The recent liquidation of a large college in Victoria which displaced over 1200 students, is a reminder to directors of not for profit (NFP) organisations of their duties. Even though directors in this sector are sometimes 'well meaning amateurs,' they play an important function and carry the burdens and responsibilities that accompany the office of a director.
In the current economic climate, NFPs face increasing demand for their services and a decreasing supply of funds from corporates and individual donors. They and their directors may face difficult times. In this context, the governance and accountability of the NFP board are significant issues that are worth revisiting.Tania Mannello and Aaron Lane
This article concerns NFPs operating as Australian companies under the Corporations Act 2001 (Cth) (Act). Like all NFPs, these companies:
Directors of these NFPs have additional duties as set out in the Act. These duties do not apply to trustees of charitable trusts or committee members of incorporated associations.
NFP companies, and other NFP organisations, are an essential part of the community and the number of different organisations, and the number of people involved in operating them, continues to grow. This proliferation continues despite the challenging economic times.
This means that:
The circumstances surrounding the recent closure of an independent school in Melbourne's west reinforces the need for directors of NFPs to exercise their duties with care.
The school comprised 3 campuses and was operated by an NFP company. In late May 2012, the company was placed into voluntary administration. In July 2012, its creditors voted to place it into liquidation.
The school's liquidator has commented that the likely causes of the school's financial troubles were:
The liquidator is investigating whether the directors were trading the company whilst it was insolvent or breached any of their other duties under the Act.
Knowledge For directors of NFPs to properly discharge their duties, they must understand:
Advisors to these NFPs (and to clients considering taking board positions) should ensure directors understand these key duties and requirements.
Systems If there are gaps in those financial governance and controls, then directors need to ensure that good financial management policies and procedures are put in place to suit their organisation.
Also, directors should be educated on financial management, including the essential elements of income and expenditure, balance sheets and financial statements.
Inquire If a person plans to consent to act as a director of an NFP then, before they do so, they should ask the NFP for:
These inquiries might include meeting with the NFP's treasurer or financial officer to get their view on the financial health of the organisation, including issues around the reliability of revenue streams (including access to government grants), costs management and how long the NFP's creditors are waiting to get paid.
Insurance Directors should check whether:
Advice If doubt exists about the organisation's financial governance and controls, or financial health, then boards should consult with appropriate professional advisors and take action swiftly.
Directors of a company are required to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise:
Directors will have discharged this duty if they have:
This 'reasonable person' standard means that it will not be an excuse for a director to say that they were an amateur, or that they did not properly understand the reports or the decisions the board was making. In particular, directors cannot avoid their responsibilities by:
Also, 'nominee' directors, who may be appointed to represent specific interests on the board, owe a broad duty to act in the best interests of the company as a whole – rather than just the interests of the members they represent. For example, an independent school may have a teacher that has been appointed to the board as a nominee director on behalf of the teachers of the school. In this case, the nominee director must make decisions and judgments that are in the best interests of the school as a whole, rather than the teachers' best interests.
Directors must act in the best interests of the organisation for proper purposes and avoid conflicts of interest.  The Act prohibits directors from using their position, and information obtained from their position:
This obligation not to use information for personal gain continues after a director has left the organisation.
Directors must disclose all conflicts of interest. If a director has a conflict of interest and the company is a public company (NFP or otherwise), then the director's right to vote may be restricted.
Many organisations in the NFP sector will be familiar with the obligation to avoid trading while insolvent.
A company will be insolvent where it is unable to pay all its debts, and as when they become due and payable.
Directors of a company must prevent the company from incurring a debt if:
Again, the 'reasonable person' standard applies. A director will be in breach of the obligation to prevent insolvent trading if, at the time of incurring the debt, a reasonable person in the same circumstances would have had reasonable grounds to suspect that the company was already insolvent, or would have become insolvent by incurring the debt.
Accordingly, directors must ensure that their company maintains an adequate cash flow to continue their operations.
The law provides civil and criminal penalties for directors who fail to discharge their duties under the Act. These penalties apply to a director of a NFP company in the same way that they apply to a director of a company operated for profit.
Currently, the maximum civil penalty for a contravention of a directors' duty is $200,000. Additionally, the Court may order a director to compensate the corporation for any loss or damage to the corporation resulting from breach of the duty.
Criminal penalties also apply to the duty to prevent insolvent trading if the breach is found to be dishonest. Currently, the maximum criminal penalty is a fine of $220,000 or 5 years imprisonment.
While these laws are still in a draft form, the possible impacts may include:
A well organised and managed NFP, regulated under the Act, should be able to effect a smooth transition to these new regulatory arrangements. NFP directors should ensure they are monitoring these developments and preparing to seek advice on them when the laws are finalised.
For questions or more information about the above article please contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Maddocks Insolvency Team.
You can read other articles concerning companies and not-for-profits here.
Order the Cleardocs Company Registration package here.
 Section 180 of the Act.
 Sections 181-184 of the Act.
 Section 191 of the Act.
 Section 588G of the Act.
Leigh is a partner in the Maddocks Tax & Revenue team.
Leigh regularly provides advice on:
His advice covers both direct and indirect tax considerations.
Leigh advises Australian and multinational companies, high net worth individuals, accountants and financial advisers on all areas of taxation law.
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