All not-for-profit organisations will at some time have to deal with directors who have a personal interest in an issue which conflicts with the director’s obligations to the organisation.

How does a board respond to the dysfunctional activities of a director: a member who may cite conventional governance mantra regarding conflict of interest, but who actually operates in a way that is objectively designed to favour their own interests to the detriment of the organisation as a whole?

The legal response

A traditional legal response would rely on governance rules and guidelines, such as the Corporations Act, Australian Standards, and ASX Corporate Governance Rules and AICD Code of Conduct for Directors. However, these do not adequately acknowledge the potential situation and mind-set of the director.

A director owes their company an overriding duty of undivided loyalty, and an obligation to avoid situations where there is a real or substantial possibility of conflict between personal interests and those of the company. The obligation to avoid being in a position of conflict is not a strict liability, but rather ‘a counsel of prudence’. Ultimately, the obligation is to not take advantage of a situation if a conflict arises.

Substantial difficulties arise where a subtle conflict of interest is not identified either by the party involved or the other members of the board. Left unchecked, such conflict has the potential to destabilise the board and damage the organisation’s reputation.

In this context, the legal response to a conflict of interest differs from that of the wider understanding in the community, and often seems to fall short in dealing with the issue at hand.

All directors must understand the legal response and develop a compliance attitude in the board. It is also essential to recognise that there are times when that response will not be enough.

An alternative approach

Directors who are operating at an emotional or political level when interacting with the organisation are generally not amenable to persuasion by reference to legal or conventional norms of governance, and alternative approaches may be required.

Even though the legal response is sophisticated and carries strong weight, it fails to adequately equip a board to respond to the governance challenges that arise. Modern theories of corporate governance go beyond the mechanical and procedural legal approaches to consider political and emotional aspects which are often encountered in philanthropic organisations.

Boards need to build strategies that will enable them to react and even pre-empt conflicts, and this will involve equipping themselves with a mindset that looks beyond traditional legal responses.