Melbourne | Sydney | Brisbane | Canberra | Perth

‘Dare We Take a Risk? Dare We Not?’Presented by Vera Visevic

25 July 2015

Melbourne | Sydney | Brisbane | Canberra | Perth


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Introduction Recent and dramatic shifts have seen the traditional NFP

sector transform into an increasingly competitive, rapidly-changing and consumer-driven market.

Increasingly, directors must make quick decisions that entail risks for the benefit of their organisations.

However, they also have duties as directors. This presentation will assist you in knowing how the law

supports, not hinders, considered risk-taking behaviour.

Sources of dutiesStructure Sources of duties

Incorporated Association • Constitution• State Incorporated Associations legislation• Common law

Company • Constitution• Corporations Act• Common law

Charity • Constitution• ACNC Governance Standards• Common law


Constitution = ContractAn organisation’s constituent or governing document is, in effect, a legal contract between: the organisation and its members; and the organisation, its members and its board. Section 140(1) of the Corporations Act states that a constitution has effect as a contract between: the company and each member; the company and each director and company secretary; and a member and each other member;under which each person agrees to observe the terms of the constitution so far as they apply to that person.Similar provisions exist in State Incorporated Association legislation.



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Incorporated AssociationsState / Territory

Duties Legislation

NSW Duty to disclose interestsDuty not to misuse position or information

Associations Incorporation Act 2009 (NSW), sections 31-33

VIC Duty of care and diligenceDuty not to misuse position or informationDuty of good faith and proper purpose

Associations Incorporation Reform Act 2012 (VIC), section 83-85

QLD Common law duties No duties specified in the State legislation.

WA Duty to disclose interests Associations Incorporation Act 1987 (WA), sections 21 and 42.


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Incorporated AssociationsState / Territory

Duties Legislation

SA Duty to disclose interestsDuty not to misuse position or informationDuty of care and diligence

Associations Incorporation Act 1985 (SA), sections 31 and 39A

ACT Duty to disclose interests Associations Incorporation Act 1991 (ACT), section 65

TAS Duty to disclose interests Associations Incorporation Regulations 2007 (TAS), section 27

NT Duty to disclose interestsDuty not to misuse position or informationDuty of good faith and proper purpose

Associations Act 2012 (NT), sections 31 and 33.

Duties under the Corporations Act

Type of Duty Description of the Legal Duty

Fiduciary duties Duty to exercise powers in good faith (section 181(1)).

Duty of care, skill and diligence Duty to act with care and diligence (section 180(1)).

Improper use of position or information Must not improperly use position or information

(sections 182 and 183).

Insolvent trading Duty to prevent insolvent trading (section 588G).



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Duties of Charities (which are also companies)

The following duties are switched off by section 111L of the Corporations Act.

They have been replaced with Governance Standard 5.Duty Section

Duty of care and diligence Section 180

Duty to act in good faith Section 181

Duty not to misuse position Section 182

Duty not to misuse information Section 183

(a) Duty of Good Faith What is ‘good faith’? It is:

• acting honestly;• exercising your powers in the interests of the organisation;• exercising your powers for a proper purpose, i.e. not misusing your

powers; • exercising independent judgment; and• avoiding conflicts of interests.


(a) Duty of Good Faith Exercise independent judgment. It will not ordinarily be a breach of the duty if

a director makes a bona fide decision by:• considering relevant material and views; • applying his/her mind; and• forming his/her own opinion.


(b) Duty of care, skill and diligence Directors have a duty of care, skill and diligence to the organisation. The director must exercise the level of care and diligence a

reasonable person would exercise if that person were a director in the organisation’s circumstances and held the same office and responsibilities.

This duty requires:• understanding the organisation’s affairs;• having the appropriate skills and experience for the role;• not simply relying on information given by others, but asking questions and exercising

independent judgement; and• attending board meetings.


(b) Duty of care, skill and diligence Directors may delegate and rely on others (e.g. management and

external consultants). However, a director must:

• objectively assess what is presented to him/her; and• exercise sufficient discernment to identify the reliability of the information he/she

has been given (e.g. figures for the organisation).• Ask questions!

