This article was first published in the 2nd quarter 2014 edition of Personal Finance magazine.
Non-profit organisations (NPOs) feature large in the lives of many South Africans. There are the multitudes on the receiving end, such as those benefiting from charities. But there are probably just as many givers: donors, which range from large corporations to anyone dropping a few coins in a collection tin, and the many who contribute time and expertise to run these organisations – and who form the backbone of the non-profit sector.
Unlike for-profit businesses, NPOs rely heavily on unpaid volunteers. Volunteers can be found at all levels, from selling raffle tickets to sitting on the board. They may be retirees who have time to spare, but they may equally be working people with full, busy lives.
Perhaps you are a volunteer, or are considering becoming involved in a cause that is dear to you. If so, you need to be aware – particularly if you are representing an organisation at board level – of the financial implications for you directly if something goes awry and the organisation and/or its board members is held liable for financial loss. The risk is greater than it used to be, but it can be minimised if it is managed correctly.
Although civil actions involving NPO board members are rare, the corporate landscape in South Africa has changed in line with greater global emphasis on good governance, increasing the likelihood of litigation in the future. Two developments, in particular, over the past few years have contributed to the changed landscape: the release of the so-called “King III” report in 2009, which raised the bar for corporate governance in South Africa, and the promulgation in 2011 of the new Companies Act of 2008, which went much further than its predecessor in addressing governance issues.
Types of NPO
To a large extent, NPOs operate in the same way that for-profit businesses do. They employ staff; provide services and/or products; contract with suppliers and landlords; deal with money coming in and going out, which must be accounted for; and fall under the ambit of laws (some of which don’t differentiate between for-profit and non-profit entities) that govern many aspects of their operations.
Under the Nonprofit Organisations Act of 1997, registration as an NPO, through the Department of Social Development’s Directorate for Nonprofit Organisations, is voluntary. An organisation, whether registered with the directorate or not, can take one of three legal forms:
1. Voluntary association
This is the most informal of the three structures. Ricardo Wyngaard, a Somerset West-based attorney specialising in the non-profit sector, has written a number of legal advice publications for NPOs. He says a voluntary association, in essence, is an agreement between three or more people to achieve a common object, which cannot be the making of profits.
“It is popular among smaller and informal community-based initiatives and is regulated by common law, not statute. The association is not required to be registered with a public office in order for it to exist,” he says.
According to The Law of Partnership and Voluntary Association in South Africa by Brian Bamford (Juta, 1982), for the association to have a legal personality, it must meet three requirements:
* Have perpetual succession;
* Be able to hold property distinct from its members; and
* Stipulate that no member has any rights, by reason of his or her membership, to the property of the association.
2. Non-profit trust
A trust may be set up if a large donation needs to be administered and the money directed to a specific cause. The NPO must be registered as a trust with the Master of the High Court and is subject to the Trust Property Control Act of 1988.
Wyngaard says that even in situations where large donations are not part of the equation, the trust has become a popular option. It is a very flexible structure that can take on different forms.
“A trust is not a separate legal person but a unique form of legal entity. The assets and liabilities of a trust vest in the trustees, but not in their personal capacity … the lack of legal personality on the part of the trust does not equate to personal liability [on the part of the trustees].”
The trustees constitute the non-profit trust’s governing board. The Master authorises the appointment of the trustees, Wyngaard says.
“There are no restrictions on the qualifications of trustees, except to the extent that … the Master has the discretion to remove trustees from office under certain circumstances, including situations where [they] have been convicted and imprisoned for an offence related to dishonesty. Trustees may also be called on to account to the Master on the administration of the trust and the disposal of trust property.”
3. Non-profit company
Under the Companies Act of 2008, an NPO may take the form of a non-profit company, previously known as a section 21 company. The company must be registered with the Companies and Intellectual Property Commission and is subject to the provisions of the Companies Act and its regulations.
A non-profit company can be incorporated for “a public benefit object or an object relating to cultural or social activities, or communal or group interests”. Like any company, a non-profit company is a juristic person. Its governing board is made up of directors, of which there must be at least three. The directors are not liable for losses to the company, but a director may be held liable for losses as a result of a breach of his or her duty.
Responsibilities of trustees
Shelagh Gastrow, who heads Inyathelo, the South African Institute for Advancement, an important support body for NPOs, says that, because NPO board members are volunteers, they are likely to be people who are interested in the specific cause of the charity or organisation.
“Most organisations try to recruit someone with financial skills and someone with legal skills. In NPOs that are active in advocacy, civic activism, research, policy development, environment and other causes, board members are likely to be from a wide range of representative groups – for example, communities in which the NPO works, academics with expertise in the field and political leaders,” Gastrow says.
