News | 02/02/2017

The ‘reasonableness’ of directors’​ remuneration

Providing remuneration to skilled directors, committee members, executives and advisers on the boards of non-profit organisations is an important way of ensuring their continued success, but can place undue strain on an organisation’s resources and jeopardise the tax concession endorsements held.  Dominic McCormack considers the aspect of ‘reasonableness’ in assessing appropriate remuneration.

Introduction

As I recently discussed in “To Pay or Not to Pay – Directors and Committee Members of Not-for-profit and Charitable organisations[1], the committee members and directors of not-for-profits and Public Benevolent Institutions (PBIs) are entitled to receive remuneration for their respective roles.  In fact, it is in the public interest that such organisations are managed competently and diligently, while keeping as the foremost consideration the objects of the organisation as set out in their constitution or rule book.

In order to combine the common law and current legislative approaches (and adhere to the Australian Charities and Not-for-profit Commission’s (ACNC) view), such organisations should ensure that two aspects are competently addressed in order to safeguard their tax concession status:

1. The remuneration of committee members or directors should be explicitly provided for in the constitution or rule book; and

2. At all times the remuneration must be able to pass the test of “reasonableness” – that is, it must take into account the circumstances of the organisation, the responsibilities involved in the employment, the employee’s experience and performance record, and their length of service.

It is to this second aspect which I now turn, looking at the circumstances of the organisation, the related party, and the role of the board of directors or committee members concerned (now simply referred to as ‘directors’).

Background

Australian law does not specifically provide for a cap on the remuneration of directors for non-profit organisations.   The requirement is merely that the remuneration should be explicitly provided for in an organisation’s constitution or rule book, and that it be reasonable.  Providing for remuneration in the constitution or rule book is a matter of drafting and member approval; deciding on remuneration that is ‘reasonable’ is one for careful consideration by the directors particularly where, in Australian law[2], the term ‘reasonable’ is a relative one and the facts of a particular circumstance must be considered.

As noted in “To Pay or Not to Pay – Directors and Committee Members of Not-for-profit and Charitable organisations“, both section 211 of the Corporations Act and section 287-1 of the Corporations (Aboriginal and Torres Strait Islander) Act provide that member approval is not needed to give a financial benefit if the benefit is remuneration to a related party as an officer or employee of the public company, and to give the remuneration would be reasonable given the circumstances of the public company giving the remuneration and the related party’s circumstances (including the responsibilities involved in the office or employment).

Directors need to make, and take responsibility for, such decisions, and do so following a proper and transparent process.

The remuneration of directors will only endanger PBI tax concession endorsements held if they result in “the direct relief of poverty, sickness, destitution or helplessness” no longer being the predominant purpose of an organisation’s existence and operation.  The fact that the entity is purportedly incorporated for the right purposes by way of stating suitable charitable objects and purposes in its constitution is not sufficient – its actual activities and operations must be directed towards relief with respect to those right purposes as well.   This is an objective question of fact and degree and one that will be different for every organisation.

‘Reasonableness’

Overall, directors must act in the best interests of their company and this must, of necessity, include the setting of remuneration. ‘Reasonableness’ is to be tested by two objective factors – circumstances of the company and of the related party[3].

The company circumstances could include referring to matters such as the following:

·  what the organisation does

·  operating location

·  structure and responsibilities of the board

·  risks, challenges and complexity of its business

The circumstances of an individual may include referring to matters such as the following:

·  current economic conditions

·  the person’s qualifications

·  an independently assessed range of remuneration for comparable roles in the same or similar industry

·  the organisation’s own remuneration structure

Policy and process

When considering remuneration policies and terms for directors or senior management staff, directors should also, and more broadly, have reference to and carry out the following[4]:

·  establish executive remuneration policies that set out the aims of the various remuneration components, and any relevant conditions

·  have in place a remuneration process that incorporates independent opinion, expertise and transparency – in particular, utilise the services of a reputable accountant familiar with the salaries of similar organisations

·  obtain appropriate expert advice, independent of company management, when entering into employment contracts with executives and setting their remuneration

·  undertake stress testing of proposed incentive arrangements before accepting them or before agreeing to variations or renegotiations

·  ensure remuneration is reasonable, having regard to the best interests of the organisation

·  ensure that the remuneration is publicly defendable

In considering these factors, directors must appreciate that they are accountable for decisions made about remuneration and must not treat expert advice as final.   To put it bluntly, directors must exercise their own judgement and, ultimately, the board is answerable for the remuneration arrangements it approves.

However, it is interesting to note the contrast provided by section 189 of the Corporations Act which states that reliance by a director on information, or professional or expert advice, given or prepared by ‘a professional adviser or expert in relation to matters that the director believes on reasonable grounds to be within the person’s professional or expert competence… and [that] reliance was made in good faith and after making an independent assessment of the information… [then] the director’s reliance on the information or advice is taken to be reasonable unless the contrary is proved’.

As it proceeds through its assessment process, a board of directors or committee should carefully compile information relied upon and then document the reasons for a particular remuneration decision, and the decision itself.   Any remuneration arrangement made should then be reviewed on a regular basis (for example, annually).

Conclusion

Remuneration set for an organisation’s committee members, board of directors or executive staff and advisers must be able to pass the test of “reasonableness”.   A remuneration policy needs to be in place which incorporates a robust remuneration assessment process, and takes into consideration the organisation’s resources, clearly setting out the principles and factors that apply in making remuneration decisions.   This will go a long way towards demonstrating a commitment by the organisation to the fair and proper use of the resources and tax concessions afforded to it.

Key to passing the test of “reasonableness” will be an assessment of the circumstances of the organisation and those of the recipient of the remuneration, and the role of the decision makers in such an assessment – the board of directors or committee members.  These people must take responsibility for decisions, and do so following a proper and transparent process.   However, expert advice, independent of company management, should be proactively utilised.   At all times, the process should be documented.

For advice as to whether the remuneration of your organisation’s committee members, board of directors or executive staff and advisers is ‘reasonable’, please contact Bowden McCormack on 08 8941 6355 or email the writer at dominic@bowden-mccormack.com.au.

[1] See https://www.linkedin.com/pulse/pay-directors-committee-members-not-for-profit-dominic?articleId=6217130872748023808

[2] See Electricity Generation Corporation T/As Verve Energy v Woodside Energy Ltd & Ors; Woodside Energy Ltd & Ors v Electricity Generation Corporation T/As Verve Energy [2014] HCA 7

[3] See both http://www.companydirectors.com.au/~/media/resources/director-resource-centre/policy-on-director-issues/2013/executive-remuneration.ashx at p. 16-17 in particular and http://www.guerdonassociates.com/articles/setting-performance-pay-standards-a-guide-for-board-remuneration-committees/?print=pdf at p. 4

[4] See again http://www.companydirectors.com.au/~/media/resources/director-resource-centre/policy-on-director-issues/2013/executive-remuneration.ashx at p. 16-17 in particular