Being judged on the relations you keep

Background

While mere humans are stuck with their relations be they Uncle Charlie and his bad dad jokes or Aunt Gertrude with her inedible cheesy puffs suffered at every family function, corporate bodies that are artificial persons at law do choose who are related parties. Further, they are held accountable for their choices.

For-profit companies, particularly those that are listed on the stock exchange and seek mum and dad investors, have been increasingly regulated by the corporate watchdogs when they provide a financial benefit to a ‘related party’. This relation might be a director, relatives of a director or other entities connected with a director through remuneration payments, overpriced supply or service contract transactions, asset transfers and loan arrangements.

The mischief is that the wealth of the company can be siphoned off without the member’s (owner’s) consent through non-arms length dealings that reduce the value of their stake in the corporate venture and diminish possible dividends (share of profits).

Much of this abusive behaviour by the controllers of companies could be caught by the pre-existing fiduciary duties owed by directors to the company conflicts and profits, acting in good faith in the interests of the company and for proper purposes and acting with care and diligence. One issue was how would anyone know what the directors were doing unless there was transparency of the transactions?  The corporate law continues to develop a complex web of statutory corporate and accounting rules to try and curb the mischiefs of unduly favouring the ‘relations’ of directors.

The central provision provides that, unless an exception applies, in order for a public company or an entity that the public company controls to give a financial benefit to a related party of the public company, the public company must obtain the approval of its members (in a specified way that involves the Australian Securities and Investments Commission (ASIC)) and give the benefit within 15 months after the approval.

Persons involved in a contravention may be liable for civil penalty consequences, and dishonest involvement constitutes an offence. Civil penalty consequences consist of a declaration of contravention; disqualification; pecuniary penalty and/or compensation.

While director fiduciary duties have always applied, often more strictly, to charities and other nonprofits, legislators are now applying the related party disclosure regime to these organisations.

Charity and Non-profit relations

At the heart of why nonprofit organisations exist and are so generally trusted, is that at their core, the organisation is prohibited from distributing its surplus to any member or controller or anyone else unless it furthers the stated purpose of the organisation. The lack of a profit motive that drives commercial companies gives comfort that any donations of time and talent to a nonprofit organisation will not be diverted to other purposes.

The public has always been suspicious of charity governors who depart from this mantra and try and siphon off funds for their private benefit. Their wrath is even more vehement than that reserved for corporate miscreants.

The existing common law duties of those that control nonprofit organisations and in the case of ACNC charities, Governance Standard 5 deal with situations such as:

• receiving goods or services from for-profit organisations that are owned or operated by relatives of the organisation’s board or committee members. This is done without conflicts of interest being considered and managed, and in the absence of any formal arrangement such as a contract or service agreement.
• Goods and services are provided at inflated prices beyond what would be a reasonable market rate. No due diligence was conducted by the charity to determine that the price was appropriate.
• Board members awarding contracts or projects to their own companies without managing conflicts of interest or considering any alternative providers.

Not every related party transaction is offensive, particularly where it is approved by the members of the organisation, is conducted at arm’s length, decided by market tender and good value for the organisation.

Many nonprofit organisations would not continue to exist without contributions at less than market price, such as discounted professional services and goods. However, such transactions need to be transparent to avoid ill-informed conclusions being formed by members and the public when mischievous accusations are made against the organisations and their controllers.

Organisations deal with such matters by maintaining a permanent register of actual and perceived conflicts of directors and committee members that is updated at each meeting; conflicts of interest are recognised and dealt with according to constitutional and statutory provisions and reported as appropriate to members and reported in the annual financial statements in compliance with the relevant AASB reporting standard.

Enhanced regulations are coming

Charities

• Charities and other nonprofit associations will be required to pay greater attention in the coming year to recording and reporting benefits given to persons or bodies who are related.
• In 2018 a review of the ACNC was conducted to meet the Commonwealth Government’s statutory obligation to undertake a review of the legislation establishing the ACNC after the first five years of operation of that legislation, and it recommended that registered entities should be required to disclose related party transactions as part of their financial disclosures.
• The Australian Charities and Not-for-profits Commission Amendment (2021 Measures No. 3) Regulations 2021 implemented the change to related party reporting for charities.
• Charities will be required to report related party transactions in the 2023 ACNC Annual Information Statement (AIS). This means charities will need to keep records of related party transactions from the start of their 2023 reporting period. For many charities, this will be from 1 July 2022.
• The ACNC has not yet released the new AIS form to cater for related party reporting.

Queensland Incorporated Associations

• The Parliament of Queensland passed the Associations Incorporation and Other Legislation Amendment Act 2020 (Amendment Act) in June 2020. The Amendment Act introduced changes to the Associations Incorporations Act 1981 and the Collections Act 1966, and the regulations to the amendments are due to be made effective in the coming months.
• One part of the forthcoming regulations will deal with how remuneration and benefits given to management committee members and senior officers (and their relatives) must be disclosed at an association’s annual general meeting (AGM), and what information as to remuneration and benefits must be disclosed. The Department of Justice and Attorney-General (Department) consulted on the form of the regulation in the second half of 2022, but has not yet finalised the regulation.
• In the Department’s consultation paper, it noted that:
• It is further proposed that to be of any benefit, disclosure of related-party transactions would need to provide the detail of the transaction, including:
  • the identity of the management committee member, senior staff member or relative with whom the related-party transaction is entered;
  • the annual amount paid for the transaction by the association; and
  • what the transaction provides the association

Management committees would not be prevented from stating the benefits that the arrangement provides to the association when making the disclosure. For example, they would be free, but not obligated, to disclose comparisons to the usual market rates that would apply if the service or product was sourced externally from an unrelated party.^[1]

• The Department has indicated that there might be a disclosure threshold to reduce the paperwork burden. Recording some common practices would be an administrative nightmare. For example, on every free pie and lemonade that a management committee member received while volunteering in the canteen (along with other non-committee volunteers who received the same benefit).^[2]

What to do?

Whatever legal form your organisation is, the governing body needs to review its related party governance procedures and ensure they are in order and being implemented.

A checklist to start the process might be:

• Do you understand what related party provisions apply to your organisation as different regulatory regimes are not uniform, and more than one can apply at the same time?
• Do you have a register of director’s existing conflicts of interest?
• Do you have a related party transaction policy?
• Do you have a procedure to follow for identifying, recording and dealing with related party transactions?
  • What do your constitution and by-laws provide in relation to conflicts of interest?
  • Is there a board meeting agenda item for disclosure of new conflicts or related transactions?
  • Are any matters recorded in the minutes and then the central conflicts registry?
  • Do new board members receive information on related party transactions at their induction?
  • Does the board annually review its conflict of interest and related party policies?
  • Does the audit/finance committee consider disclosure of related party transactions when reviewing the financial statements with the auditor?
• Do your financial statements comply with the appropriate AASB standards in relation to disclosure of related party disclosures?

Note that your organisational type will affect related party reporting and procedures as differences apply to charities registered with the ACNC (differences for small, medium and large charities), ACNC basic religious charities, public companies (that is, company limited by guarantee), private and public ancillary funds and Queensland incorporated associations.

We can provide assistance for organisations seeking to ensure that they have procedures in place to comply with related party provisions and whether transactions are material conflicts of interest.

[1] Associations Incorporation Regulation 1999, Priority Consultation Paper 2: Disclosure of Remuneration

[2] Associations Incorporation Regulation 1999, Priority Consultation Paper 2: Disclosure of Remuneration

Article by:

Myles McGregor-Lowndes
Consultant
Email Myles