If you are a trustee or a director on an NPO board, you are bound by certain responsibilities and are obliged, under the applicable Act, to exercise prudence and care:
* The Trust Property Control Act requires that “trustees must, in the performance of their duties and the exercise of their powers, act with the care, diligence and skill which can reasonably be expected of a person who manages the affairs of another”.
* The Companies Act, Wyngaard says, is more explicit about the duties of directors and their potential for liability. A director may be held liable for any loss, damages or costs sustained by the company in situations where there has been:
– A breach of fiduciary duty;
– A failure by the director to deal with a personal financial interest; or
– A failure by the director to act in good faith and for a proper purpose.
The Inyathelo publication Governing Boards in the Non-Profit Sector, by Gastrow, Mellet and Wyngaard, elaborates on the issue of conflicts of interest: “A conflict of interest … is not limited to situations where a board member may stand to benefit financially from the affairs of the NPO, though this is the most common form. It may also arise when the board member, his or her family or business partners may directly or indirectly benefit as a result of that member being on the board. The existence of an actual or potential conflict may not in itself be a problem, but how the board deals with that situation is of the utmost importance.”
Society at large places special demands on those running charities and other NPOs. A paragraph from the Department of Social Development’s Code of Good Practice for NPOs, published in 2001, points out that there is a higher public expectation of NPOs to behave properly than there is of for-profit organisations. It states: “NPOs exist on the support they receive from others, given in trust and with the hope that problems and issues will be effectively addressed by the organisation’s mission and objectives. Because NPOs are expected to ‘do good’ with these resources, the public expects them to be beyond reproach. Any misbehaviour brought to light by enquiry or the media becomes a slight on the entire NPO community.”
Living up to certain standards is one thing, but it is another to live with a threat of financial loss if, perhaps through no direct fault of your own, someone decides to sue.
Gastrow believes this issue of personal liability could affect the ability of NPOs to attract board members. Complicating matters is the fact that NPOs have problems unique to them.
She says: “There is a level of incapacity in the NPO sector that might be a threat to good governance. In addition, board members are volunteers, and the organisation is sometimes not a priority when their own work and personal commitments weigh heavily. This means that things could fall through the cracks if not well managed.
“In 2012, the Independent Code of Governance for NPOs in South Africa was launched, as it was felt that King III was too focused on the for-profit sector and had a very different values base, especially taking into account that non-profit board members are volunteers and unpaid.”
Gastrow says the sector recognised the urgent need to improve its levels of governance, and the resulting independent code is a key resource to guide good governance in the sector.
Breach of duty
NPOs may not have shareholders, but they do have stakeholders. In fact, the independent governance code (which can be downloaded from www.governance.org.za) points out that NPOs are accountable to a number of constituencies and stakeholders. These include:
* Donors, with respect to the organisation’s integrity and effective use of funds;
* Beneficiaries, with respect to the organisation’s awareness of needs, and deployment of resources;
* Members, with respect to democratic governance and fidelity to purpose;
* Employees, with respect to fair remuneration, employment conditions, transformation and empathetic human relations;
* Volunteers, with respect to their contributions of time, energy and skills;
* Government, with respect to legal and fiscal compliance, and effectiveness in allocating resources and addressing needs; and
* The general public, with respect to tax benefits and fiscal privileges.
Any stakeholder – particularly one such as a supplier, donor or employee with whom the NPO has a legal, contractual relationship – is a potential source of liability for the NPO and its board members.
Wyngaard says board members may also be held personally liable for failure to comply with specific legislation. For example, the Income Tax Act provides that failure to pay over employees’ taxes may result in personal liability on the part of board members.
As far as their fiduciary responsibilities are concerned, NPO board members may be in breach of their duties if, for example, they allow donor funds to be misused or spent for a purpose that is outside the NPO’s objectives, allow funds to be inappropriately invested, or fail properly to insure NPO property.
It is common practice for NPO boards to reach decisions unanimously, so it is unlikely that one board member would be singled out for liability. But all the board members of an organisation could be held jointly and severally liable in the case of a collective breach of duty (see “Definition”, below).
Solutions for non-profits
So what can an NPO do to minimise the threat of litigation, protect its board members, and ensure that prospective volunteers aren’t put off joining because of personal liability fears?
First, it can tighten up its governance codes, accounting mechanisms and disciplinary procedures for paid staff members and volunteers. The brochure Governing Boards in the Non-Profit Sector, referred to above and available from the Inyathelo website (www.inyathelo.co.za), provides clear and easy-to-implement guidelines in this regard.
