If you’re lucky enough to be a board member with a background in law and compliance, then terms like fiduciary duty, good faith, and duty of loyalty are likely familiar. But for the rest of us, these commonly referenced terms used to describe the legal and ethical responsibilities of nonprofit board members can cause fear, confusion, and consternation.
But don’t stick your head in the sand just yet. Fiduciary duties, as codified in state law, board bylaws, and common practice, are quite simply a set of rules to ensure that boards are run effectively, lawfully, and with the best interests of their mission in mind. Here, we’ll look beyond the legal jargon to distill the legal and ethical responsibilities of board members to oversee the management of and ensure accountability to your nonprofit organization.
Follow these key tenets to ensure you carry out your fiduciary and ethical obligations to your nonprofit:
1. Put the interests of the organization first.
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. And don’t forget that this also applies to putting your organization’s interest before that of other members, employees, or clients. For example, what is good for one client or employee may not always serve the best interests of the organization as a whole.
2. Do your job (as a board member).
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. For organizations with a diverse or expansive scope of operations, instilling controls, processes, and policies, in addition to utilizing well-functioning committees, can help you to better carry out your essential duties as a board member.
3. Stay focused on your mission.
Over time, the activities and objectives of your nonprofit will be impacted by changes in executive staff, board membership, and community needs. Some refer to this as mission creep, or when your nonprofit activities begin to stray from the original purpose and activities set forth at formation. As a board member, it’s your duty to ensure your nonprofit is abiding by the proposed activities as stated in its application for IRS tax-exempt status. If there are good reasons for a shift in your activities and purpose, you may need to consider amending your articles, bylaws, and/or alerting the IRS of changed activities within your original purpose or if the changes are significant, they could trigger a change in tax status to better reflect the current nature of your operations.
4. Provide effective oversight of your Executive Director.
Hiring the CEO, setting the salary, and providing oversight and accountability of your 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, boards should establish whistleblower policies, signed by all staff members, that allow 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 complaint, the board should clearly document its receipt and investigation of the complaint and the board’s action in response to the complaint.
5. Follow the law.
Directors that hail from the for-profit world often assume nonprofits operate in a less-regulated environment. In reality, the opposite is true. Tax-exempt organizations enjoy an array of tax and other benefits. To ensure those benefits are not exploited, Congress and local governments have imposed additional legal requirements that tax-exempts must follow. It is essential that directors of tax-exempt entities be aware of the various federal, state, and local laws that apply to the organization.
Many directors are unaware whether they are governing a private foundation, a public charity, a supporting organization, or another form of tax-exempt entity, or another type of entity altogether such as a social welfare organization, all of which are subject to different limits on their activities. Board members should understand, at a minimum, the penalties they face for overpaying key employees or other insiders, for engaging in excessive lobbying or political activities, for accommodating tax shelter transactions, for making egregious bad bargains on behalf of the organization, the impact of failing to pass the public support test, etc. Ongoing board training and orientation for new board members is often the best solution.
6. Pay your taxes.
Board members must have knowledge of, and ensure that their nonprofit is paying all required taxes in a timely manner and timely filing all required annual state and federal tax returns. Although nonprofits are exempt from income tax, they must pay all applicable state and federal employment taxes, tax on unrelated business income, property taxes, payroll 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.
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 board members do not simply rubber stamp what staff and/or committee members recommend. Good documentation of board meetings and important decisions can help in this respect.
7. Stay informed.
Effective board members don’t just go to board meetings; they also remain active on the ground level. By continuing to volunteer and work with the nonprofit, a board member ensures that they know what’s really going on and that they don’t become disassociated from the day-to-day realities of their processes. This opens them up to better, more relevant ideas regarding improvement. Not everyone has the ability to be in the soup kitchen or animal shelter weekly, but a general familiarity with staff and the mission is crucial.
8. Ask for help.
We often talk about how board members need to be skilled at leveraging their networks for fundraising. Just as important, a great board member can tap his or her network for expertise and advice for the board. As a board member, you’re an expert in your nonprofit. However, you’re obviously not an expert in all the professional areas your nonprofit may need. The best board members are able and willing to reach out to experts and specialists as needed, to find the best strategies for achieving goals. Working with talented, driven individuals when necessary will give you a better idea of where to go, and bring more human capital into the mix.
9. Make sure your nonprofit has D&O insurance and make sure you are acting within the limits of your authority.
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 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. A non-profit board member may be liable if the board member personally causes injury to someone; if the board member personally guarantees an organization bank loan or business debt; if the board member fails to ensure that the non-profit pays taxes due or files tax returns; if the board member does something intentionally fraudulent or illegal that causes injury or harm; or if the board member holds or combines his/her personal funds with organizational funds. In order to provide board members with peace of mind, and to minimize risk, nonprofits should carry Director and Officers (D&O) insurance, and educate board members and the CEO regarding areas of potential liability.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.