A not-for-profit organisation’s constitution will invariably be its single most important document. The constitution formally outlines a not-for-profit’s purpose as an entity, aids in determining the tax exemptions that will apply to it, and dictates the way in which it will be governed. As a result, considered and precise drafting of this governing document is crucial to a successful not-for-profit.

However, it can often be forgotten that every organisation’s constitution also has the effect of operating as a ‘legal contract’ for both directors and members. The constitution is not merely a guide. All acts committed by an organisation must strictly follow the provisions in its governing document. A minor procedural misstep can invalidate major company decisions, and can potentially bring an organisation to its knees.

The recent case of Kimberley College Ltd v Davis[1] (Kimberley College Case) is a stark reminder to not-for-profit organisations that they need to keep a close eye on their governing documents, sometimes quite literally.

The case is significant for two reasons:

1. it highlights the potential ramifications for a not-for-profit organisation that does not strictly follow the procedural elements in its constitution; and
2. it indicates to not-for-profit organisations under what circumstances the courts may be able to ‘bail them out’ if they have disregarded procedure.

1. Facts – The Kimberley College Case

Kimberley College is a not-for-profit public company limited by guarantee (PCLG) that was registered in 1997.

The College did not keep accurate or detailed records of the constitution that it adopted at any one time. Despite ‘several purported versions’ of its constitution, it was eventually accepted that a constitution was adopted around July 2001 (2001 Constitution) and another was later adopted on 28 November 2017 (2017 Constitution).

Between October 2014 and October 2017, four individuals were purportedly appointed to the Board as Directors. None of the four were members of the company (which was a prerequisite to being appointed to the Board, under the constitution) at the time of their appointments.

On 12 June 2018, these individuals received an email from a group of members asserting that all four were ‘unqualified to hold office’ as directors of the College for the following reasons:

1. they had breached the 2017 Constitution upon its adoption because, pursuant to that Constitution, ‘no person may be a director unless that person is an ordinary member’; and
2. even if they had been admitted as members, their membership was invalid because their application forms were not signed properly in accordance with the 2017 Constitution.

Upon receiving this email, the directors took a proactive approach to dealing with the issue. They sought orders in the Federal Court of Australia (Federal Court) pursuant to the Corporations Act 2001 (Cth) (Act) declaring that their appointments were not invalid by reason of any contravention of the College’s constitution.

Ultimately, the Federal Court judge, Justice Greenwood, found the following deficiencies in the directors’ appointments:

• in failing to be members, the directors had breached both the 2001 Constitution and the 2017 Constitution;
• even after the directors were supposedly admitted as members in March 2018, these admissions were invalid because:
  • the application forms were not signed in accordance with the 2017 Constitution; and
  • there was never a formal resolution confirming their appointment as required in the 2017 Constitution.

Justice Greenwood therefore stated that the directors were never validly appointed under the provisions of any Kimberley College constitution.

2. The Court’s Discretion and ‘Irregularities’

Clearly these circumstances presented a daunting dilemma for the College. Justice Greenwood’s confirmation called into question not only the validity of the individuals’ appointments as directors, but also the validity of all decisions made during their supposed appointments. Further, the College would have to deal with the potential immediate removal of four board members.

However, the law envisions this scenario whereby a procedural hiccup has a potentially seismic impact. Section 1322 of the Act grants the Federal Court the discretion to validate any act done despite a contravention of a provision of a corporation’s constitution. The four directors in this case sought orders under this section.

In response, Justice Greenwood provides a succinct but extremely informative breakdown of how section 1322 can be enacted to overlook an organisation’s ‘procedural irregularities’.

2.1 Is ‘honesty’ required?

Section 1322(6) of the Act states that the Federal Court can only correct a contravention of a constitutional provision if satisfied that:

• the relevant act, matter or thing was essentially of a procedural nature;
• the person or persons concerned acted honestly; or
• it is just and equitable that the order be made.

The Kimberley College Case confirmed that these conditions are to be read ‘in the alternative’. In other words, only one of these conditions needs to be satisfied to justify an order being made.

Why is this significant? This interpretation confirms that, theoretically, the Federal Court may still validate a procedural breach even if those concerned did not act honestly.

While this was not the concern in the present case, this interpretation provides much greater scope for the Federal Court to potentially rectify a procedural breach and would prevent individuals from having to prove they made an ‘honest mistake’ in every instance.

2.2 The substantial injustice threshold

While honesty may not be a prerequisite to an order, this case clearly reinforces that an order can only be made to rectify a breach of constitutional procedure if no substantial injustice has been, or is likely to be, caused to any person.

Justice Greenwood asked a key question:

Would an order under section 1322 simply be confirming the state of affairs previously assumed to be valid and acted upon by the relevant parties?

It was ultimately found that this was in fact the case. The four individuals had always acted on the assumption they were validly appointed directors and they were recognised as directors by members in the minutes of annual general meetings. The individuals were only made aware of any issue when they were confronted by an assertion of invalidity in the email from members on 12 June 2018.

As any Federal Court order would only be confirming the current state of affairs, it was found there could be no suggestion of substantial injustice being suffered, and ultimately orders were made stating that the individuals’ appointments were not invalid because of a breach of any Kimberley College constitution.

It is important to note that the Federal Court’s discretion under section 1322 is absolute. While the group of members who challenged the four directors’ validity actually consented to orders that the irregularities be ‘overlooked’, the Federal Court still had to be satisfied that it was proper to exercise its discretion in favour of the College.

2.3 The public interest

In coming to this decision, Justice Greenwood notably quoted from Weinstock v Beck, [2]  calling it the ‘definitive construction’ on section 1322:

‘Section 1322… reflects a long-standing legislative recognition that mistakes will happen in corporate governance and that it is not in the public interest that the validity of decisions… be unduly vulnerable to innocent errors which may be corrected without substantial injustice to third parties.’

This construction provides some solace for organisations as a reassurance from the Federal Court that it will not excessively punish companies where it can be avoided. It should also act as an encouragement to organisations to proactively come to the courts where a procedural breach is recognised – as was done by the directors in this case.

3. Take-away Points for NFPs

In light of the Kimberley College Case, not-for-profit organisations that are also PCLGs need to consider the following points in relation to the procedural elements of their constitutions:

1. breaching a seemingly minor procedural provision can have serious consequences for an organisation, and will require considerable time in court and money to rectify;
2. if the breach caused, or likely will cause, ‘substantial injustice’, the court will not make an order correcting the procedural mistake;
3. courts generally, though, will construe the discretion broadly and apply it pragmatically – they will rectify mistakes if they can; and
4. if an organisation discovers a procedural mistake, it should seek orders as soon as possible – any delay increases the opportunity for ‘substantial injustice’.

Mills Oakley acted for the independent members of Kimberley College in these Federal Court proceedings, who first raised the procedural irregularities with the directors involved.

[1] [2018] FCA 1102

[2] (2013) 251 CLR 396