Managed Services Agreements: Avoiding ACNC & ATO Litigation

Introduction

Managed services agreements are increasingly used by not-for-profit (NFP) organisations to improve efficiency, but these arrangements can quickly become the source of business disputes, director disputes, or even litigation if not properly structured and documented. Regulatory scrutiny from the ACNC and ATO often focuses on conflicts of interest, non-arm’s length transactions, and the risk of private benefit, making it essential to understand the commercial litigation risks involved.

Given the complexity and the potential for common disputes to escalate, consulting an NFP dispute lawyer is critical for effective dispute resolution and to ensure your organisation’s agreements withstand regulatory and legal challenges.

Understanding NFP Managed Services Agreements

What is a Managed Services Agreement

A Management Services Agreement is a legally binding contract between an NFP organisation and an external service provider. Through this agreement, the NFP outsources the responsibility for managing specific business operations or functions, rather than employing a manager directly. This arrangement allows the organisation to delegate key tasks to a specialist entity.

The provider is often an expert in a particular field, such as IT, finance, or administration. Sometimes, the provider may even be a related party to the charity. A clear agreement will typically specify:

• The scope of services to be provided
• The manager’s level of authority
• Payment structures
• The process for handling any potential business dispute

Common Uses for Your NFP Organisation

Management service agreements are widely used within the NFP sector as a strategic tool to enhance operational efficiency and access specialised skills. An NFP may find such an agreement beneficial in a variety of practical situations.

These agreements are particularly valuable for the following purposes:

• Outsourcing key functions: An NFP can delegate the management of entire departments, such as IT, payroll, human resources, or marketing, to a provider with proven expertise in that area.
• Supporting growth: As a charity expands, it may require expert help to manage its growing operational or administrative workload without the need to hire additional full-time staff.
• Maintaining consistent standards: For organisations operating across multiple sites or regions, these agreements can ensure that a uniform and high standard of management is applied consistently.
• Ensuring regulatory compliance: NFPs in sectors with specific regulatory requirements, like healthcare or social services, can use these agreements to help meet their complex compliance obligations.

Identifying ACNC & ATO Red Flags in Your Related Party Agreement

When an Agreement is Not at Arm’s Length

An arm’s length transaction is one where the parties involved do not have a pre-existing special relationship that could influence the outcome. Regulators assess whether the terms of an agreement are fair and comparable to what would be expected in a competitive market between a willing buyer and a willing seller.

Agreements with related parties that lack a clear commercial purpose or are not benchmarked against market rates face intense scrutiny. The ACNC and ATO look for specific warning signs that suggest a transaction may not be at arm’s length, including:

• A lack of clear commercial rationale for the agreement.
• Failure to benchmark fees and charges against independent, objective metrics.
• Inconsistent or irregular payments that do not align with a formal agreement.
• An absence of contemporaneous records or written agreements to substantiate the dealings.

The Risk of Facilitating Private Benefit

Poorly structured agreements can create situations where a Responsible Person or their associate personally benefits from the charity, which is a clear breach of their duties. ACNC Governance Standard 5 requires that Responsible People act in the best interests of the charity and not misuse their position or information.

When an agreement results in a private benefit, it can be viewed as a misuse of position and create serious conflicts of interest. For example, if a charity pays a board member’s company excessive fees for a service, that arrangement may not be in the charity’s best financial interest.

Such a situation can lead to a business dispute and regulatory action, as it fails the requirement to manage the charity’s financial affairs responsibly.

Breaching Director Duties Through Managed Services Agreements

ACNC Governance Standard 5: An Overview

ACNC Governance Standard 5 requires charities to ensure their Responsible People (such as directors or board members) understand and comply with a set of fundamental duties. ACNC Governance Standard 5 frames the expectations that guide every board decision.

These duties are designed to ensure that all decisions are made with integrity and in the best interests of the charity. Integrity and the charity’s best interests must remain at the forefront of each action.

Failure to adhere to these duties, a key area of ACNC compliance for charities, can trigger internal director disputes and even regulatory action. Ignoring director duties therefore carries significant risk.

Under ACNC Governance Standard 5, the core duties of Responsible People include:

• Acting with reasonable care and diligence in their roles.
• Acting honestly and fairly, always prioritising the charity’s best interests and its charitable purposes.
• Not misusing their position or any information gained through their role for personal benefit or to the detriment of the charity.
• Disclosing any actual, potential, or perceived conflicts of interest that may arise.
• Ensuring the charity’s financial affairs are managed responsibly and in a sustainable manner.
• Not permitting the charity to continue operating if it is insolvent.

Managing Conflicts of Interest in NFPs

Related party transactions are closely connected to conflicts of interest, which can create significant risks for a charity if not managed transparently. A conflict arises when personal interests, or duties to another entity, clash with the duty to act in the charity’s best interests.

These situations can create a business dispute and are generally categorised in three ways:

• Actual – a direct conflict exists where a person is influenced by a competing interest.
• Potential – a situation where a competing interest could influence a person in the future.
• Perceived – a scenario where a reasonable person might believe an individual could be improperly influenced by a competing interest.

To properly manage these situations, Responsible People must disclose any conflicts of interest.

For example, consider a case where a board member runs a consultancy that could provide services to the charity. The board member must disclose this interest.

If the board considers awarding a contract to that consultancy, the conflicted member must not participate in the discussion or vote on the decision.

