A recent decision by Israel’s Supreme Court, clarifies the responsibilities of Nonprofit Board members, and when the line of negligence has been crossed.
The case centered on the damages caused by the mismanagement of the CEO of a large non profit facility which provided housing , support services and employment to people with disabilities. The CEO’s decisions led the organization close to bankruptcy. The families of the individuals who resided in the village were also among those who sued the Board members for negligence. The Board members were all good people, who had voluntarily and generously given of their time and funds to support the village.
The High Court threw out an earlier decision (machozi), which had accepted the Boards claim, that because of illness, frequent travel, incompetence, age etc they were not in a position to question the reports they had been given by the CEO, and the organization’s accountants.
The Judges clearly define “negligence” :
A claim of damages for negligence (of Board members) does not indicate that a person who is “negligent” acted maliciously or with intent to harm, but that his actions or omissions did not conform to the objective standards required in similar circumstances. This, even if the intentions of the person who caused the damage was without malice.
The Judges went on to detail what are the objective standards required in similar circumstances.
Below we bring a quote from the High Court decision. This is translated from Hebrew and we recommend reading the full original text.
The test of the reasonable director
“The basis for our discussion is the scope and content of the duty of care incumbent upon corporate officers, including members of the Company’s Board of Directors. The rule is that the duty of caution of a director towards the company imposes on the director the duty to take reasonable precautions in order to prevent damage to the company. The decisive test in this regard is the test of the reasonable director (unlike the “reasonable person” test), in the sense that serving as a director requires compliance with the demanding skill of management as a professional occupation. In other words, every director must take all the precautions that a reasonable director would have taken under the circumstances. This obligation is also anchored in Section 253 of the Companies Law, which states that:
“An officer shall act at a level of proficiency in which a reasonable officer would act in the same position and circumstances, including taking reasonable steps to obtain information concerning the business viability of an action brought for his approval or of an act performed by him in his capacity and for any information Which is of importance for such acts. “
This section requires, in fact, an officer in the company to meet two main requirements – the first is to take reasonable measures to obtain information regarding the feasibility of an action brought for his approval and any other information that is important in this regard. The second is that he should have an appropriate level of expertise and skill.”
Our analysis, concerns and recommendations:
To demonstrate the severity of the exposure by Board members to a ruling of negligence and associated penalties, consider the following “theoretical” scenarios :
- The CEO’s financial management skills are weak, and employees, suppliers or the tax authorities sue the organization
- A volunteer to the organization is charged with sexual harassment and proper protocols had not been implemented.
- A donor sues the organization to have his significant donation returned, since he discovers that it has not been used as promised.
- A visitor to the facility, falls and break a limb, and because the instructions from the insurance company were not exactly followed, the 3rd part insurance does not provide coverage.
The list of risks is extensive, and we would recommend that all Boards undertake a discussion to map the potential risks, the degree of severity and the appropriate response.
We STRONGLY recommend:
- Board members must be made aware of their responsibilities.
- The MOST IMPORTANT responsibility is to be PROACTIVE members.
- Board members must have relevant expertise to fulfil the role
- Board members should resign if they are unable to commit the time and effort to fulfilling Board responsibilities. Not showing up at meetings does NOT reduce the responsibility!
- Board members should not accept at face value reports from the CEO, CFO and accountants.
- Board members should ensure that decisions AND discussions are well documented.
- Board members must be confident that the senior management of the organization is competent.
- Board members should ensure that there is a professional liability insurance for all Board members.
Fortunately, the Directors (or their descendants) did not have to pay out of pocket the 12 million shekels in damages. The High Court had also decided that the insurance company must pay the damages despite having presented numerous arguments claiming that the professional liability policy was not applicable.
Please contact us to further discuss Risk Analysis and the exposure of Board members