Governance Propriety for Not-for-Profits

Beyond just conflicts of interest

I discussed the management of conflicts of interest in societies and charities in an earlier article.  Apart from conflicts of interest, there may be conflicts of loyalty arising from the other activities or commitments of people in governance, and these also need to be recognised and managed.  Both types of conflict also need to be considered in the wider context of the legal and moral obligations of those in governance.

Duties of those governing a not-for-profit

Those “… duties have often been broadly described as the duty of care, the duty of loyalty, and the duty of obedience” (Joining a Nonprofit Board – What You Need to Know, Epstein and McFarlan, 2011, and other quotations in this article come from this source).  Three core responsibilities in realising a not-for-profit’s purposes are to develop and oversee delivery of the mission, being accountable for mission performance and financial sustainability, and evaluating the performance of senior staff.

While realising the purposes and mission are the key drivers for both for-profits and not-for-profits, there are key differences:

For-profit entity:

  • Realising the purposes (mission) produces cash
  • Success in realising the purposes (mission) is measured in cash earned,   and retaining and growing the customer base
  • Without cash the entity fails
Not-for-profit entity:

  • Realising the purposes (mission) consumes cash
  • Success in realising the purposes (mission) is measured in the services   provided and the numbers of “clients” served
  • Without cash the entity fails

A not-for-profit’s purposes are primary and must be at the forefront of all governance thinking and actions, but financial skills are also critical in providing and managing resources to realise the purposes.  The successful pursuit of the purposes with adequate finances makes not-for-profit governance and management especially challenging.

Duty of care

“The duty of care refers to the diligence and skill that must be exercised when a member makes a decision as a steward of the organisation …”

To comply with the duty of care, those in governance need the appropriate skills; have enough time to meet their responsibilities; must really understand the entity’s finances (the balance between income and expenditure); know if the entity has adequate financial (cash and capital) resources; understand the entity’s cash situation; know if any debt is sustainable; know whether the entity’s balance sheet and cash are protected against adverse economic conditions (e.g. if donations and fees drop sharply); and have available adequate transparent measures to monitor the entity’s efficiency and financial health.

In essence, those in governance must accept responsibility for pursuing their entity’s purposes and mission, understand what is happening in their entity, ask questions if anything is not clear, and not allow themselves to be fobbed off.  They also need to understand that they are in governance not because of reputation, popularity or good looks – but to do a job with serious responsibilities and requiring a significant time commitment.

The “buck” stops with those in governance, collectively and individually, and Companies Act obligations can extend to those in governance on a not-for-profit’s liquidation.  As recent prosecutions of finance company directors illustrate, relying on others in the governance team or on staff or external consultants does not diminish personal responsibility.

Duty of loyalty

The “duty of loyalty means that members must subordinate their personal interests to those of the organisation, avoiding all possible conflicts of interest.”  This requires that any competing external loyalties be declared and properly managed; that any conflicts of interest (financial or non-financial) are declared and properly managed; and that those in governance maintain objectivity (and avoid bias and predetermination).

Duty of obedience

The “duty of obedience requires that members must obey the law and ensure that the organisation itself complies with the law.”  At its simplest, this requires that the entity and those in governance comply with the law; with the entity reporting as required by statute or contracts, those in governance knowing and complying with the entity’s constitutional requirements, and the entity meeting its obligations to employees, volunteers and clients.

Those in governance are ultimately accountable for compliance with Charities Act 2005, Charitable Trusts Act 1957 or Incorporated Societies Act 1908, s 28A, Fair Trading Act 1986 (if activated), and all other applicable laws; lodging all required returns with Charities Commission (annual, constitutional amendments, changes of those in governance) and meeting IRD requirements; and complying with laws specific to its activities and accounting and auditing requirements.   In addition, they must comply with entity’s constitutional provisions (purposes, election or appointment of those in governance, and as to meeting processes, especially required notice of and agenda for meetings); declare all financial and other conflicts of interest (including conflicts of loyalty); ensure that reimbursements for those in governance are reasonable; recognise that any honoraria for those in governance are taxable; and meet normal meeting procedure and minutes requirements.

The dangers inherent in governance duties

In reality, the majority of such organisations are well-run by people who exercise commonsense and their life skills.  The duties and obligations outlined impose significant responsibilities on those governing not-for-profits, and if fully understood there is a danger that this may dissuade many from volunteering their services.

While the extent and onerous nature of the duties of those governing a not-for-profit will not ever trouble most people, knowing that they exist should avoid any complacency.  In essence, the price of peace for those governing not-for-profits is eternal vigilance.  We all need to recognise that governing a not-for-profit is not an honour; it is hard work, it involves asking searching, hard, even distasteful, questions, and it may require the making of hard, even unpleasant, decisions.

This is one of a series of articles on societies and charitable trusts (originally published in the NZ Lawyer magazine) by Mark von Dadelszen, a Hastings lawyer and author of Law of Societies, 3rd Edition, 2013. If any reader has examples of issues that have arisen or questions about societies or charitable trusts that might be a suitable subject for one of these articles please contact Mark at mark.vondadelszen@bvond.co.nz.