Top 15 Nonprofit Governance Mistakes (and How to Avoid Them)
This list was started as the inaugural post to CharityLawyer Blog, has been added to by San Francisco lawyer and publisher of the Nonprofit Law Blog, Gene Takagi, and is now introduced in its 3.0 iteration. We’ve updated our list of Top Nonprofit Governance Mistakes to include additional observations over the past decade and to provide our best advice on how to avoid these mistakes.
- Failing to Understand Fiduciary Duties. When you volunteer to serve as a director or officer of a nonprofit, you accept the responsibility to act with the duties of good faith, due care and loyalty, along with the potential liability that comes with that responsibility. 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. But in today’s enforcement environment, it is no longer sufficient to rubber stamp committee or staff recommendations or to simply abstain from dicey decisions.
What can you do? Equip your board members with regular education on their fiduciary duties and what they require. Board members should also take care to demonstrate thoughtful consideration and deliberation of key decisions and ongoing oversight.
- Failing to Provide Effective Oversight. Boards can delegate tasks to committees, officers, staff, or in certain cases, professionals, but that doesn’t mean they can then set it and forget it. Fiduciary duties still require that a board maintain effective oversight of delegated responsibilities.
What can you do? Oversight can be effectively exercised by ensuring that your nonprofit has specific policies and procedures in place (conflict of interest policies, executive compensation policies, travel and expense reimbursement policies, signature authority, whistleblower policies, etc.) AND that these policies and procedures are actually followed. The board can approve an annual budget with clear limits and delegate difficult tasks that require more time and focused attention to committees. Common governance committees include those designed to oversee finances, investments, audits, and compensation. In any event, your board should regularly review financial statements, income and expenditures compared to the budget, the annual Form 990, and receive periodic reporting from committees and those with delegated responsibilities.
- Deference to the Executive Committee, Board Chair or the Organization’s Founder. No one owns a tax-exempt nonprofit and no one committee, director, or individual can control the organization. The executive committee, if one exists, is typically charged with acting on behalf of the board when the board is not in session and cannot be easily convened. The executive committee is, however, accountable to the full board. Similarly, the chair’s primary duty is typically to preside over board meetings and to act as a liaison between the board and the chief executive. Still, the chair remains accountable to the full board and does not have the power to override decisions of the board. And, while founders often may act as the chief executive and run the day-to-day affairs of the organization, and also sit on the board, they still serve at the pleasure of the board.
What can you do? Set clear lines of authority and responsibility within your organization’s bylaws and procedures and stick to them. Avoid rubber-stamping decisions or actions made by an executive committee, chair, or founder. If a pattern of improper deference and unilateral decision making begins to emerge, it is critical that your board take strong and decisive action to reinforce the proper procedures for bringing matters to the board for decision, discussion, and ratification.
- Micro-managing Staff. The board’s key duties are to provide oversight and strategic direction, not to meddle in the organization’s day to day affairs. Board members who cross this line are undermining the authority of the chief executive to their own detriment and that of the organization. Similarly, staff should not invite micromanagement by asking the board to take on day-to-day tasks that the staff should be handling.
What can you do? The size and budget of smaller organizations may sometimes necessitate that board members play a more active role in the day to day operations, but board members and staff should know their roles and attempt to adhere to them as much as possible. If problems persist, it may be necessary for the board chair or other leader to address the matter directly (but thoughtfully) with the offending party.
- Avoiding Hard Questions. It can be uncomfortable to ask tough questions or to disagree with one’s fellow board members. However, groupthink rarely leads to sound decision-making. A board that passes every resolution unanimously should evaluate whether it needs to do more to encourage a thoughtful and open discussion.
What can you do? It is important to set a tone that encourages a free exchange of ideas, both good and bad. The board should encourage open, vigorous discussions about key issues. And often, the most valuable board members are the ones who, calmly and respectfully, speak their mind; their participation should be acknowledged and encouraged.
