From time to time, themes emerge in my practice. Lately, a recurring question has been why does a nonprofit corporation have to comply with its articles and bylaws. Yes really.
While it is true that the sky won’t fall and you won’t necessarily be arrested on the spot, there are a number of unsavory consequences that can flow from a decision to take action that is in conflict with a nonprofit’s articles and/or bylaws.
Ultra Vires Acts
First, there is a doctrine called ultra vires. It is a Latin term that essentially means that acts outside the permissible scope of authority set forth in the governing documents are an unauthorized activity that cannot be ratified by the board.
In many states, this common law doctrine has been effectively abolished by statutes that grant corporations the power to do anything a person can do. However, the doctrine is applicable to most tax-exempt nonprofit corporations because they are required to limit their powers in their Articles of Incorporation to qualify for tax exemption.
As an example, if a 501(c)(3) enters into a contract to endorse a political candidate that is outside the scope of its permissible activities, the nonprofit could argue that the contract could be voided. While there may be other arguments that could be raised to enforce an ultra vires contract, acting “ultra vires” puts the nonprofit at risk as well as those that are entering into transactions with it.
Breach of Fiduciary Duties
Second, if directors act in ways that conflict with the nonprofit’s governing documents, they may be opening themselves up to an argument that they are breaching their fiduciary duties including the duty of due care and the duty of obedience.
In most states, fulfilling one’s fiduciary duties is a prerequisite to a statute that basically says the board members can’t be held personally liable for their mistakes so long as the mistakes were made in good faith, out of loyalty and obedience to the corporation, and with due care.
Failing to comply with articles and bylaws breaches the duty of due care and obedience, risking liability for any harm caused by their actions.
Third, if the directors are ignoring the rights of the nonprofit corporation, most states have a process that permits a group of directors (or voting members in a membership corporation) to get together to bring a derivative suit on behalf of the corporation.
In the nonprofit context, a derivative suit is a lawsuit brought by a group of directors or members against a third party. That third party can be another insider such as another director or group of directors. These suits are brought from time to time when relations break down and factions form on the board of a nonprofit.
Exceptions to Insurance Coverage
Fourth, the typical saviors for wayward nonprofit officers and directors, D&O insurance and corporate indemnification, won’t save directors who act outside the scope of their authority. D&O policies typically exclude ultra vires acts from coverage and corporate indemnification is generally not available to those acting outside the scope of their authority.
Officers and directors of nonprofit corporations who ignore the nonprofit’s articles of incorporation and bylaws are setting themselves up to be on the losing side of a lawsuit that could hold them personally liable for the consequences.