Directors should attend ALL Board meetings:• Unless there are exceptional circumstances.• More missed meetings = more difficult for directors to argue that they are sufficiently

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(c) Improper use of information or position

A director must not improperly use:• their position; or• information

to:• gain an advantage for themselves or someone else; or• cause detriment to the organisation.


(d) Insolvent trading

Directors have a duty to prevent insolvent trading. If a organisation incurs a debt and there were

reasonable grounds to expect that the debt (or other debts) could not be paid, the directors could be personally liable for the organisation’s debts.

The liability can extend to criminal liability.



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Scared yet?


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You’re not alone In 2010, a survey found that:

• 73% of directors considered that there was a medium to high risk of being held personally liable for decisions they or their board made in good faith;

• more than 90% of directors said that the personal liability of directors had an impact on optimal business decision-making or outcomes; and

• 65% of directors felt that the risk of personal liability had caused them, or the board on which they sat to occasionally or frequently take an overly cautious approach to business decision-making.


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But don’t fear

Source: GiveEasy Pty Ltd and Australia Post 2015, Innovation Index of the Australian Not-for-Profit Sector (March 2015)

Directors may be hesitant to take risks for fear that they will breach their legal obligations if their decisions do not succeed.

However, taking risks and innovating is essential for the growth and success of an organisation.

Organisations with higher levels of innovation have higher revenue from new sources.


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How the law protects directors

The business judgement rule was developed for two main reasons, to:1. protect honest directors and officers from the risks

inherent in hindsight review of any unsuccessful decisions; and

2. refrain from stifling innovation and venturesome business activity.


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The Business Judgement Rule

Section 180(2) of the Corporations Act protects directors in respect of a business judgement if they:a) make the judgment in good faith for a proper purpose; b) do not have a material personal interest in the subject matter of the

judgment; c) inform themselves about the subject matter of the judgment to the

extent they reasonably believe to be appropriate; andd) rationally believe that the judgment is in the best interests of the

corporation.


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The Business Judgement RuleIs there a duty of

care owed?

• No business judgement rule does not apply.

Has the director or officer made a

business judgement?

• No no protection

Have the four requirements

been met?

• No no protection

Officer/director is protected from

liability

Yes

Yes

Yes


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Application of the rule to other structures

Entity State / Territory

Details

Charity All The rule is encapsulated in Governance Standard 5(2)(a).

Incorporated Associations

VIC The rule is encapsulated in section 84 of the Associations Incorporation Reform Act 2012 (VIC).

Incorporated Associations that are not charities

NSW, QLD, WA, SA, ACT, TAS and NT

• No statutory business judgement rule.• Under the common law, committee members have long been held to

have similar fiduciary duties to those of company directors.• It is arguable that, if a committee member can meet all the

requirements of the business judgement rule, then he/she will have discharged his/her duty of skill and diligence.


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Application of the rule to other structures

Entity State / Territory

Details

Incorporated Associations that are charities

NSW, QLD, WA, SA, ACT, TAS and NT

The same as above until:• 1 July 2017; or• The State/Territory legislation is amended to comply with Governance

Standard 5. Note: a bill is currently with the WA Parliament to amend the Associations Incorporation Act 1987 to include the business judgment rule.


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Limitations to the rule The business judgement rule has the following limitations, it

is:• only applicable to the duty to exercise due care and diligence; and• limited to “business judgments.”


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What is a ‘business judgement’? A business judgment is defined in the Corporations Act as “any decision to take or

not take action in respect of a matter relevant to the business operations.” This is mirrored in Governance Standard 5(2)(a) (for charities) and the Associations

Incorporation Reform Act 2012 (VIC) (for Victorian Associations). This is not as broad as it appears. There must be a decision – whether to do something or not to do something. It does

not extend to the failure to make a decision or where the directors abdicate their responsibilities and fail to exercise any judgment.

For example, decisions taken in planning, budgeting and forecasting have been found to be business judgments, but not a director’s oversight duties like monitoring the company’s affairs and maintaining familiarity with the company’s financial position.


