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Legal obligations of board members of nonprofit organizations
Intending to support a worthy cause, many people agree to sit on the board of directors of nonprofit organizations. More often than not, they approach this responsibility with little under-standing of the obligations of a board member. In fact, there are situations in which personal liability can arise and ways to mitigate that liability. Further, many board members (otherwise reasonably cautious people) often increase their risk by allowing others (usually paid staff) to exercise the judgment that properly belongs with the board.
The easiest way to avoid such a problem is to be prepared. The following is a brief outline of the legal obligations of a board member of nonprofits:
Know the Governing Instruments. This will generally consist of the Articles of Incorporation and Bylaws (or trust instrument for an unincorporated organization). In addition, there should be internal policies and procedures, especially for any organization with paid employees. There should also be financial policies and procedures developed in connection with outside accountants. A strategic plan should provide the roadmap for the organizations activities.
Federal and State Laws.
Federal Law. Federal tax law is often significant for organizations with diverse operations. Issues include continued treatment as a public charity instead of a private foundations, as well as whether certain activities give rise to unrelated business taxable income. In addition, organizations exempt under federal law have severe restrictions on lobbying activities, and an absolute prohibition against participating in political campaigns. Nonprofits are subject to applicable employment laws the same as for-profit organizations, such as federal tax and social security withholding, the Fair Labor Standards Act, ERISA, and applicable anti-discrimination laws.
State Law. State laws not only govern the legal obligation of board members and the legal requirements for the organization, but most states have adopted laws regulating charitable solicitations. Exemptions for state income, sales and property taxes must be carefully examined, because these laws do not always mirror federal tax exemption requirements.
Board Member Duties. Board members must adhere to certain standards of conduct in carrying out his or her obligations to the nonprofit organization:
Duty of Care. This describes the level of competence that is expected of a board member. This generally means that the board member owes the duty of care that an ordinarily prudent person would exercise in a like position and under similar circumstances. For nonprofit boards, this may be difficult because many board members do not regularly attend board or committee meetings, which may make it more difficult to exercise an adequate duty of care.
Duty of Loyalty. This means that the board member must put the interests of the organization first. Board members can have business dealings with the organization, but such dealings will be subject to a higher degree of scrutiny if ever tested in the courts. This generally requires that there be full disclosure of the board members interest, and the terms of the transaction must be fair to the organization.
Duty of Obedience. This means that the board member must promote actions consistent with the organizations stated mission.
Risk Management and Insurance. Risk Management for board members of a nonprofit organization is best accomplished through avoidance or reduction of risk, and insurance against risk. Risk is avoided or reduced through careful adherence by board members to their standards of conduct as outlined above. Responsible governance is always the first line of defense.
Indemnification. The Bylaws of the nonprofit should provide an indemnification of officers and directors for the legal costs, judgments and settlements of suits against board members. Board members should be comfortable, however, that the nonprofit will have sufficient funds to fulfill its indemnity obligations.
Immunity Under State Law. State law also provides broad protection for officers and directors of nonprofit organizations. For example, applicable Florida statutes provide that officers and directors of certain tax-exempt, nonprofit organizations (note that this does not apply to all nonprofit organizations), are not personally liable for monetary damages to any person for any statement, vote, decision or failure to take an action, regarding organizational management or policy by an officer or director unless:
(a) the officer or director breached or failed to perform his or her duties as an officer or director, and
(b) the breach of, or failure to perform, such duties constitutes a violation of the criminal law (unless the officer or director had reasonable cause to believe the conduct was lawful), the officer or director derived an improper personal benefit, directly or indirectly, or the officer or directors conduct was reckless or an act of omission that was committed in bad faith, with malicious purpose, or in a manner exhibiting wanton and willful disregard of human rights, safety or property. Note that in defining officer, this only means a person who serves as an officer without compensation, except to reimbursement for actual expenses incurred or to be incurred.
Because the laws vary from state to state, board members and officers should consult the laws in the states in which they operate.
Insurance. Risk is transferred by having both general liability insurance, as well as directors and officers (D&O) liability insurance. Such insurance is designed to protect board members by paying defense costs, settlements and judgments in suits that challenge decisions made by directors and officers. In reviewing a D&O policy, carefully review the exclusions and coverage. Many claims against nonprofits involved employment related issues, so this should be covered by insurance if possible.
Audit Committee. Nonprofit organizations have a duty to funders and beneficiaries, both of which rely strongly upon appropriate financial management of the nonprofit organization. The Audit Committee has a special responsibility in helping the board of directors in overseeing that appropriate accounting policies and internal controls are established and followed, and that financial statements and reports are prepared properly and timely. The Audit or Finance Committee will be the first line of defense with regard to both accounting and tax matters. This will include overseeing the selection of auditors, oversight of the audit process, and post-audit evaluations. In addition, the Audit or Finance Committee should understand the special laws relating to tax-exempt organizations, including limitations on lobbying, restrictions against private inurement, and avoidance or mitigation of the unrelated business income tax.
