Caring about the ‘duty of care’
There are four main duties of Australian directors, all of which apply whether they are members of commercial or not-for-profit boards. As illustrated in the header image above, these are the:
- Duty to act with reasonable care, skill and diligence
- Duty to act in good faith in the best interests of the organisation and for a proper purpose
- Duty not to improperly use information or position
- Duty to disclose and manage conflicts of interest.
The focus of this reflection is the first of these duties. While the three elements of care, skill and diligence are really aspects of one duty, before thinking about them in combination, there is nonetheless some benefit in reflecting on each of them separately.
Starting with the concept of ‘reasonable care’ highlights the widely used notion of organisations and responsible persons having a ‘duty of care‘.
This notion can be confusing for non-lawyers in the non-profit sector (of which I am one). The other two aspects of this first duty, relating to ‘skill’ and ‘diligence’, will be explored in later posts.
Duty of care
Those working in childcare, disability care, education, aged care and healthcare, all recognise their primary obligation to place the welfare of their clients above their own, and this is mainly expressed as an obligation to avoid them being harmed.
For teachers, the concept of being ‘in loco parentis‘, requiring equivalent vigilance and responsibility to that of a parent guarding their child’s safety, is a foundational one in their training.
In healthcare, the aphorism ‘no-one cares how much you know until they know how much you care‘ may be a little cliched, but it illustrates use of the word ‘care’ to convey the two distinct concepts of interest or concern on behalf of patients, and beneficence on behalf of the practitioner.
Legal and other definitions
Words which have common usage meanings can have quite different emphasis when they appear in legislation governing the conduct of not-for-profit entities and corporations. ‘Care’ is a word with a multitude of meanings in common usage (as illustrated in the whimsical header image of an earlier post). As it happens, this is also true to some extent in various legislative instruments.
In civil law, “(A) duty of care is a legal obligation to avoid acts or omissions that could foreseeably lead to harm to another person. A breach of a duty of care that leads to harm to someone amounts to the tort of negligence.“
Established duty of care relationships include:
- Teacher to student;
- Employer to employee;
- Parent to child;
- Occupier of premises to entrants;
- Road user to other road users;
- Manufacturer to consumer.
Directors and officers will also be seen to have a ‘duty of care’ which shares the objective of avoiding harm, however in the governance context, the harms to be avoided go well beyond those inflicted on “another person”. Compliance with laws and regulations is a foundation of good governance, however, so too is compliance with standards of care for the community, the environment, and third party commercial entities, and also with ethical codes.
A balancing act
The Victorian Department of Health acknowledges that when seeking to avoid or limit harm, workers in the health sector are performing a balancing act:
“There are several aspects to duty of care:
Legal – What does the law suggest we do?
Professional/ethical – What do other workers expect us to do?
Organisational – What does our organisation, and its funding body, say we should do?
Community – What do the parents of our clients and other community members expect us to do?
Personal – What do our own beliefs and values suggest we do.“
In offering advice to youth workers, they note:
“We need to balance the safety of the young person against other concerns such as:
the safety of other people/our personal safety
other rights of young people (e.g. the right to privacy)
the aims of the service (e.g. to empower young people)
the limits of our organisation (e.g. money and other resources)“
Similar trade-offs are involved when directors are making governance decisions, and if an adverse outcome occurs, they will be judged according to the court’s application of the Business Judgment Rule (otherwise referred to as the ‘reasonable person test’). See also my earlier posts about cost/risk/benefit trade-offs here and here.
