How NFP Can Manage Liability and Financial Distress in Joint Venture Disputes

Introduction

Joint ventures offer a pathway for a not-for-profit (NFP) organisation to leverage its assets, but these partnerships also introduce significant legal risks. When disputes arise or a venture fails, a charity can face serious financial distress, exposing its directors to personal liability.

This article outlines how an NFP or charity organisation can manage these challenges. It covers the key legal risks in joint ventures, the duties of directors during financial distress, and strategies for resolving disputes while protecting the organisation’s assets and mission.

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Understanding Joint Ventures & Legal Risks

Evaluating the Impact on Tax-Free Status & Endorsements

A charity organisation must protect its tax-free status when entering a joint venture. This status can be jeopardised if profits from a commercial enterprise are distributed to private shareholders instead of being directed back to the charity. Importantly, the case of Commissioner of Taxation of the Commonwealth of Australia v Word Investments Limited [2008] HCA 55 (‘Word Investments’) established that charities can operate for-profit enterprises, but only if the profit is given to the charity.

Furthermore, a joint venture that significantly alters the character, objects, or purposes of the NFP can also affect its endorsements. This change in direction could impact the organisation’s eligibility for key concessions, including:

• Deductible Gift Recipient (DGR) status;
• GST concessions; and
• FBT status.

Ensuring Compliance with Governing Constitution

Before committing to a joint venture, a charity must conduct a close analysis of its constitution, a key component of NFP governance and ACNC compliance. This review ensures that any commercial enterprise falls within the powers of the entity. Ultimately, the legal capacity of the organisation depends on its structure:

• Body corporate: generally has all the powers of a natural person, providing more flexibility.
• Trust or unincorporated entity: the proposed venture must fit squarely within the terms of its governing document.

Mitigating Exposure to Finance Covenants & Guarantees

Joint ventures often require borrowings, and a charity may be expected to use its assets as security. This creates a significant legal risk for the organisation, as financiers commonly require third-party covenants from the NFP, which are similar to a personal guarantee.

For a cash-poor charity, providing such guarantees can expose its asset base to deterioration or loss. Therefore, it is advisable for an NFP organisation in this position to resist giving these covenants to protect its financial stability and assets.

Managing Financial Distress & Personal Liability in NFP Joint Ventures

Director Duties to Prevent Insolvent Trading

Understanding the risks and responsibilities for directors of Australian charities is critical, including the legal duty to ensure the organisation does not operate while insolvent. This responsibility is outlined in ACNC Governance Standard 5, which requires Responsible Persons to act with reasonable care and diligence. This includes preventing the organisation from incurring debts when it is unable to pay existing ones as they fall due.

For charities structured as companies, the Corporations Act 2001 (Cth) (‘Corporations Act’) imposes a strict duty on directors to prevent insolvent trading. A breach of this duty can expose directors to significant personal liability and severe consequences. The penalties for allowing a charity to trade while insolvent can include:

• Civil penalties: Courts may impose substantial fines on individual directors.
• Compensation orders: Directors can be held personally liable to compensate the charity for losses that result from debts incurred during insolvency.
• Disqualification: An individual may be disqualified from managing corporations for a specified period.
• Criminal charges: In cases involving dishonesty, directors could face criminal charges, potentially leading to large fines or imprisonment.

Additionally, the Australian Taxation Office (ATO) may issue a Director Penalty Notice, making directors personally liable for the charity’s unpaid tax and superannuation obligations.

Utilising Safe Harbour Provisions to Protect Your Board

Directors of an NFP facing financial distress may be able to seek protection from personal liability for insolvent trading through the safe harbour provisions. Under Section 588GA of the Corporations Act, these provisions shield directors if they begin developing a course of action that is reasonably likely to lead to a better outcome for the organisation than immediate administration or liquidation.

To access safe harbour protection, two threshold conditions must be met: all employee entitlements must be paid when they are due, and the charity must be up to date with its tax lodgements. Meeting these conditions allows the board to continue operating the charity while working on a viable turnaround plan.

To effectively use the safe harbour provisions, directors of a charity should take several key steps:

• Engage qualified advisers: Seeking advice from experienced legal and insolvency professionals is a critical factor in developing a successful turnaround strategy.
• Develop a formal plan: Directors must create and document a viable plan, comparing the proposed strategy to the likely outcome of an immediate administration or liquidation.
• Maintain proper financial records: It is essential to keep clear records of the turnaround plan, the reasoning behind it, and the progress being made.
• Ensure legal compliance: The organisation must continue to meet all its legal and regulatory obligations throughout the process.

However, this protection ends if:

• the plan is not acted upon within a reasonable time;
• it is no longer likely to succeed; or
• an administrator is appointed to the organisation.

Resolving NFP Joint Venture Disputes & Internal Conflicts

Implementing Practical Dispute Resolution & Mediation Procedures

Disagreements in joint ventures between for-profit and not-for-profit (NFP) entities are common due to their fundamentally different objectives. To manage these legal risks, any agreement between the two organisations should be in writing and include a practical dispute resolution provision. This ensures a clear process is in place before conflicts escalate.

For an incorporated association, the constitution is required to set out a procedure for handling disputes. A typical dispute resolution process should:

• Give each party an opportunity to be heard; and
• Ensure decisions are made by an unbiased party.

