Fiduciary Responsibility of Nonprofit Boards

fiduciary duties of nonprofit boardsThe recent high-profile ouster of Southern Poverty Law Center CEO and Founder Morris Dees, and the resignation of Board Chair Richard Cohen, show how things can go awry when a board does not provide appropriate oversight.

The board collectively, and directors/trustees individually, owe fiduciary duties to the nonprofit organization they serve. In essence, exercising fiduciary duties means that board members have a duty to act with care and in the best interest of the organization and remain loyal to its mission, as opposed to acting in their own interest or the interest of the CEO/Executive Director they supervise.

Business Judgment Rule. When an organizational decision of a nonprofit corporation’s board turns out to be, in hindsight, a bad or even disastrous one, a board member that properly exercised his or her fiduciary duties will be able to use this fact as a defense against personal liability in the event of a lawsuit. This is known as the “business judgment rule.” Essentially, a court will not second guess the Board’s judgment so long as the board made the decision with due care, out of loyalty to the organization, in good faith, and in some states, out of obedience to the corporation. This is one of the key advantages directors of nonprofit corporations have over trustees of charitable trusts.

Although most board members understand this fiduciary duty in concept, the pressures of fund-raising, organizational culture, and following a successful CEO/Executive Director, without great care, can obscure the details of board responsibilities. It is thus important for board members and CEOs to remain focused on the details of their fiduciary duties.

Board members have both a legal and ethical responsibility to oversee non-profit management and provide accountability. There are three categories of the fiduciary duty. They are the duty of care, the duty of loyalty, and in some states the duty to act in good faith and in others the duty of obedience.

Duty of Care. The fiduciary duty of care means that board members should give reasonable care and attention to their responsibility to provide organizational oversight. Although there are no precise rules as to what this means, at a minimum, board members should make every effort to attend meetings, read board reports, and have an understanding of organizational finance. Granted, volunteer board members with busy professional lives can struggle to understand the nuances of organizational management. Thus, the IRS and auditors often focus on the controls, processes, and policies that are in place to minimize the risk of wrong-doing. For example, it is a good idea to have a board treasurer and a finance committee that have a more in-depth understanding of accounting practices, budgeting, annual independent audits, and IRS 990 and state tax filings. The treasurer and/or finance committee can then provide a more summarized report to the board. However, it is important that the Board be able to show that it does not simply “rubber stamp” what staff recommendations.

Duty of Loyalty. The fiduciary duty of loyalty of board members is the responsibility to act in the interests of the non-profit, those it serves, and those donating funds for operations, as opposed to their own self-interest.  Again, the presence of written controls that are routinely practiced are very important to minimize risk.  (IRS Form 990 includes additional questions about governance and whether such controls exist.) For example, it is important to have a written conflict of interest policy and for the board to review it annually, and that each board member sign a conflict disclosure each year. At a minimum, the policy should ensure that board members disclose any possible conflicts of interest, and that they abstain from any discussion or vote that can potentially benefit them or those closest to them personally.

It can also be said that board members have a duty not to act in the personal best interest of the non-profit CEO (lead staff member) where that interest conflicts with the nonprofit’s best interest. Hiring the CEO, setting the salary, and providing oversight and accountability of such CEO, is among the most important responsibilities of a non-profit board. For example, the IRS can fine individual board members who knowingly set excessive compensation for the CEO. To minimize this risk, boards can establish a CEO compensation committee that benchmarks CEO salary against industry standards for comparable non-profits. Moreover, as the Southern Poverty Law Center case mentioned above makes abundantly clear, boards should establish whistleblower policies, signed by all staff members, that allows staff members to bypass the CEO to make complaints of impropriety directly to the board with a guarantee of non-retaliation. When the Board receives a whistleblower compliant, the board should clearly document its receipt and investigation of the complaint and the board’s action in response to the compliant.

Duty to Act in Good Faith. The concept of “good faith” generally requires that directors act honestly, with faithfulness to their duties and obligations, and not attempt to take advantage of the corporation. A director or officer is not acting in good faith if the director or officer has knowledge concerning the matter in question that makes reliance on another person unwarranted.

Duty of Obedience. The fiduciary duty of obedience means that the board has a responsibility to ensure the non-profit is abiding by the purpose of its activities as stated in its application for IRS tax-exempt status, and is complying with all state and federal laws. For example, board members must have knowledge of, and ensure that they are paying all required taxes in a timely manner and timely filing all required annual state and federal tax returns. Although non-profits are exempt from income tax, they must pay all applicable state and federal employment taxes, tax on unrelated business income, property taxes, etc. Most importantly, a failure to file the IRS 990 return three years in a row may result in revocation of tax-exempt status. Moreover, boards must follow the dictates of the Uniform Prudent Management of Institutional Funds Act when deciding upon investment decisions and managing endowment funds.

Protection from Personal Liability. Although there are multiple types of potential liability for a non-profit corporation, board members are generally protected from individual liability by the business judgment rule discussed above and non-profit “shield laws.” However, individual board members can be held personally liable for actions of the non-profit corporation on whose board they sit. Thus, in order to provide board members with peace of mind, and to minimize risk, non-profits should carry Director and Officers (D&O) insurance, and educate board members and the CEO regarding areas of potential liability. A non-profit board member may be liable if he/she personally causes injury to someone; if he/she personally guarantees an organization bank loan or business debt; if he/she fails to ensure that the non-profit pays taxes due or files tax returns; if he/she does something intentionally fraudulent or illegal that causes injury or harm; or if he/she holds or combines his/her personal funds with organizational funds.

Board members have responsibilities and potential liabilities. Proper education upon the specifics of such duties and responsibilities will provide peace of mind, reduce risk to the non-profit brand, and lower the risk of organizational and personal liability.

Ellis Carter is a nonprofit lawyer with Caritas Law Group, PC. To contact Ellis, call 602-456-0071 or email us at info@caritaslawgroup.com.

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