Standard of care
Professionals are familiar with the Law of Negligence (as opposed to the ‘diligence’ referred to in the first director duty) and legal liability. Section 18 of the Law of Negligence and Limitation of Liability Act 2008 addresses the standard of care expected of persons holding themselves out as possessing a particular skill as follows:
“In a case involving an allegation of negligence against a person (the defendant) who holds himself or herself out as possessing a particular skill, the standard to be applied by a court in determining whether the defendant acted with due care is, subject to this Division, to be determined by reference to—
(a) what could reasonably be expected of a person possessing that skill; and
(b) the relevant circumstances as at the date of the alleged negligence and not a later date.“
Directors’ duty of reasonable care and diligence
For directors, the most obvious implication of this legislation is that diligence is required to avoid an accusation of negligence. In their role as a board member, that diligence will chiefly consist of instituting a system of controls (i.e. good governance) by which risks are managed and compliance obligations are met, whilst advancing the constitutional and strategic objectives of the organisation. Relevant standards of care will also be applied to assess whether a director or officer was diligent or negligent in performing their duties.
Section 84 of the Victorian Associations Incorporation Reform Act 2012 is one example of governing legislation which defines the ‘duty of care and diligence’ for association directors and officers.
“Duty of care and diligence
(1) An office holder of an incorporated association must exercise his or her powers and discharge his or her duties with the degree of care and diligence that a reasonable person would if that person—
(a) were an office holder of the association in the circumstances applying at the time of the exercise of the power or the discharge of the duty; and (b) occupied the office held by, and had the same responsibilities within the association as, the office holder.“
Section 180 of the Corporations Act 2001 defines the duty of care and diligence required of Australian company directors and officers (such as the CEO and company secretary), including non-profit entities registered as companies limited by guarantee.
“CORPORATIONS ACT 2001 – SECT 180
Care and diligence–civil obligation only
Care and diligence–directors and other officers
(1) A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they:
(a) were a director or officer of a corporation in the corporation’s circumstances; and
(b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.
Note: This subsection is a civil penalty provision (see section 1317E).
Business judgment rule
(2) A director or other officer of a corporation who makes a business judgment is taken to meet the requirements of subsection (1), and their equivalent duties at common law and in equity, in respect of the judgment if they:
(a) make the judgment in good faith for a proper purpose; and
(b) do not have a material personal interest in the subject matter of the judgment; and
(c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and
(d) rationally believe that the judgment is in the best interests of the corporation
The director’s or officer’s belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in their position would hold.
Note: This subsection only operates in relation to duties under this section and their equivalent duties at common law or in equity (including the duty of care that arises under the common law principles governing liability for negligence)–it does not operate in relation to duties under any other provision of this Act or under any other laws.
(3) In this section:
“business judgment” means any decision to take or not take action in respect of a matter relevant to the business operations of the corporation.“
Skill – a common law requirement
The sharp-eyed reader will have noted that neither the State nor the Commonwealth legislation includes the word ‘skill’ in their requirements. That additional requirement arises from common law, where courts have ruled that in performing the ‘duty of care and diligence’, a reasonable person will exercise a level of skill or expertise commensurate with their responsibilities. This in turn leads to such governance activities as preparation of a director skills matrix to inform succession planning, and implementation of director development and training programs.
In commenting on Section 180 of the Corporations Act, Dennis Martin, Director of Snedden Hall & Gallop Lawyers, highlights that while all directors need to share a basic set of skills, where a director is recognised as having a special skill, they are held to a higher standard in exercising that skill (see especially the underlined portion below):
“… requires a director to act with a degree of care and diligence that a reasonable person might be expected to show in the role. Common law places great weight on this duty with respect to approval of financial statements [Centro, 2011] and statements issued by a company [James Hardie, 2012]. Further, risky transactions without the prospect of producing a benefit, or failure to inform board members of significant issues can create a breach of this duty. The extent of this duty is dependent on a range of circumstances. These include the type of organisation, the size and nature of the business and the composition of the board [ASIC v Rich, 2009]. Also, if a particular director holds out to possess certain expertise to obtain the directorship, the director’s exercise of care and diligence will be assessed against that expertise. For example, if a director holds out that she has specialised financial knowledge and she occupies a financial role, her accountability for the organisation’s finances will be higher compared with an ordinary director [ASIC v Adler, 2002]. Moreover, non-executive directors still have a duty to acquire at least a rudimentary understanding of the business of their organisation. Even if it is practice for a non-executive director to be unaware of the organisation’s circumstances, the position of a director comes with the responsibility of a core irreducible standard [Daniels v Anderson, 1995]. There is, however, the business judgment rule which could protect a director in relation to a claim for breach of this duty. This essentially requires directors to make a judgment that they rationally believe is in the best interests of the organisation. A judgment is considered to be rational unless no reasonable person in the director’s position would consider it rational.”