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Recent case – unsuccessful defence

ASIC v Macdonald & Ors (2009) 71 ACSR 368 James Hardie made an ASX announcement that it had sufficient compensation funds

to meet anticipated future claims. There was a $1.3 billion shortfall. The issue: whether the directors rationally believed that this business judgment was

in the best interests of the company. There was no evidence that the directors rationally believed that this business

judgment was in the best interests of the company. It did not matter if they had no material interest in the decisions, made the judgment

in good faith for a proper purpose and informed themselves of the subject matter.• This is because a successful defence must meet ALL the requirements of the

business judgement rule.


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Stop panicking!

• The business judgment rule is not a shield for delinquent, dishonest or reckless directors – but we know that’s not you.

• It has been used as a successful defence.


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Recent case – successful defenceASIC v Mariner Corporation Limited [2015] FCA 589 Directors made a decision that Mariner would announce a takeover bid for

Austock without securing funding. The issue: whether the directors informed themselves about the subject matter. I.e. did the directors “reasonably believe they had taken appropriate steps on the

decision-making occasion to inform themselves about the subject matter”? The directors had considered that they had been provided with sufficient

information to make an informed judgment, and were therefore protected. The Court must balance the foreseeable risk of harm to the company flowing

from the contravention and the potential benefits to the organisation that could reasonably be expected from that conduct.


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Further protection – section 1318 Section 1318 of the Corporations Act gives the court power to:

• have regard to all the circumstances of the case; and• excuse a director for any negligence, default or breach of duty.

The courts have recognised that the purpose of section 1318 is to:• ‘excuse company officers from liability in situations where it would be

unjust and oppressive not to do so, recognising that such officers are business men and women who act in an environment involving risk and commercial decision making.’


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Further protection – section 1318 The scope of section 1318 is potentially broader than the

business judgment rule. For example, a director who did not make a decision when

required to has not made a ‘business judgement’.• They would therefore not be protected under section 180(2).

However, if they acted honestly in making this choice, they may still be protected under section 1318.


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Directors are also protected by common law

There is also recognition from the High Court that the quality of directors’ judgments should not be a matter for revision by courts with a critical eye and the benefit of hindsight.

Courts are reluctant to “second guess” business judgments, as long as they were made in good faith and for a proper purpose.


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NFP sector today

Issue ChallengeThe NFP sector is increasingly dynamic. To adapt to the changes and maintain long-

term sustainability.The NFP sector is made up of more than 600,000 entities.

To differentiate your organisation from the rest in the sector.

Increasingly competitive – 9 new charities are registered every day.

To stay relevant and competitive.

Government funding is declining – the Department of Social Services is cutting $271 million over the next four years.

To diversify your sources of funding and minimise reliance on public funding.

Demand for services from beneficiaries is only increasing.

To not only survive but grow the organisation to meet increasing demand.


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The solution1. Act commercially Like the private sector, NFPs need to work hard to be sustainable, thrive

and continue to make a positive impact. Competition for the charity dollar is fierce and the operating environment

of the sector is changing. In the commercial world, businesses know how to strike a balance

between short term result and long tem sustainability. Innovation is as important in the NFP sector as it is in the private sector. NFPs need to think and behave more like a commercial business to

compete and thrive on today’s sector.


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The solution2. Change your mindset Directors must encourage and stimulate the generation of new ideas, creativity and

innovation that can benefit the organisation. This can be done by:

• suspending judgement to encourage the creative process and avoid premature criticism;• tolerating ambiguity and embracing risk;• recognising when assumptions are being made and challenge them; • learning to spot ‘safe’ thinking and tunnel vision which leads to the organisation staying on

the same track; and• developing and adapting ideas from the experiences of other individuals/organisations.

Creativity and innovation can be stifled by fear of failure, negativity, lack of enthusiasm for change or a real or perceived lack of resources.