Second, the organisation can implement a suitable risk management strategy, suggests Wyngaard, which could include seeking legal advice when entering into contracts.
Third, it can take out liability insurance for itself and its directors or trustees.
Gastrow says that Inyathelo, which is registered as a trust, sought professional legal advice on this matter. “As a result, we have two types of insurance: trustees’ errors and omissions insurance, as well as directors’ and officers’ (D&O) liability insurance. Trustees’ insurance doesn’t cover or make provision for remunerated staff, which is why we opted for the D&O liability insurance for the staff that run Inyathelo on a daily basis.”
Gastrow says she believes that an increasing number of NPOs are beginning to pay to protect themselves against liability risk.
“In the sector, there is always a cost balance between what organisations believe are ‘nice to haves’ and essential day-to-day operations. However, it does appear to be growing in importance. For instance, the requirements for our annual external audit have become more stringent. [Senior staff members] are interviewed by the auditor, and questions are asked on policies, procedures and control mechanisms that the organisation has in place to mitigate against fraud and errors.”
Camargue is a Johannesburg-based underwriter that specialises in business liability cover. John Stebbing, underwriting manager: commercial general liability at Camargue, says it’s not just bigger for-profit companies, which have shareholders to report to, that have a need for D&O cover.
“It is just as important for directors of non-profit companies to take out this cover,” he says. “A similar argument is often raised by owners or managers of small and medium enterprises. The flaw in their argument is that it is not just shareholders who sue directors. In the claims we have seen, the most common plaintiffs are creditors. The reality is that almost any stakeholder in the company could potentially sue the directors.”
Stebbing says D&O cover is almost always sold to the organisation, for the benefit of the management, rather than to individuals. “In other words, the policy would cover the management team of a specific organisation, rather than covering one person across several organisations that they may work for. Since directors would typically be jointly liable for an oversight, it would make sense to purchase cover for the entire board and management team and not in their own personal capacities.”
He says Camargue underwrites a large number of NPOs, both companies and non-profit trusts. Although some types of trust require specific cover, the trustees of organisations such as educational institutions can be covered under a D&O policy.
Joint and several liability is a form of liability used in civil cases where two or more people are found liable for damages. The winning plaintiff in such a case may collect the entire damages amount from any one of the parties, or from any and all of the parties in various amounts until the amount is paid in full. In other words, if any of the defendants cannot pay an equal share of the award, the other defendants must make up the difference.
Defendants in a civil suit can be held jointly and severally liable only if their concurrent acts brought about the harm to the plaintiff. The acts of the defendants do not have to be simultaneous; they must simply contribute to the same event. – The Free Dictionary (www.thefreedictionary.com)
CASE STUDY: KFC’s ADD HOPE
In 2009, KFC South Africa launched Add Hope, a national feeding initiative. KFC customers are invited to buy “hope” off the menu for R2. At the end of last year, the total donations raised since Add Hope’s inception, including a portion of franchise holders’ marketing contributions, amounted to R210 million (R49 million in 2013 alone), benefiting more than 90 children’s feeding schemes.
The operation is run by the KFC Social Responsibility Trust, which ensures that every cent of a customer’s R2 donation is used to feed a hungry child.
Personal Finance asked Lauren Turnbull, corporate social responsibility and sponsorships manager for KFC South Africa, how the trust is governed.
Can you describe the make-up and functions of the board of the KFC Social Responsibility Trust? Does the board actively oversee the allocation and distribution of funds to feeding schemes? The trust was established in 1992. It’s managed as a separate public benefit organisation and is audited by KPMG. The board of trustees comprises KFC and franchisee representatives who have extensive knowledge in business. The board oversees, recommends and approves the allocation of funds and the annual budget. A legal and financial adviser sits in on all trustee meetings.
What measures are in place to ensure that donor money is used for its intended purpose?
An application needs to be completed by any potential beneficiary and the criteria need to be met. All beneficiaries report throughout the year on their programme and finances. All beneficiaries are audited by external corporate social investment consultants.
Who do you consider the parties to whom your board is most accountable? We believe these to be our customers and franchisees. The question we get asked most by our customers is: “Where does my R2 go?” So it is important that we are open and transparent about where their money goes, to ensure they want to keep donating. Our franchisees also donate a percentage of their marketing contribution to the trust, and we need to report to them on where the money has been used. Any member of the public can contact KPMG to see the full details of the trust.
Both the King III report and the Trustees Property Control Act place an onus on trustees to uphold principles of good governance. Are there measures in place to mitigate the trustees’ liability risk? All trustees have to sign and adhere to the trust deed, which includes a code of conduct outlining good governance and practice for the trust.