Michael Shattock says Lord Nolan should examine whether governing bodies can cope with more laws and less cash, while John Hall (right) argues that governors face too much risk of financial liability.

There are already emerging from the second inquiry of Lord Nolan's committee issues which lie deeper than the "democratic deficit" question at universities and colleges. It is becoming all too apparent that the local public spending bodies under investigation are a hotch-potch of different structures and systems which lack coherence and a common logic. Since they have developed haphazardly, it is not surprising that design faults have occurred. What is causing concern is reluctance by the Department for Education and Employment to remedy those faults by reaching for the tool box.

Concern centres on the legal uncertainty about the extent to which governors may become personally liable for the acts of their institutions, particularly those established as statutory corporations. Connected to this issue is the unresolved debate about whether universities and colleges should have the freedom to pay remuneration to governors. Thus, unremunerated governors who are expected to conduct themselves in accordance with standards of openness and transparency are denied a clear answer to the question: "What is the extent of my personal liability?" The stock response of the DFEE is that ". . . it is not possible to give an absolute assurance that no governor could ever face financial jeopardy", while the mantra of the funding councils is that liability is a matter for interpretation by the courts.

The message seems to be that governors will have to wait for the legal fog to clear until one or more of their number makes legal history in a test case. In the meantime, if an institution becomes insolvent, according to evidence given by the Further Education Funding Council to the Public Accounts Committee, governors of insolvent corporations "might be held personally responsible for the money that was lost". No wonder there is concern among governors.

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Unless something is done to clarify the issue of governor liability, there is a danger that the Nolan committee will build a house on sand, since its inquiry is based on the simple premise that there are enough public spirited people who are prepared to volunteer themselves as governors. If this assumption is wrong and the supply of able governors dries up because of fear of financial jeopardy, then codes of conduct, independent scrutiny and more effective training will be so much chasing after the wind.

Is the fear of financial jeopardy more imaginary than real? After all, the legal starting point is that, unless the charter or statute otherwise provides, the members of a corporation are not liable for its debts. Similar provisions apply to members of guaranteed companies registered under the Companies Acts, and trustee governors are normally entitled to an indemnity out of the trust assets put at their disposal.

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To revert to standard guidance from the DFEE "provided that governors act within the scope of their functions and procedures, honestly and without ulterior motive, and reasonably with care and common sense, then individual governors will in practice be protected against risk to their own assets as a result of the governing body's decisions". It is the broad scope of the department's proviso which flags the danger area for governors, and the potential for personal liability which is unlimited.

Like other persons who are in a fiduciary position, such as company directors and trustees, governors may find themselves technically in breach of duty even though there is little fault on their part. For example, a transaction may have been authorised by a governing body which was outside its permitted powers because governors had good reason to believe that the act was within their remit. In that situation governors would normally be liable to the institution for financial loss suffered by it and might also be liable to any third party which suffered loss because of an unenforceable contract.

The exposure of statutory corporations to the anomalous ultra vires rule, which no longer applies to companies in the private sector, is another design fault which is profoundly unsatisfactory and which the Court of Appeal will have an opportunity to consider when it hears the Allerdale Borough Council case next February.

Similarly, governors of an institution which has slipped into insolvency might unwittingly find themselves in breach of their duty to ensure the solvency and safeguard the assets of the institution in circumstances where perhaps they had relied too heavily on advice from senior management or on past practice. In that event, their difficulty would be compounded by another design fault - the lack of an insolvency regime.

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In the case of individuals and companies which have fewer assets than liabilities, the Insolvency Act 1986 ensures that the available assets are divided equitably among the creditors. It is not a question of first come first served. In contrast, a higher or further education corporation getting into financial difficulty might find that its creditors are scrambling to obtain charging orders over particular assets before competing creditors do, and in the scramble governors would inevitably be more vulnerable to personal claims.

Likewise, governors might be held in negligence because they have committed an institution to a transaction without obtaining appropriate professional advice. Governors with a particular skill or expertise must be especially careful to avoid volunteering specialist advice as a substitute for advice which should be commissioned externally.

The fact that governors may incur personal liability would be easier to accept if they were treated consistently with company directors and trustees. But that is not so. Under the Companies Act 1985, a company director may claim relief from the court in any proceedings which allege negligence, default, breach of duty or breach of trust if in the court's opinion the director has acted "honestly and reasonably" and, having regard to all the circumstances of the case, "ought fairly to be excused". There is no good reason for denying to governors the statutory relief already available to directors and trustees. Either the right to such relief should be extended or there is a powerful argument for suggesting a new statutory formulation which would define the extent of governor liability. For example, statute could provide that governors will not incur personal liability if they have acted in good faith, in the interests of the institution, have been adequately informed and their decision is capable of business justification. This cause needs championing because the DFEEinsists that it has no plans to amend the law.

The unequal treatment of governors is also illustrated by their unremunerated status. This is part of an unresolved debate which it is hoped that Nolan will end. On the one hand, according to Sir Geoffrey Holland, "there is a lot to be said for the British tradition of public service and giving to the community. . . these people (governors) give a great deal of their time and deserve expenses, but not a salary". On the other hand, there is evidence of non-executive board members of other publicly funded bodies with broadly similar equivalent responsibilities to those of governors, being paid. If corporate independence means anything, should not institutions be given the freedom to decide whether or not to pay their governors within prescribed limits? There is a huge and worthy challenge in encouraging people with talent, energy and a desire to put something back into society to take part in public service. To make this possible, governors must get a better deal. If the tradition of voluntary service is to be maintained, then the uncertainty over governor liability must be ended without having to wait for a test case.

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John Hall is head of the education law department, Eversheds, London.