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The solution3. Embrace your duty to take risks and innovate In order to succeed and thrive, organisations must innovate and take

considered risks. Directors must be proactive, open-minded and think strategically. Arguably, innovating and embracing strategic risks is in the best interests of

the organisation. Therefore, directors must take considered risks to fulfil their legal obligations

to their organisation. Simply because a director participates in conduct which contains a reasonable

degree of risk, it does not mean that the director exercised his or her duties in a manner contrary to the law.


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Remember: taking (considered) risks is not a crime

Being innovative requires taking risks. However, taking risks requires informed, fact-based decision-making.

Directors must act in the best interests of their organisation and that may mean taking considered and educated risks…..not risks like this


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Examples of considered risk-taking40K Foundation Object: to improve access to an effective education in developing

countries. Problem: lack of government funding for overseas causes and heavy

competition from large international charities. Solution: creation of 40K Globe, a program to enable students to assist

on projects overseas while gaining credit for their university degree. Reason for success: diversified funding sources, collaborated with

universities, increased appeal to younger donors and grew 40K’s database.


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Examples of considered risk-taking

Oxfam Object: to create long-term, sustainable solutions to poverty. Problem: donating money to developing countries was a band-aid solution. Solution: creating a fair trade industry and establishing retail stores. Reason for success: creating a sustainable, long-term solution to poverty, differentiating themselves from organisations with similar objects and allowing donors to see the difference their donations make.


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How to take risks (safely)1. Create a transparent culture where risk is discussed and

embraced, not avoided.• Otherwise you create a culture where actions that involve any risk are

dismissed without further discussion.

2. Don’t separate compliance from strategy.• Don’t let directors simply be the ‘rubber stamp’ for approving projects

and activities.• Directors must know the whole picture in order to make informed and

strategic decisions.


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How to take risks (safely)3. Stay true to your objects

• Organisations that enjoy enduring success have core values and a core purpose that remain fixed, while their business strategies and practices adapt to a changing world.

• It is much more difficult to breach your duties to your organisation if you are acting within its objects and purpose.

• It is important to review the objects in your organisation’s constitution every few years.

This is important to:• ensure that your activities and projects are in line with your objects; or• alert you to the fact that your objects may need amending.


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Strategies to consider1. Introduce a new product or service into a test market. Enables the organisation to test the new product/service on a smaller market first. It is cheaper, can be done faster and can be targeted using the organisation’s

database. Losses are reduced if the test market does not respond well.2. Establish a new company/organisation. The new organisation can develop a new product or service which is not line with

the objects of the current organisation. This may allow the NFP to split its assets/risks between two organisations. This

minimises the risk of losing all of the assets if the project fails.


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Strategies to consider3. Merger The NFP space is crowded and competitive; working together can be an effective strategy. Mergers can be used to improve existing services, improve efficiency or broaden the range of

services to existing clients. In 2014, 30% of directors said their board had discussed or taken action to merge their NFP with

another in the last year.

4. Collaboration An alternative to a merger that is less time and resource intensive. A collaboration is much more informal and accessible, can still provide tangible benefits. Two-thirds of directors have said that their NFP works with others to advocate for the sector. Over one-third have an agreement to refer service clients to other NFPs. In 2014, 18% of NFPs shared back-office costs.


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Don’t be passive No one wants a passive director on their board. It is much more efficient and cost productive to be proactive and not

reactive. Passive directors do not add skills or expertise to the board. So the NFP sector doesn’t look favourably on passive directors….neither does the law.


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Don’t be passive The law protects decision-makers, it does not look favourably

upon not passive directors. Remember the business judgement rule – you cannot be

protected if you don’t make a decision/judgment:• It does not extend to the failure to make a decision, or

where the directors abdicate their responsibilities and fail to exercise any judgment.


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But don’t be these guys either


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Conclusion Know your duties. Directors are now operating in a very dynamic and competitive

NFP sector. Innovation is essential to adapt and survive in today’s

environment. Don’t be afraid to take considered risks because the law supports

responsible and informed risk-taking. Making informed decisions in good faith and in the best interests

of your organisation is not against the law. So, remember - it’s OK to take risks….


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…just don’t end up like this

Questions?


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