Case Study: South Seas Holdings v COT

Key Failings That Led to the Business Dispute

The case of South Seas Holdings Pty Ltd v Commissioner of Taxation [2025] FCA 848 provides a critical example of how poorly documented related-party agreements can lead to significant business disputes and regulatory action.

The court examined a series of deductions claimed by four related entities for management fees and loan interest paid to offshore entities controlled by the same individual. The Commissioner of Taxation rejected these deductions, arguing the transactions were not genuine.

The court’s decision to side with the Commissioner was based on several key failings by the taxpayer, which serve as warnings for any organisation involved in related party transactions. The circumstances surrounding the alleged agreements demonstrated a lack of commercial substance, ultimately leading to the failure of their claims.

Critical mistakes that undermined the taxpayer’s position included:

• Absence of Written Agreements: A significant factor was the lack of contemporaneous records. The court found no documentary evidence for the managed service agreements, and the loan agreements were described as undocumented and oral.
• No Clear Commercial Rationale: There was no apparent basis for the management fees charged or a coherent explanation for why they were applied in some years and not others. The arrangements lacked a clear commercial purpose.
• Inconsistent and Irregular Payments: The management fees were not paid consistently. Instead, they often appeared as end-of-year journal entries, which suggested they were for accounting purposes rather than genuine expenses.
• Failure to Benchmark Rates: The loan agreements failed to specify interest rates or benchmark them against any reasonable, objective market standard. This resulted in extreme and unjustifiable variations in the rates charged from year to year.
• Pervasive Conflicts of Interest: The individual in control had the authority to bind both the paying and receiving entities. The court concluded that the offshore entities were established for his personal benefit, creating clear conflicts of interest that tainted the entire arrangement.

Lessons for Your NFP on Substantiating Related Party Agreements

The findings in the South Seas Holdings Pty Ltd v Commissioner of Taxation case offer valuable lessons for NFP organisations on how to structure and document related party agreements to withstand scrutiny from the ACNC and ATO.

The court demonstrated a willingness to examine the fine details of such arrangements to determine their legitimacy. This precedent underscores the need for a high level of rigour and transparency to avoid litigation.

To ensure your NFP’s related party agreements are defensible, it is essential to implement several key practices drawn from the court’s findings. These measures help prove that an agreement is commercially sound and serves the charity’s best interests.

Actionable takeaways for your organisation include:

• Maintain Contemporaneous and Corroborative Records: Always create and keep formal written agreements. Substantiate all transactions with contemporaneous evidence, such as detailed invoices, timesheets, or reports that clearly record the services provided and justify the fees charged.
• Establish a Clear Commercial Rationale: Every agreement must be founded on a clear commercial purpose that benefits the charity. You must be able to articulate why the agreement was necessary and how the terms serve your organisation’s mission.
• Benchmark Against Objective Metrics: All terms, especially fees and interest rates, must be reasonable and justifiable. Benchmark them against independent, objective market rates to demonstrate that the transaction is comparable to one conducted at arm’s length.
• Ensure Consistency in Payments: Payments should be made regularly and consistently, in line with the terms outlined in the written agreement. Avoid irregular, lump-sum journal entries that could be flagged by regulators as lacking a commercial basis.

The Commercial Litigation Process for Disputed Agreements

How a Court Can Unwind an Agreement & Force Repayment

When a business dispute over a managed services agreement escalates, it may proceed to commercial litigation, where a court can provide a definitive outcome. This legal action often occurs when alternative dispute resolution (ADR) methods have failed or the issues are too significant to be resolved otherwise.

The court process can be costly and time-consuming, so it is typically considered a last resort.

If a court finds that a contract has been breached or is non-compliant, it has the authority to enforce remedies. For example:

• If an agreement is deemed not to be at arm’s length or to facilitate private benefit, a court can invalidate it.
• In such cases, the court may order the repayment of any excessive fees or funds that were transferred under the disputed agreement to recover any losses suffered by the charity.

Defending Your Agreement by Proving Fair Market Value & Charitable Purpose

A charity can defend a challenged managed services agreement by providing strong evidence that the arrangement is legitimate and serves its charitable purpose. The burden of proof rests with the charity to present a defensible and replicable valuation that substantiates the terms of the agreement.

This defence is crucial in any commercial litigation involving related party transactions.

To successfully defend its position, a charity must demonstrate the agreement’s commercial soundness. Key evidence includes:

• A Clear Commercial Rationale: The charity must prove that the agreement was established for a legitimate purpose that benefits the organisation and its mission, rather than for personal gain or tax avoidance.
• Proof of Fair Market Value: It is essential to show that any fees or charges are reasonable. This can be achieved by benchmarking the terms against independent, objective market metrics to prove the transaction is comparable to one conducted at arm’s length.
• Contemporaneous Records: Maintaining thorough documentation is critical. This includes the written agreement itself, detailed invoices, timesheets, and reports that provide a clear record of the services provided and justify the payments made.

Conclusion

Managed services agreements, particularly with related parties, present significant risks for NFP organisations, including potential breaches of director duties and scrutiny from the ACNC and ATO. Proper governance, transparent documentation, and a clear commercial rationale are essential to prevent common disputes from escalating into costly litigation.

If your charity needs assistance reviewing or drafting a managed services agreement to ensure it withstands regulatory challenges, contact our experienced not-for-profit lawyers at LawBridge. We provide specialised advice to help your organisation manage conflicts of interest and meet its obligations with confidence.

Frequently Asked Questions