Board governance is the cornerstone of effective nonprofit management. Comprised of individuals with diverse expertise and a shared commitment to the organization’s mission, the board of directors plays a vital role in guiding and overseeing the activities of a nonprofit. The board of directors serves as the governing body of the organization, is responsible for setting strategic direction, ensures financial accountability, and safeguards the nonprofit’s mission and assets.
Due to each board member’s ability to influence and control the organization, board members are legally bound to certain ethical standards of conduct. Such standards are called fiduciary duties. In this blog, we will delve into the key aspects of board members’ fiduciary duties, including the duties of loyalty and care, the corporate opportunity doctrine, and the business judgment rule.
This blog focuses on Arizona law as it applies to nonprofits.** However, the basic principles discussed herein exist in nearly all jurisdictions throughout the United States.
Directors’ Standard of Care
Under Arizona law, directors of nonprofit corporations are not liable for any action taken as a director or failure to take any action if the director’s duties comply with the Arizona Revised Statutes. The Arizona Revised Statutes state that a director’s duties shall 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.
Duty of Care
The duty to act in good faith with the care an ordinarily prudent person in a like position would exercise under similar circumstances is known as the director’s fiduciary duty of care. The duty of care confers certain responsibilities onto each director. For example, the duty of care requires the director to understand and know the corporation’s business operations and affairs, financial condition, and to address any misappropriations of funds.
Duty of Loyalty
The duty to act in the corporation’s best interests is known as the director’s fiduciary duty of loyalty. The duty of loyalty exists as a rule against self-dealing or taking advantage of the nonprofit for personal gain. If a director is personally interested in a corporate transaction, that director has the burden to show that the decision with respect to that transaction is fair and serves the nonprofit’s best interests. A common example of a breach of the duty of loyalty is using corporate funds to pay personal debts.
Corporate Opportunity Doctrine
Arizona law also recognizes the corporate opportunity doctrine, a rule similar to the duty of loyalty. The corporate opportunity doctrine prevents a director from taking advantage of a business opportunity or transaction at the nonprofit’s expense. In other words, a director cannot seize business opportunities in the nonprofit’s line of business for that director’s personal gain. However, if the nonprofit is not in a financial position to take advantage of such opportunity, the corporate opportunity doctrine does not apply.
Business Judgment Rule
In Arizona, there exists a rebuttable presumption that a director has acted in conformance with his or her fiduciary duties. Known as the business judgment rule, the party challenging a director’s act or failure to act has the burden to rebut this presumption 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 following his or her fiduciary duty. The business judgement rule does not apply to self-dealing or conflicted transactions.
Examples of a Director’s Breach of Fiduciary Duties
Various actions can result in a breach of a director’s fiduciary duties. In the nonprofit context, retaining donations for personal use diverts resources intended for the nonprofit’s mission, violating the duty of loyalty. Failing to pay money owed to the nonprofit breaches the duty of care by neglecting financial responsibilities and demonstrates a lack of loyalty to the organization’s best interests. Pursuing a corporate opportunity otherwise available to the nonprofit violates the duty of loyalty and corporate opportunity doctrine. Finally, unauthorized actions or use of the nonprofit’s funds violates the duty of care by not acting in good faith.
Consequences for Breach of Fiduciary Duties
Generally, a fiduciary duty is one of the highest duties recognized in law, similar to that of a trust relationship. Breaching a fiduciary duty can lead to personal liability for the director. Moreover, personal liability may attach to a director who did not act in direct breach of his or her fiduciary duties but failed to act or was negligent in exercising his or her fiduciary duties.
Beyond personal liability, a breach of fiduciary duty can result in immense reputational damage to the nonprofit and destroy the organization’s goodwill in the community.
Conclusion
Effective board governance is essential for the long-term success and sustainability of nonprofit organizations. By fulfilling their roles and responsibilities with integrity, accountability, and transparency, board members can provide the leadership and oversight necessary to advance the organization’s mission and achieve its strategic objectives. By adhering to legal obligations, embracing best practices, and fostering a culture of ethical governance, nonprofit boards can enhance their effectiveness and make a meaningful impact in their communities.
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Kyler Mejia is an associate (bar admission pending) with Caritas Law Group, P.C. Kyler counsels nonprofit and socially responsible businesses on corporate, trademark, tax, and fundraising matters nationwide and advises donors concerning major gifts. To schedule a consultation, call 602-456-0071 or email us through our contact form.
**The information contained in this post is for educational purposes only and is not legal advice. If you have questions about board responsibilities or a potential breach of fiduciary duties, please contact a licensed legal professional for help.