Where a board considers that it does not possess the skill or knowledge required to address a matter internally, it has an obligation to obtain expert advice to aid its decision-making processes. This was illustrated in my previous post regarding the solvency question, where consideration of a potential restructure or wind up is likely to require external legal and financial advice.
A future post will offer further reflections on the skills required of directors.
“First do no harm”
We can thank Hippocrates for the ethical injunction to “First do no harm”, and this is a core commitment in all health professional codes.
Avoiding harm is also the objective of the duty of reasonable care, skill and diligence.
In achieving that objective, directors and officers are expected to be proactive in the performance of their roles, ensuring that strategic and operational activities are subject to suitable systems of control and risk management. The schematic header image above emphasises that in each of the financial, commercial and legal dimensions, directors need to adopt a risk-based approach, involving governance, technical, and behavioural competencies, and referencing standards of care.
Giving ‘diligence’ its due
The term ‘due diligence’ is most often used to describe a detailed appraisal of a business undertaken by a prospective buyer, with a key focus on confirming its assets and liabilities and evaluating its commercial prospects.
In the context of non-profit directorial duties however, its more generic meaning relates to reasonable steps taken by a person or board to avoid committing a tort or offence.
The antonym of ‘negligence’, ‘diligence’ can also be understood as steps taken to avoid an allegation of negligence, usually involving careful examination or inspection of the matter at hand. The attention to detail involved suggests directorial focus, mindfulness, risk aversion, and effort. (See also comments on the Law of Negligence here).
Due diligence for a merger or acquisition (M&A) involves looking at numerous matters in each of the legal, financial and commercial dimensions of the other party’s operation. Analysis of key data looks to determine whether the entity is able to add value to the future operations of the merged organisation.
Assessment of the value proposition is of course the central focus of most board decisions – at least, it should be. The trade-off between benefits, risks, and costs needs to satisfy the directors that ‘on balance‘, adopting the recommendation under consideration will add value. Parallels can therefore be seen between director due diligence and M&A processes.
The chart below uses the three M&A dimensions (legal, financial and commercial) to catalogue some of the considerations non-profit directors will bring to their regular governance deliberations.
Diligent or Negligent?
Directors who fail to read their papers before the meeting, who neglect to ask probing questions during debate, and who defer to the loudest voice in the room because they don’t really have a view of their own, are not being diligent.
Board that spend less time on strategic issues, preferring to probe the details of low priority operational or procedural matters, can also be accused of failing to be diligent.
As with good diary management, the time budget for a meeting needs to be skewed towards strategically significant matters. The ‘Rocks, pebbles, sand‘ metaphor usually applied to personal time management can also usefully be applied to board agenda planning and ‘time governance’ during the meeting, as illustrated below.
Those familiar with this metaphor (popularised by Dr Stephen R Covey’s 7 Habits of Highly Effective People – Habit 3: Put first things first) recognise the importance of putting the rocks in the jar first and the sand last. If the sand is added first there won’t be sufficient room for the rocks later.
The same principle applies to the time budget for your board meeting. Don’t let procedural ‘sand’ use up valuable time required for your strategic ‘rocks’, and ensure that your operational ‘pebbles’ are also allocated their due before remaining time is provided for low priority procedural items. Scheduling more time, early on your agenda for strategic matters, recognises their high priority status, and is one way to improve the diligence of your board.
Part 3 in this series will reflect on the skills aspect of the ‘Duty of care, skill and diligence’.
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