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BC Court of Appeal Holds that Directors of a Non-profit Society Breached Conflict of Interest Rules

In Schlenker v. Torgrimson (January 2013), the British Columbia Court of Appeal held that two elected trustees of a local trust committee (a type of municipal corporation) breached the conflict of interest rules under applicable municipal legislation because societies of which they were board members received $4,000 in funds each from the local trust committee.   It did not matter that the directors received no direct personal benefit.  Nor did it matter that their terms of office had already expired so that the remedy of removal or disqualification from the board of the local committee was moot.  In rendering this decision, the Court of Appeal reversed the lower court ruling in the case, which had held that the trustees had derived no personal benefit from the advances.

1. Facts

In 2008, the respondents, Torgrimson and Ehring, were elected as trustees of the Salt Spring Island Local Trust Area.  There was only one other trustee.  The local committee had local government responsibility for land use planning and regulations for the islands within its area.

Both trustees were active in environmental causes and, in early 2011, co-founded two separate not-for-profit societies, of which they were members and directors.

In the fall of 2011, both respondent trustees moved and voted in favour of two separate resolutions (one month apart) to approve the dedication of $4,000 to the societies of which they were directors, one to fund a project of the Salt Spring Island Water Council Society and the other to provide a progress report on greenhouse gases for the Salt Spring Island Climate Action Council Society.  At neither meeting did either trustee disclose that he or she was a director of the recipient societies.

2. Ruling

Justice Donald, writing for a unanimous Court of Appeal, reversed the lower court decision and held that the conflict or interest provision in the applicable legislation (the Community Charter) caught both direct pecuniary interests of the trustees but also indirect interests that are pecuniary in nature.  The latter was sufficient to capture payments of funds to the two societies on whose boards the trustees sat.

The object of the Community Charter was to prevent publicly-elected officials from having divided loyalties in deciding how to spend public money. Advancement of the cause of a non-profit entity in respect of which directors have a fiduciary obligation can be a powerful motive for subordinating the public interest.  Conflict of interest rules are based on the moral principle that no person can serve two masters.  The judgment of even the most well-meaning individuals may be impaired when their personal financial interests are at stake - or, by extension, when the financial interests of a non-profit organization to whom they have a fiduciary duty are at stake.

Directors of non-profit organizations, by virtue of their positions, have an indirect interest in any contract their society is awarded.  The duties of directors to put the society's interests firm were on a direct collision course with their duties as trustees to put the public interest first.  The public is disadvantaged by the conflict, whether the trustees derived any personal gain or not, because the public did not have the undivided loyalty of their elected officials.

In the course of his reasons, Justice Donald observed that the case law relating to the fiduciary duties of directors business corporations is analogous to the fiduciary duty of directors of non-profit corporations.

3. Key Observations

This significant decision is to be applauded in the broad interpretation it gives conflict-of-interest rules and the strong statements it makes in favour of the moral principle of avoiding a situation in which the judgment of a fiduciary may be impaired - whether as a result of direct financial interests or indirect interests as fiduciaries of another corporation.

It is important not to read-down the Court of Appeal ruling in Schlenker to its specific facts:  which looked at narrowly involved public elected trustees authorizing the payment of public funds to societies on whose boards they sat without disclosing their indirect interest in the societies.  But the principle espoused in Schlenker has wide application.  For example, the case is equally applicable if the directors of the recipient society are conflicted because the payor is a for-profit or not-for-profit corporation on whose board they sat.  Schlenker is also applicable where to situations involving not a cash payment but instead a contract between: (a) a not-for-profit or for-profit corporation on whose board they sit and (b) a second corporation on whose board they also sit.  In each case, directors need to consider who best to avoid conflicts of interest.

Often, it requires disclosure of the nature and extent of the conflict of interest to a disinterested decision-maker (such as the un-conflicted directors, a committee of un-conflicted directors or the members), abstention from voting and taking positive steps to establish that the contract is fair and reasonable to the corporation at the time it is entered into.  Sometimes, however, conflicted directors may have to choose which corporation they can properly represent and eliminate the conflict by simply resigning from at least one board to avoid an irreconcilable conflict.

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