In the last decade or so, directors and officers have faced an increased exposure to personal liability. While the bulk of legal actions have been against directors and officers of for profit corporations, judgments against and settlements by directors and officers of nonprofit corporations are increasing.
I am often approached by boards of public charities and private foundations to advise them on their exposure to personal liability. There are a number of protections that can be found in the organization’s own governing documents, the Arizona Revised Statutes, federal law, and if they have it, in the nonprofit’s own directors and officers insurance policy. Those protections are as follows:
Business Judgment Rule. The Arizona Revised Statutes have codified the standard of conduct generally applicable to directors of a nonprofit corporation. In Arizona, a director of an Arizona nonprofit corporation is not liable for any action taken as a director or any failure to take any action if the director’s duties were performed in compliance with the Arizona Revised Statutes. To comply with Arizona law, a director’s duties must be discharged:
- in good faith;
- with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and
- in a manner the director reasonably believes to be in the corporation’s best interests.
In discharging duties, a director is entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, if prepared or presented by one or more (in relevant part) of the following:
- one or more officers or employees of the corporation whom the director reasonably believes are reliable and competent in the matters presented;
- legal counsel, public accountants, or other person as to matters the director reasonably believes are within the person’s professional expert competence; and
- a committee of (or appointed by) the Board of Directors of which the director is not a member if the director reasonably believes the committee merits confidence.
A director is not acting in good faith if the director has knowledge concerning the matter in question that makes otherwise permissible reliance on others unwarranted.
There is a rebuttable presumption that a director has acted in conformance with his duties. Arizona law places the burden to rebut the presumption on the party challenging a director’s acts or failure to act by clear and convincing evidence. Thus, Arizona law places the burden on the party challenging a director’s conduct to establish by clear and convincing evidence that the director did not act in accordance with his or her legal duty. If the presumption is successfully rebutted, then the director or officer in question may be held liable for his or act or failure to act.
The Federal Volunteer Protection Act (“VPA”). The VPA was enacted in 1997. In general, the VPA provides immunity for volunteers serving nonprofit organizations or governmental entities for damages caused by their acts or omissions if (i) the volunteer was acting within the scope of his or her responsibilities at the time of the alleged act or omissions; (ii) where appropriate or required, the volunteer was properly licensed, certified, or authorized to act; (iii) the harm was not caused by willful, criminal, or reckless misconduct, gross negligence, or a conscious, flagrant indifference to the rights or safety of the individual harmed; and (iv) the harm was not caused by the volunteer operating a motor vehicle, vessel, or aircraft where the State requires an operator’s license and insurance.
VPA defines a “volunteer” as one who (i) performs services (including officers, directors, trustees, and direct service volunteers); (ii) volunteers for a nonprofit organization or governmental entity; and (iii) either (a) receives no compensation (other than reasonable reimbursement or allowance for expenses actually incurred), or (b) does not receive anything of value in lieu of compensation in excess of $500 per year.
The VPA preempts state laws “to the extent that such laws are inconsistent with the Act,” but does not preempt a state law that provides additional protection from liability for volunteers. Furthermore, the VPA does not preempt state law with respect to a number of conditions, including laws that make a nonprofit liable for the acts or omissions of its volunteers to the same extent that an employer is liable for the acts or omissions of its employees.
Arizona’s Volunteer Protection Statute. Under Arizona law, volunteers serving nonprofits or governmental agencies do enjoy immunity from civil liability provided that they have acted (i) in good faith and (ii) within the scope of their official duties. Pursuant to A.R.S. § 12-982, a volunteer is immune from civil liability in any action based on an act or omission resulting in damages if the volunteer acted in good faith and within the scope of his/her official functions and duties for a nonprofit corporation or nonprofit organization, hospital, or governmental entity. This statute does not protect a volunteer from liability if the damage or injury is caused by willful, wanton, or grossly negligent conduct. In any suit for damages based on a negligent act or omission of a volunteer against a nonprofit corporation or nonprofit organization, hospital, or governmental entity, proof that the act or omission was within the volunteer’s official duties and functions is sufficient to establish vicarious liability, if any, of the organization.
A.R.S. § 12-982 defines “volunteer” as any person who performs services for a nonprofit corporation or nonprofit organization, hospital or governmental entity without compensation other than reimbursement of actual expenses incurred. The term includes a volunteer who serves as an uncompensated director, officer, trustee or direct service volunteer. Therefore, the statute does not extend its protection to the board members or officers who serve with compensation.
Indemnification Rights. Most well drafted bylaws provide that the organization shall indemnify the organization’s directors against any and all liabilities to the fullest extent permitted by the Arizona Nonprofit Corporation Act (“Act”). Very generally, the Act permits a nonprofit corporation to indemnify a director made a party to a proceeding due to the individual’s status as a director so long as the director acted: (i) in good faith; (ii) with the reasonable belief that the director’s official conduct was in the corporation’s best interests; and (iii) with the reasonable belief that the director’s unofficial conduct was not opposed to the corporation’s best interests.
The Act prohibits indemnification of a director in connection with (i) a proceeding by (or in the right of) the corporation in which the director was adjudged liable to the corporation; and (ii) a proceeding in which the director was adjudged liable on the basis that the director received an improper benefit.
Arizona law also permits a nonprofit corporation to advance claim expenses prior to the resolution of a case under certain circumstances. Note that advances of expenses may amount to acts of self-dealing under Internal Revenue Code Section 4941(a); therefore, it is preferable to rely on insurance coverage to cover expenses of defending claims.
Directors and Officer’s Insurance. A common question by directors is whether they have coverage under homeowners or personal liability umbrella policies for actions as a director of a nonprofit corporation. Generally, to the extent there would be coverage, it would be very limited and cover bodily injury and property damage only. Another question is whether they need both indemnification and insurance. Generally, they should have both because the indemnification provided to directors and officers from the corporation under statutes or Articles and Bylaws may be inadequate because:
- The corporation becomes insolvent or does not have sufficient resources to pay the losses and expenses incurred by the officers and directors.
- Because of public policy considerations or because of the indemnification statute, some claims are not indemnifiable but may be insurable.
Arizona law specifically permits a nonprofit corporation to purchase insurance on behalf of directors and officers to cover claims based on their status as a director or officer of the corporation, even if the corporation cannot indemnify the director or officer against liability for the same conduct.
D&O policies typically have two parts: One part reimburses the corporation for any indemnification payment it makes to directors and officers, and the second part provides for direct payments to directors and officers when they are not reimbursed by the corporation. The D&O policy affords no protection to the corporation itself for its own (nonindemnification) liabilities, which may be covered under a comprehensive general or commercial general liability policy. There is no “standard” form policy, and different policies contain different terms and different exclusions. The cost of D&O insurance can be significant and varies substantially from company to company. It is essential to shop. Common policy exclusions include:
- ERISA violations
- Pollution or environmental damages
- For bodily injury or damage to property
- For libel and slander
- For discrimination
- With respect to antitrust claims
- For illegal personal gain or remuneration.
- For security law violations
- Based upon a final adjudication of fraudulent or dishonest acts
- Failure to maintain insurance
- Activities relating to joint ventures and partnerships
- Based upon a claim of breach of contract, and particularly employment contracts
- Based upon a claim of malpractice
- Claims brought by regulatory agencies.
- Claims brought by officers or directors against other officers or directors.
Many insurance companies include coverage of excess benefit penalties for directors of public charities and social welfare organization. Such coverage may cost more but is generally worth the investment.