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Board Governance

for the rest of us non-lawyers
by
Rick Sutcliffe

Disclaimer: The contents of these pages are offered as general principles, but not as legal opinions. Statutory law and entity policy on board structure, lines of authority and board discipline vary widely. Some of the comments here may not be applicable, or may be wrong in some situations, depending on the regulatory and organizational environment. When in doubt consult competent legal counsel. See the further disclaimer at the end.


Definitions and basic concepts for board governance are on the starting page.

Some scenarios illustrating fiduciary misconduct are collected on a separate page.

Fiduciary Duty

The word "fiduciary" comes from the Latin "fides" meaning "faithful". Like many pervasive concepts of Western Civilization, the idea may be traced to the Bible: Now it is required that those who have been given a trust must prove faithful.--1Corinthians 4:2, NIV

Under Common Law and various specific statutes (varies by jurisdiction), board members owe an absolute primary duty (called a fiduciary duty or duty in trust) to the entity. This obligation includes financial legal, and personal obligations.

In positive terms, this means:

  • they are required at all times to act in the best interests of the entity they have agreed to serve,
  • they must put the organization's interests ahead of their own personal, political, or other agendas,
  • they are constrained to act upon and represent only agreed-upon policy according to the organization's established policies procedures,
  • they must perform their duties with due diligence in accord with the requirements of common and statutory law and the specific codes of conduct and ethics for the organization,
  • if a board member becomes aware of any business opportunity in the sphere of the entity that opportunity is the legal property of the entity, not of the board member, and must be disclosed to the entity.
  • they are required to disclose any instances of their own misconduct.
  • this duty must be exercised to some degree in the public interest, as most entities are incorporated under or regulated by statute law, [Where this is not the case, such as with unincorporated community clubs or churches, the common law provisions touching on legal and proper conduct of board members still apply.]
  • thus, this duty cannot be narrowly solely construed as an obligation to maximize the entity’s stock value, market share, or reputation at the expense of all other considerations.

The usual legal test for whether their actions are in accord with fiduciary duty is whether they are what a reasonable person would do in the circumstances (that is, they are not all required to be lawyers).


In negative terms, this means

  • the duty of fiduciaries is absolute and cannot be compromised by giving priority to other interests, whether personal or institutional,
  • they may never use their position as a board member to further their other interests or for any personal purpose whatever,
  • they may never engage in an activity on their own behalf or that of some other entity that would be in conflict with or harm the entity on whose board they serve,
  • they may not simultaneously be fiduciaries of two competing organizations,
  • they may not engage in any explicit or implied criticism of or dissent with the entities policies, procedures, or personnel outside a board meeting.

When in doubt about whether a potential action or a change in situation might generate a conflict or a violation of fiduciary duty--don't do it without first consulting legal counsel and/or the board as a whole.


Exception

If a board member has reason to believe that the entity has engaged in illegal activities, and upon raising it at a board meeting is out voted by the other directors, then the dissenting director must first resign from the board, then lay the matter before the proper authorities for investigation and disposition. Though still bound by all other aspects of fiduciary duty even after resigning, duty to the law trumps duty to the entity in such instances.


Conflicts of Interest

A conflict of interest exists when a board member owes a duty to another person or entity that may dilute or deprecate the fiduciary duty. All real or potential conflicts of interest must be disclosed upon becoming a board member, or upon any of the relevant circulstances changing.

Corporate counsel and/or the board itself must then determine whether the disclosed conflict is material, that is, of sufficient import to require the member not take part in discussions that relate to the conflicted situation (a business, legal, or other relationship with an entity in which the member has an interest, or a situation that involves the member). A conflict with another such entity is material if the board member:

  • owns a beneficial interest in the other entity valued at more than five per cent (this may be set lower in some cases)
  • is a fiduciary, a close relation to, or has business or personal dealings with a fiduciary of the other entity
  • has been involved in a legal or personal issue with the other company,
  • is under a non-disclosure agreement with the other entity that might bear on the matter at hand.

Any and all personal disputes or disagreements with management, staff, or other board members of the entity the member directs are automatically material conflicts of interest and must be disclosed at once to the rest of the board. (A duty to report one's own misconduct.)

In all discussions relating to a mmatter where a director has a material conflict, (s)he must absent himself or herself from meeting during the discussion. The minutes should note the time of departure and re-entry of the member. These absences are excusable failures to carry out fiduciary duty, but if they become frequent or material in themselves, the director must resign and be replaced.

Note that the conflict need not be financial to be material.


Violations of fiduciary duty

The fiduciary obligation is a very comprehensive concept—one that places a bar against any abuse of power. It is therefore not possible to elaborate every possible violation that constitutes a breach of duty. However, fiduciary misconduct falls into the following general categories:

  • use of the position for personal profit, gain, or to promote a personal interest, belief, or other agenda, whether this is specifically at the expense of other stakeholders or not,
  • use of the position for the benefit of some other entity in which the director has an interest,
  • use of the board position as a means of pursuing a personal vendetta, disagreement, or other agenda against particular stakeholders,
  • the showing of favoritism among stakeholders,
  • bypassing the board to interfere with the management function of the president or with a specific staff member.

A board must maintain a disciplinary committee to, among other things, determine whether a fiduciary has violated its code of ethics, the law, or their fiduciary duty in such a manner as to compromise the effectiveness of that fiduciary. See the separate section on discipline.

Note that violations of fiduciary duty (also known as breaches of trust) are civil and/or criminal offenses, and in many cases reportable. For instance, a board member who interferes with management to deal directly with a perception of a personnel problem in the organization exposes him/herself to criminal harassment charges, and exposes the organization to civil suits for damages for failing to restrain the behaviour. Further, any failure to disclose an interest that results in a gain (monetary or not) or any misrepresentation by the violator constitutes fraud. In addition, any financial loss on a breach of trust is recoverable.


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Last updated 2013 02 06
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