Over the past six months we have been examining the fifth governance standard for charities established by the Australian Charities and Not-for-profits Commission (ACNC): that is, board members or other responsible persons owe a fiduciary duty to their charities. This is one of the highest standards of care imposed and means that board members must be loyal to their charity and act in good faith.
This general, overarching duty can be broken down into six more specific duties. Previously we have dealt with the duty of board members:
• to act with reasonable care and diligence;
• to act in the best interest of their charity and for a proper purpose;
• not to improperly use information or their position;
• to manage financial affairs responsibly; and
• to disclose and manage conflicts of interest.
The topic for this final month is the duty of board members not to allow a charity to operate while insolvent.
"Board members must ensure that their charity can pay its debts when they are due."
Solvency and insolvency
Board members must ensure that their charity can pay its debts when they are due. This is called being solvent. If their charity is unable to do this then it will be insolvent. Board members must not allow their charity to continue to take on new debts (for example, wages, rent and equipment lease payments) if they know the charity will not be able to pay those bills when they are due.
A practical example
In 1988, the Victorian Division of the National Safety Council Australia (NSCA) advised the Board that further information was required to complete the (then) current audit. They were also told that they needed to modify their audit reports for the previous three years. During this process accountants discovered that many of the financial records were fraudulent. It was found that the company was insolvent and owed $300 million to major Australian banks. The company was placed into liquidation.
The Commonwealth Bank of Australia sued the directors in their personal capacity for allowing NSCA to trade while they had reasonable grounds to believe it was insolvent. One of the directors was found to be personally liable for almost $100 million!
This situation, and all the court cases that followed, reinforce the importance of not allowing a charity to operate while insolvent.
"... the company was insolvent and owed $300 million to major Australian banks."
A good way for board members to gauge whether they are in danger of allowing a charity to operate while insolvent is for them to ask themselves, ‘will my charity be able to pay its debts when they fall due?’ Doing so will help board members to uphold their fiduciary duty and, in turn, ensure that their charity complies with this ACNC governance standard. This is our final article in the series.
If you would like further information on any of these topics please contact.