Personal Liability of those in Governance

My article, “Winding up a society or charitable trust” LINK, closes with a warning of the officers’ potential liability on liquidation:

Society committee members and charitable trustees may be personally liable following liquidation if the entity they have governed has suffered losses caused either by the failure to keep adequate accounting records or by misapplication or retention of an entity’s money or property, or they have been guilty of negligence, default, or breach of duty or trust in relation to the entity.  Recovery may be ordered at the instigation of a liquidator, member or creditor.

Ralph Chivers, Chief Executive of the Institute of Directors, writing in the Dominion Post, 5 March 2012, referred to “the possible collapse of a venerated rugby union” as one of the reasons why the quality and accountability of those in governance was then being much discussed.  He commented that those in governance “must keep an eye on the big picture, but still drill down to the detail.  They are there to identify risks and opportunities, and implement strategies to manage them.  It is a weighty responsibility.”  He concluded by saying “Crucially, the board will also take time to reflect, appraise and evaluate its own performance, to regularly ask: ‘What could we be doing better?’”  Mr Chivers’ remarks apply equally to all those governing not-for-profit entities.

The responsibilities of those governing a society or charity must be proportional to the nature and scale of its activities, but what does that mean in practice?  The answer may be as long as the proverbial piece of string.

Otago Rugby Football Union Incorporated

The high profile woes of the Otago Rugby Union in the first decade of this century may have been a timely reminder of the risks that may be faced by those governing voluntary organisations whose financial position becomes precarious.  I know nothing about the Union’s governance or management, but over that decade the picture was, on the face of it, not good (details from the Registrar’s website, with the 2011 figures as reported in the media):

Had the Otago Rugby Union been liquidated, the decisions made by its Board in those years would almost certainly have come under close scrutiny.

Potential liability under statute

Part 16, Companies Act applies on liquidation of an entity incorporated under the Incorporated Societies Act 1908 (sections 24(3) and 26(3)) and Charitable Trusts Act 1957 (section 24(2)).  In consequence, those in governance face potential liability (especially under sections 300 and 301), although the effect of the deeming legislative provisions remains somewhat uncertain.

The effect of section 300 appears to be that societies and charities are required to comply with section 194, Companies Act, or section 10, of the Financial Reporting Act 1993:

  • Section 194 requires that accounting records be kept that: −  Correctly record and explain an entity’s transactions, −  Will at any time enable the financial position of an entity to be determined with reasonable accuracy, −  Will enable those in governance to ensure that the financial statements of an entity comply with section 10 of the Financial Reporting Act (and any group financial statements comply with section 13 of that Act), and −  Will enable the financial statements of the entity to be readily and properly audited.
  • Section 10 obliges those in governance to prepare financial statements that comply with generally accepted accounting practice, and give a true and fair view of the matters to which they relate.

Under section 300 the High Court, on a liquidator’s application, may declare those in governance personally liable, without limitation, for all or part of the debts and liabilities of the incorporated society or trust.  The Court will consider whether failures under the relevant sections have either contributed to the entity’s inability to pay its debts, resulted in substantial uncertainty as to the assets and liabilities of the entity, impeded orderly liquidation, or for any other reason it is proper to make such declaration.  The only defences are that the director or former director “took all reasonable steps to ensure compliance” or “had reasonable grounds to believe and did believe that a competent and reliable person was charged with the duty of seeing that that provision was complied with and was in a position to discharge that duty.”

Under section 301 (on application by a liquidator, creditor or shareholder) where in the course of liquidation it appears to the High Court that a person involved in the formation, promotion or governance of an incorporated society or trust has misapplied, or retained, or become liable or accountable for, money or property of the entity or been guilty of negligence, default, or breach of duty or trust in relation to the entity the Court may order the person either to repay or restore the money or property or any part of it with interest or order the person contribute a sum to the assets of the entity by way of compensation (if the application is made by a creditor the Court may also order that money or property with interest be transferred to the creditor).  The amount of compensation awarded will take into account the degree to which the person’s activities caused loss, the culpability of the person, and duration of the activity subject to litigation (see Fautipaito v Bates [2001] 3 NZLR 386, [111]-[112] and Maloc Construction Ltd v Chadwick & Ors (1986) 2 BCR 217).  Section 301 contemplates compensation being payable to the entity itself (see Walker v Allen 18/3/04, France J, HC Nelson CP13/00).

As noted above, the new Incorporated Societies Act is expected to make the governance and management obligations of society committee members far more explicit.

Protection from liability?

Many incorporated societies and trusts have a provision in their constitutions designed to protect those in governance or management from the risks of personal liability, but this is generally limited to circumstances where they have acted lawfully and honestly in furtherance of their responsibilities and in accordance with the constitution.  The problems with such a rule when a society gets into financial strife are two-fold:

First, questions will arise as to whether those governing an organisation that gets into a financial crisis can properly claim to be acting “lawfully … in furtherance of their responsibilities and in accordance with the constitution.”  If their actions are subject to successful challenge under Part 16, Companies Act, members of committees and trustees may not be entitled to claim indemnity under such clauses.

Second, even if indemnity is available those in governance will still be faced with having to defend their actions from a liquidator’s or creditor’s claims and if the entity is insolvent the indemnity will be worthless.

 Some voluntary entities obtain the equivalent of directors’ indemnity insurance for those in governance.  The conditions of such cover may be such that committee members or trustees will find that their actions are not covered (and some excess will almost certainly apply), and in any event they will have to spend time (and experience the stress of) defending their actions.

For specific advice the issues discussed in this article, please contact Mark at mark@nfplaw.co.nz.

This is one of a series of articles on societies and charitable trusts by Mark von Dadelszen, a lawyer and author of Members’ Meetings, 3nd Edition, 2012, and Law of Societies, 3nd Edition, 2013 (both texts being in the course of editing for 4th editions to be published after the new Incorporated Societies Act is enacted).