Agony Uncle: Can we insure against director breaches of our constitution?

Borthwick Chris Jul2019lg

In this help sheet series, Our Community’s resident agony uncle, Chris Borthwick, offers answers to frequently asked questions about issues not-for-profits are facing.

Dear Agony Uncle,

“I am part of an association tasked with assessing insurance requirements, particularly directors’ and officers’ liability insurance.

My committee has asked about legal liability in the case of a committee member doing something that violates our constitution or our code of ethics, and in the case of the committee as a whole doing the same type of thing. What is the worst-case scenario that could eventuate in either situation?

– Concerned committee member, Victoria

Agony Uncle’s answer

The answer, you will be glad to hear, is “practically nothing”. It is not a matter that should concern you when considering insurance choices.

To begin with, your code of ethics is as binding as any other code of ethics – the ten commandments, say. You can’t be locked up just for coveting your neighbour’s ox, and you can’t be sued just for being unethical unless some other legal prohibition is involved (‘Thou shalt not steal’, for example, is more than just good advice).

Ideally, you will have given your code of ethics constitutional status by providing in the constitution that a breach of the code (or your policies, or your standing orders) will be grounds for revocation of membership, which will give them a featherweight of consequence – but for that, see below. This doesn’t mean that codes are worthless – they do set out what’s expected, and they can contribute to a culture of respect – but they’re really not justiciable.

So, to breaches of your constitution.

In the eyes of the law your constitution is a contract – between the organisation and its members, and between every member and every other member. It follows from this that the only people who have standing to act on it are parties to the contract, being other members.

That’s civil law, so the police have no place. Regulatory bodies – the ACNC, state regulators – have nothing whatsoever to do with constitutional issues and so say clearly on their websites. “Sort it out for yourself” is their view.

That leaves your members. If there’s a dispute there, they can enter the dispute resolution provisions in your constitution, and if they can get those to work then the best of Australian luck to them. Alternatively, they can take the direct route and appeal to the members at a special general meeting, or wait it out and try to roll the board at the next AGM. All good clean fun.

And, if you have a very, very aggrieved member, they can as a last resort take their constitutional fight out into the civil courts to enforce the terms of that civil contract. Anyone who does this has to be willing to spend a lot of money on a very long shot, but it certainly happens from time to time. Still, do note that:

  1. it’s rare
  2. it’s going to be a suit against the board, not the individual board member, because no individual board member, no matter how deranged or partial or prejudiced or stupid or incompetent – no matter how at fault – can actually fix the situation. The organisation made the decision, the organisation has to provide the remedy.
  3. defendant boards have the wind behind them.

A court won’t intervene if:

  • it’s trivial
  • it’s purely a procedural breach and the same decision could have been taken legally
  • it could be fixed by holding a special general meeting
  • it’s just a disagreement about the board’s judgement (to be overruled, a decision has to be not just stupid, not just suspect, but a decision that no sane board could possibly have made – and that’s a high bar).

If a court does intervene, all they’re going to do is tell the board to go back and do it over. No monetary damages are going to be involved, because the aggrieved member doesn’t have, as a member, any financial interest in what is by definition a not-for-profit.

At this point you may well ask what good directors’ insurance is. Well, it’s valuable in for-profit bodies, because money is at stake and people have an incentive to sue. There are things that a not-for-profit board can be sued over, certainly; they’re just nothing to do with your constitution. They’re straightforwardly commercial matters like trading while insolvent (though here you might have to check your insurance: some insurers specifically exclude TWI). For low-risk activities such as I imagine are involved in your organisation I don’t necessarily recommend D&O insurance at all – but that’s up you.

To answer the last part of your question, the worst-case scenario is that the organisation is hauled into court to fix a misapplication of the constitution. That can be gruelling – look up Gnych v Polish Club cases on Austlii – but it’s not directed at individuals. You needn’t take it into account when considering D&O liability insurance.

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