:20:22] What’s wrong with the race car driver?

Audience: [crosstalk 00:20:24].

Sophie: Yeah, he should have just used his race car for that. All right. So basically there are so many things you can do now to vaccinate your board against the kind of problems we talked about. I think the biggest thing for me is culture. It has to be really okay to have collegial, polite disagreements, and to be able to point out problems when they arise. So it’s important to make sure you have a culture where that’s accepted, that’s encouraged, and systems and policies in place. Joanne talked about that a lot, I won’t cover it too much more, but it’s really good to get advice about that, anything that you’re not sure of, and obviously Better Boards have some really good resources about that as well.

Sophie: Get training for your board early and often, I think at least annually have governance training for your board. I find it’s really good on the boards I’ve been on. It can sometimes flesh out issues that you haven’t thought of, and it’s just good, I think, for everyone to have a reminder. It can also help you manage a director that isn’t complying in kind of a passive aggressive way. If you get someone else in to say these things, if they can realise for themselves ways that they’re not perhaps compliant, this is a really good way to do it.

Sophie: And I think another thing that really inoculates boards is having a diversity of people on the board. It shouldn’t be one family. It shouldn’t be like a bunch of mates. There should be a diversity in ages and genders, of closeness to the issue. Raf mentioned before I was on the board of the Foster Care Association of Victoria. When I joined, I was the only member that wasn’t a foster carer, and I think what we realised was that it was not great to have entirely a board of foster carers. I think everyone was too close to the issue in that example, and we agreed at least 30% of the board should be personally unaffected by the issue, just to sort of have an arm’s length perspective in meetings. So that’s something I would recommend.

Sophie: And the other thing is that also sometimes people, you have boards where everyone is very closely involved, and I think that sometimes you lose a lot of different perspectives. I just wanted to use this picture, but it’s also to remind us that it’s a continual process. You can’t have a one month, smash it out, let’s be great governance people. It’s an ongoing process. It’s something you should look at annually, quarterly, whatever is appropriate for your board.

Sophie: These are some other slides that some of our organisations really like when we’ve handed them out. It’s just basically, what does good governance look like in simple language? Is everyone reading the papers? Is everyone ready to make a decision? Are you turning up to meetings? It’s amazing how often these things aren’t being done, but in practise, that’s what good governance looks like. If I was going to look through the window at your board meetings and I had to make an assessment on whether you are governing or not, these kinds of things would be a real litmus test. And likewise, this is something that some of my clients find helpful as well, that’s basically what it would look like, what we think a really well-governed, legally compliant organisation would look like in effect.

Sophie: So I’m pretty much coming to the end. I hope I’ve convinced you that complying with your legal obligations is not onerous. It is absolutely worth the effort. It’s not about making the right decision every time. Don’t stress about every decision. It’s really just about making decisions in the right way. No one’s going to haul you to jail because you picked the wrong painting company. It’s really about what led to that decision, what process you entered into. And above all, have fun. Oh, if you type dysfunctional board Lego, you get that, and it reminds me of Kill Bill. That’s it. Thank you very much.

Author

Head of Sustainability and Social Impact
Gadens
About

Sophie McNamara is the Head of Sustainability and Social Impact at Gadens Lawyers.

Found this article useful or informative?

Join 5,000+ not-for-profit & for-purpose directors receiving the latest insights on governance and leadership.

Receive a free e-book on improving your board decisions when you subscribe.

Unsubscribe anytime. We care about your privacy - read our Privacy Policy here.