- Insufficient Conflict of Interest Management. If a conflict of interest is with an insider, their family member, or business, its not enough to simply disclose the conflict and have the disinterested directors approve the transaction. Likewise, many nonprofits have a conflict of interest policy but may fail to follow it, resulting in a finding of excess benefit or private inurement.
What can you do? In such cases, the disinterested members of the board need to consider alternative arrangements that do not give rise to a conflict of interest. If after considering alternatives, the board still finds the transaction with the insider is in the organization’s best interests, then the board should carefully document the basis for the decision. The board should also document that the interested director did not participate in the deliberations or vote. The best practice is to follow the procedures outlined in the intermediate sanctions regulations to properly analyze and document the proposed transaction.
- Lack of Awareness of Laws Governing Tax-Exempts. 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, regulators have imposed additional legal requirements that tax-exempts must follow. Many directors are also unaware whether they are governing a private foundation, a public charity, a supporting organization, or another form of tax-exempt entity, all of which are subject to different limits on their activities.
What can you do? It is essential that directors of tax-exempt entities be aware of the various federal, state, and local laws that apply to the organization AND are applicable to their specific type of charitable organization. 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, 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.
- Operating with Outdated, Inconsistent Governing Documents. Over time, many organizations change their mission and purpose without updating their governing documents. Similarly, many organizations develop governance practices that do not comply with their original governing documents. For example, it is not uncommon to see bylaws that call for voting members although no member votes have ever taken place; or bylaws with a term that calls for the cessation of the organization on a date that has long since passed. Frequently, these issues stem from using stock forms or copying another institution’s bylaws without regard to the distinctions between the organizations or current law.
What can you do? Encourage compliance by conducting regular reviews of the governing documents and checking the bylaws before electing additional officers or directors, creating additional committees, adopting amendments, etc. Remember that governing documents aren’t just made up. They are based on state and federal law so it is best to have them revised by a lawyer who practices nonprofit law.
- Airing Disagreements Outside the Boardroom. Inherent in the duty of loyalty that all board members must adhere to, is an implied duty of confidentiality. Yet when disagreements between board members ensue, its quite common for members to stir up debate and chatter in other forums, such as email or text, or in private conversation.
What can you do? Every board’s motto should be what happens in the boardroom stays in the boardroom. Once an issue is settled by board vote, the board members who voted against the majority must present a united front. If a vote is so disagreeable that a board member cannot carry on in this manner, the board member should consider resigning. In extreme cases, if the board member believes the corporation’s rights are being violated, the board member could join together with other like-minded board members to bring a derivative suit to enforce the organization’s rights.
- Failure to Cultivate Board Diversity. Having diverse perspectives on the board is vital to the success of a nonprofit. Each member will bring his or her own personal and professional network of contacts, values, and life experiences to their service on the board. With this diversity of experience, perspectives, and contact networks, a nonprofit is in a stronger position to expand its reach and tackle blind spots. However, as the initial board is typically made up of friends and advisors of the organization’s founder, who then reach out to their trusted friends and advisors to fill vacancies, a usual suspect approach to board recruitment can develop. As a result, the same individuals who went to the same schools, belong to the same clubs, and hail from the same neighborhoods and professions are institutionalized onto an organization’s board.
What can you do? If your organization is run by a group of usual suspects, consider mixing it up by creating a matrix of skills, experiences, and backgrounds that would add valuable perspectives to the board. Those with law, accounting, and fundraising skills are obvious choices. Use this matrix to inform your search for new board members and detail these desired characteristics as you reach out to civic leaders and other reputable nonprofits to recommend potential board candidates.
- Recruiting and Selecting Board Members Without Due Care. We sometimes select friends, relatives, and business associates often because we believe that they will share our vision, support our views, and make meetings pleasant. And sometimes because we can’t find anyone else. We sometimes select influential and wealthy individuals because they will contribute substantial sums to the organization and connect us to their network of other influential and wealthy persons. All of this may be well and good, but only if we make sure that we select directors who are going to attend meetings, provide real oversight, and govern using their independent judgment.