Mediation is a voluntary and confidential process that can help resolve disputes effectively. An independent mediator facilitates a discussion, allowing the parties in conflict to control the outcome. This approach is often cheaper and quicker than court proceedings. Furthermore, for associations in NSW, Community Justice Centres offer free mediation services to help resolve disputes.

The Role of the NSW Supreme Court & Fair Trading

NSW Fair Trading has the authority to investigate an incorporated association if there is evidence of a breach of the Associations Incorporation Act 2009 (NSW) (‘Associations Incorporation Act’). Its powers cover issues such as an organisation failing to conduct annual general meetings or keep proper financial records. However, NSW Fair Trading generally does not intervene in internal disputes that do not involve a breach of the Act.

The NSW Supreme Court can become involved in more complex matters, particularly to protect trust property from mismanagement. Under the Charitable Trusts Act 1993 (NSW) (‘Charitable Trusts Act’), the Court has the power to intervene to ensure a charity’s assets are used for their intended purpose. Ultimately, going to court should be considered a last resort, typically reserved for situations where an organisation has not followed its constitution or when disputes cannot be resolved through other means.

Protecting Charity Assets During a Joint Venture Exit

Upholding Trust Law & Preserving the Existing Asset Base

A not-for-profit (NFP) organisation holds its assets in trust for its specific charitable purpose. The directors of the charity owe a duty of care to ensure these assets are used to further the organisation’s mission. This responsibility becomes critical when a joint venture ends or faces financial distress.

Any risk that the charity’s assets could be lost or suffer a deterioration in value must be carefully managed. To protect the existing asset base, the board should implement safeguards, including:

• Securing replacement assets of a similar value to those used in the venture.
• Ensuring a cash injection equivalent to the value of any assets sold as part of the venture.
• Confirming the venture is expected to produce a disproportionate increase in value over time to justify the risk.

Analysing the Breach of Trustee Duties: Chaina v Presbyterian Church Property Trust Case

The NSW Supreme Court case of Chaina v Presbyterian Church (NSW) Property Trust [2015] NSWCA 66 (‘Chaina’) demonstrates how trust law protects the assets of a charity from mismanagement. In this matter, a property was purchased by church members for religious worship. The court determined that even though the church was an unincorporated association, the property was held on a charitable trust for the organisation’s purposes.

A trustee breached his duties by transferring the church’s property into his and his sons’ names and then mortgaging it for personal business interests. This action was a clear misappropriation of a charitable asset, and the court found this to be a severe breach of the trustee’s obligations to the organisation.

Ultimately, the court ordered the defendants to restore the property to the church by transferring the title back, and they were also required to cover the charity’s legal costs. This case confirms that property dedicated to a charitable purpose retains its protected status. Furthermore, members of an NFP have the right to take legal action to protect the organisation’s assets from being misused.

Executing a Compliant Exit Strategy

Choosing Between Winding Up & Deregistration

When closing a not-for-profit organisation, the two main pathways are deregistration and winding up.

Each pathway serves different circumstances:

• Deregistration: This is often a faster and cheaper method for an organisation to cease operations. However, it has limitations, including asset value thresholds that may make it unsuitable for some charities.
• Winding up: This is a more formal process required for an NFP with higher-value assets, complex financial affairs, or one facing insolvency. It usually involves appointing a liquidator to manage the charity’s affairs.

Furthermore, the legal framework for winding up depends on the organisation’s structure. For example, a company limited by guarantee must follow the Corporations Act, whereas an incorporated association in NSW is governed by the Associations Incorporation Act.

Distributing Surplus Assets & Avoiding Litigation

A primary cause of disputes during an exit is the distribution of surplus assets. Under the Associations Incorporation Act, there is a strict prohibition against distributing any surplus property to the members or former members of a charity. This rule ensures that assets intended for a charitable purpose are not used for private benefit.

After settling all debts and liabilities, an organisation must manage its remaining assets appropriately:

• Transfer to a similar charity: Any surplus property must be transferred to another registered charity with similar purposes.
• Adhere to the winding up clause: This requirement is typically outlined in the organisation’s constitution or governing document.

Ultimately, strictly following this clause is essential for a compliant exit and helps to avoid legal challenges from members or regulators.

Examining Ambiguous Winding Up Clauses: Maitland Benevolent Society Dispute

The NSW Supreme Court case of In the matter of Maitland Benevolent Society Limited (In liquidation) [2020] NSWSC 1284 (‘Maitland Benevolent Society’) highlights the legal risks of an unclear winding up clause. When the NFP aged care facility was wound up, its constitution contained ambiguous criteria for the organisation that could receive its surplus assets. As a result, this led to a court dispute between two charities making competing claims for the funds.

To resolve the issue, the court had to carefully interpret the constitutions of both potential recipients to determine which one met the specific requirements set out by the Maitland Benevolent Society. This case demonstrates how imprecise wording can lead to costly litigation, making a clearly drafted winding up clause critical for ensuring assets are distributed according to their intended purpose without conflict.

Conclusion

Joint ventures can expose a not-for-profit organisation to significant legal risks, including threats to its tax-free status, personal liability for directors, and the potential loss of assets. A charity must manage these challenges by understanding director duties during financial distress, upholding trust law to protect its asset base, and executing a compliant exit strategy.

To ensure your NFP organisation is protected from liability and can manage financial distress effectively, obtaining specialised legal advice is a critical step. Contact our experienced not-for-profit lawyers at LawBridge for guidance on protecting your charity through every stage of a joint venture.

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