The Innovation Risk

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By Vera Visevic, Partner

“The Innovation Strategy announcement signals the end of an era for the charity sector as we know it. An incremental laggard mindset is no longer good enough.
Catherine Stace, CEO of the Cure Brain Cancer Foundation.

Innovation and risk taking are no doubt a risky business for not-for-profits seeking to challenge traditional operating practices and funding sources, in order to stay relevant in a quickly changing environment. With innovation recently flagged by the Prime Minister to become the driving force of economic growth in the commercial space, not-for-profits cannot simply sit back and hope this innovation revolution will pass them by. At this time, more risky than taking a risk, is to take no risk at all.

As the not-for-profit sector becomes more competitive, the need for innovation to drive new sources of funds and service delivery also grows. There is a direct correlation between innovation and revenue, yet the adoption of innovative ideas by not-for-profits has been slow. A key reason is the belief that the law will personally punish directors if innovative ideas fail. Often there is concern amongst not-for-profit directors that risk taking will result in a breach of their duties, and leave them exposed to personal liability.

A 2010 survey undertaken by the Australian Institute of Company Directors found that:

  1. 73% of directors considered that there was a medium to high risk of being held personally liable for decisions they or their board made in good faith;
  2. more than 90% of directors said that the personal liability of directors had an impact on optimal business decision-making or outcomes; and
  3. 65% of directors felt that the risk of personal liability had caused them, or the board on which they sat, to occasionally or frequently take an overly cautious approach to business decision making.

The law has recognised the challenges facing not-for-profit directors, caught between fulfilling their duties and making ideal business decisions. Whilst it is important for directors to always be mindful of their duties under the law, it is also important to not let the fear of a breach of these duties define a not-for-profits’ operations and practices.

The business judgement rule operates to protect honest directors and officers from the risks inherent in hindsight review of unsuccessful decisions, and to refrain from stifling innovation. The protection is only available in the context where there was a duty of care owed, and the decision relates to a business judgement. Under the Corporations Act 2001 (Cth), a business judgement is defined as ‘any decision to take or not take action in respect of a matter relevant to the business operations of the corporation’. Importantly, this does not cover instances of oversight or negligence. Further, the decision must adhere to the four requirements:

  1. make the judgment in good faith for a proper purpose;
  2. do not have a material personal interest in the subject matter of the judgment;
  3. inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and
  4. rationally believe that the judgment is in the best interests of the corporation.

The director’s or officer’s belief that the business judgement is in the best interests of the organisation must be a rational one, unless the belief is one that no reasonable person in their position would hold.

Whilst this law applies specifically to companies, it is also encapsulated in Governance Standard 5(2)(a) for charities registered with the Australian Charities and Not-for-profits Commission.

For not-for-profits that are incorporated associations, there are varying degrees of similar protection, which may operate to protect directors / committee members.

Though the business judgement rule does not apply in every instance, and only provides protection for potential breaches of the duty of care and diligence, directors of companies are also offered further protection under the Corporations Act 2001 (Cth). In legal proceedings brought against a director for negligence, default, breach of trust or breach of duty, that director may be excused for the negligence, default or breach in some circumstances. The Court has said that this protection operates to:

“excuse company officers from liability in situations where it would be unjust and oppressive not to do so, recognising that such officers are business men and women who act in an environment involving risk and commercial decision making.”

Thus, rather than the law operating to restrict directors and stifle innovation, there is scope for directors to take informed risks for the benefit of the organisation, without necessarily being personally liable if the risks fail.

As the sector looks toward the new year, with potential funding challenges, proposed mergers, service delivery consolidations and no doubt other unforseen changes, it should not seek to simply continue business as usual and hope to weather this tide of change. It is time to think creatively, embrace innovation and reward bold, new ideas. It is time to take a risk.

For further information, please do not hesitate to contact us.

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