What can you do? Board recruitment and selection should be treated with the same care you give to hiring your own personal lawyer, financial advisor, etc. Think of it like dating–you should have a process for the potential board candidate to learn more about your organization and you about them and then determine if you are a good fit. It’s also important to clearly set forth your expectations and estimated time commitment so a prospective candidate can determine if they can fully commit to the job. A little due diligence and clear communications will ensure that board membership is a positive experience for everyone involved.
- Failing to Educate and Motivate Board Members. Intentional misconduct aside, the vast majority of directors simply don’t understand what they are supposed to be doing and believe that they will not be held accountable for their inaction. As a result, they inevitably eventually fail to meet their legal duties of care and loyalty.
What can you do? It’s up to the president, chair, executive director, and really each board member to correct this lack of understanding. While this may be an ongoing (and seemingly Sisyphean) process, we can make some quick fixes. Set up a basic orientation process. Invite a nonprofit-exempt organization’s lawyer to present to the board (directors ears tend to perk up when they hear the word liability). Regularly send out information to the board about the organization’s major issues (its okay to be repetitive if the issues remain outstanding) and how board members might help. Have the board conduct a SWOT (strengths, weaknesses, opportunities, threats) analysis on itself (not just the organization) and create an action plan based on the analysis.
- Failing to Document Actions Appropriately. Some of us adopt minutes that are virtual transcripts of board meetings. Others adopt minutes that only document actions without any mention of the process or deliberations. What’s proper? Well, it depends. But often what’s most appropriate lies somewhere between these two extremes. Documenting every discussion could create greater exposure for liability and makes it unlikely that minutes will be reviewed except in cases where we are looking for something specific. On the other hand, documenting only actions can result in a loss of institutional knowledge about why certain decisions were made and provide less evidentiary support of a board’s due care in making decisions. Still, documenting nothing is not an acceptable alternative, but it’s a common problem.
What can you do? As a start, key decisions should have more documentation of deliberation and discussion, and less important decisions…well, less. Here, consistency is also key; are detailed minutes taken regularly, yet conspicuously missing from a meeting concerning a key decision? A discrepancy in standard practice can raise red flags and cause important decisions to later be questioned.
- Failing to Review Program Effectiveness and Efficiency and Take Appropriate Follow-up Actions. Many of us board members understand that we are fiduciaries and have a responsibility to provide financial oversight. And we know that our charities are doing great work because the executive tells us so. But how do we really know this? And if charities exist to provide some sort of public good, and not to maximize profits, isn’t programmatic oversight just as, if not more, important than financial oversight?
What can you do? Here, a SWOT analysis and some basic strategic planning can help. What is your organization’s objective over the next year, the next five? What steps are you taking to get there? And how does your impact align with other service providers and community expectations? Likewise, it is implicit on board members to require reporting from executive staff on other metrics and evaluative measures apart from financials.
- Failing to Hold Executives (and Nonparticipating Directors) Accountable. This one earned a retweet from NY Times philanthropy correspondent Stephanie Strom. How many of us give regular performance reviews to our executives? Do we just give pats on the back (which we should do whenever deserved) or do we also take a hard look at deficiencies and take corrective actions? Many nonprofits are transitioning to younger, less experienced leaders as the boomers start to retire or move to other positions. Mistakes happen and may happen more often with new leaders. How do we respond to this? Do we document errors in judgment, complaints, abuses of authority? Are we prepared to fire an executive even without malfeasance where he or she is just not getting the job done? And what about removing directors who don’t show up at meetings or otherwise fail to fulfill their governance responsibilities? Tricky stuff, but don’t we need to deal with it?
What can you do? Having policies and procedures (that you actually follow) in place for evaluating and addressing performance issues can help ease the sting when it actually comes to time to address and discuss the problem. Still, it often boils down to having to do the hard thing…and then doing it. There are no shortcuts. But there are certainly consequences for failing to do so. Your scythe, when well-placed and used properly, will ultimately allow your nonprofit to flourish, better accomplish its mission, and serve your clients and community more effectively.
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.