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By Elizabeth Lathlean

Director recruitment is an important task for both not-for-profit and for-profit organizations alike. It is an opportunity to enhance the skills, experience and diversity of the existing board and ensure the directors are best placed to serve the organization into the future.

 

But what happens when the preferred candidate already sits on multiple boards, including the board of a potential competitor?

It is a well-known principle of corporate governance that a director owes certain duties to the organization they serve. For those individuals who have the privilege of holding multiple directorships, these statutory and common law duties are owed equally to each organization.

 

An individual should not be precluded from joining a board simply due to their holding of other directorships. Multiple directorships alone are insufficient to constitute a breach of director duties and often an individual will be able to fulfil their duties to each organization without issue.

However, there are times when the duties a person owes to each organization may conflict.

What duties are owed?

The nature of the directors’ duties owed varies slightly depending on the type of organization. For the purposes of this article, the directors’ duties outlined are those which apply to organizations registered as charities with the Australian Charities and Not-for-profits Commission (ACNC). In the case of other types of not-for-profits, there may be variations to these duties based on the relevant applicable legislation (and case law).

 

Under ACNC Governance Standard 51 registered charities must take reasonable steps to ensure its directors meet certain duties. These are the duty to:

  1. act with reasonable care and diligence;

  2. act honestly in the best interests of the charity and in furtherance of its purposes;

  3. not misuse the position of director;

  4. not misuse information obtained in performing duties;

  5. disclose any perceived or actual material conflicts of interest (including any related party transactions);

  6. ensure the charity’s financial affairs are managed in a responsible manner; and

  7. not allow the charity to operate while insolvent.

 

In the case of multiple directorships, situations may arise where the duties a director owes to one organization conflict with those owed to another organization. This is often referred to as a conflict of loyalty or a conflict of duties.

Conflict of duties

Generally speaking, directors have a duty to be aware of and manage (and in some cases avoid) two kinds of conflicts:

  1. conflicts between their duty of loyalty to the organization and a personal interest; and

  2. conflicts arising due to different loyalties i.e., between their duty of loyalty to the organization and a duty to another party or individual (including another organization of which they are a director).

 

As the holding of multiple directorships is not of itself impermissible, it is not the mere existence of a conflict of interest which attracts liability. Instead, the director’s conduct must be improper to constitute a breach of their duties. This means there is nothing on its face to prevent an individual director holding a position of director with another organization or organizations. In fact, multiple directorships have the opportunity to bring a richness of depth and experience to not-for-profit organizations.

 

The courts have adopted a practical approach to such situations for directors, requiring an objective test as to whether there is “a real sensible possibility of conflict”. The duty to manage (and in some cases avoid) conflicts requires a degree of vigilance, as in some circumstances it cannot just proscribe certain actions but positively compel certain courses of action.

 

A conflict will most commonly arise in circumstances where there are direct dealings between the two organizations. This may include:

  1. being a director of two organizations involved in designing and/or negotiating a transaction;

  2. being a director of two organizations pursuing the same commercial opportunity or looking to engage with the same third party (e.g., Government funding); and

  3. being a director of two organizations pursuing the same market or strategic opportunity.

 

For example, a director sits on the board of both Charity A and Charity B. Charity A agrees to sell an asset to Charity B. In these circumstances the duty to act honestly can require that director to disclose information to Charity B concerning Charity A’s assets, which may be material to Charity B’s decision about whether to acquire those assets. In such a case, Australian law suggests disclosure of the nature of the interest to Charity B may suffice, without the need to disclose confidential particulars of Charity A’s assets. However, this is often the minimum requirement and the extent of the disclosure (and other actions) required will vary depending on the nature of the conflict.

Practical considerations

The actions an individual might need to take to manage or avoid a conflict will usually become more onerous depending on how serious the potential conflict may be. Practical actions, rated from least drastic to most, include:

  1. disclosing the conflict to the directors;

  2. not exercising their powers for the benefit of one organization without the consent of the other organization;

  3. abstaining from taking part in negotiations or voting;

  4. seeking a leave of absence; and

  5. resigning from the position with one or both organizations.

 

What action, above and beyond mere disclosure, the individual must take will vary from case to case depending on matters such as the degree to which the individual has been involved in the transaction and the gravity of possible outcomes for one or another of the organizations. In some cases, it may be enough for the individual (in their role as director) to refrain from voting or absent themself from the board’s deliberations on the matter. In other cases, circumstances may require the individual to take some positive action to limit any possible harm to the organization.

Where a situation can cause an organization serious harm or where the individual knows entry into the transaction is illegal the individual may need to resign from office as a director to avoid a breach of duties.

Each individual must also assess their own ability to continue to fulfil their duties, particularly in circumstances where managing conflicts results in an individual being absent from multiple directors’ meetings or from important decision-making processes within meetings. For example, if the board’s time is dominated by a particular matter over a prolonged period (such as entering a transaction), and a director is either on the board of the counter-party or a board of another organization also bidding for or participating in the transaction process, it may be worth a conflicted director seeking a leave of absence until the transaction is complete or even resigning from the board altogether.

Ultimately, directors of multiple organizations should be alert to the potential for conflicts of duties to arise and ensure any actual or potential conflict is managed appropriately. Board’s themselves should also be aware of such conflicts and ensure they have adequate policies and procedures in place to confidently manage conflicts when they arise.

This article was first published in the 2022 Better Boards Conference Magazine.

At the time of writing Elizabeth Lathlean was a Senior Lawyer in Gilbert + Tobin’s Charities + Social Sector Group. Elizabeth specializes in the provision of legal advice and assistance to charities, not-for-profits and social sector organizations

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