Risk, Reward, and Risk, Reward, and Responsibility:Responsibility:

Understanding the Legal Understanding the Legal Role of a Nonprofit Board Role of a Nonprofit Board

MemberMember

Donald R. Simon, Donald R. Simon, J.D./LL.M.J.D./LL.M.

Simon Business Consulting, Inc.Simon Business Consulting, Inc.

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• AgendaAgenda::– Fiduciary dutiesFiduciary duties– Financial responsibilitiesFinancial responsibilities– Volunteer liabilityVolunteer liability– Q & AQ & A

Me:Me:

• 8 years of experience in the 8 years of experience in the areas of business and intellectual areas of business and intellectual property.property.

• 7 years of experience teaching 7 years of experience teaching legal and business issues to legal and business issues to aspiring artists.aspiring artists.

• Board member experience: Joplin Board member experience: Joplin Area Advertising Federation, Area Advertising Federation, KKFI-FM, and Vice City KKFI-FM, and Vice City Productions.Productions.

• Serving on a board of directors can Serving on a board of directors can be fun, rewarding, and challenging.be fun, rewarding, and challenging.

• It’s NEVER boring!It’s NEVER boring!• Board members have a lot of Board members have a lot of

responsibilities: administrative, responsibilities: administrative, financial, ethical, and…financial, ethical, and…

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LEGAL!LEGAL!

• Principal legal dutiesPrincipal legal duties::– Fiduciary dutiesFiduciary duties– Tax and other financial Tax and other financial

responsibilitiesresponsibilities– Volunteer liabilitiesVolunteer liabilities

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FiduciaryFiduciaryDutiesDuties

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• Fiduciary dutiesFiduciary duties::– To act reasonably, prudently and To act reasonably, prudently and

in the best interests of the in the best interests of the organization;organization;

– To avoid negligence and fraud; andTo avoid negligence and fraud; and– To avoid conflicts of interest.To avoid conflicts of interest.

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• Fiduciary dutiesFiduciary duties::– Fundamental legal duties that all Fundamental legal duties that all

boards must follow.boards must follow.– Apply to everything the board Apply to everything the board

does.does.– Members must keep these duties Members must keep these duties

in mind when making decisions or in mind when making decisions or taking action for the nonprofit.taking action for the nonprofit.

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• Fiduciary dutiesFiduciary duties::– Failure to observe these Failure to observe these

obligations may subject nonprofit obligations may subject nonprofit directors to directors to civil and criminal civil and criminal liabilityliability!!

– It’s a mistake to believe one can’t It’s a mistake to believe one can’t be sued just because they are a be sued just because they are a volunteer director serving an volunteer director serving an organization with a great cause.organization with a great cause.

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• Fiduciary dutiesFiduciary duties::– Duty of careDuty of care– Duty of loyaltyDuty of loyalty– Duty of obedienceDuty of obedience

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• Fiduciary dutiesFiduciary duties::– In carrying out each of these fiduciary In carrying out each of these fiduciary

duties, board members will be duties, board members will be entitled to the benefit of the doubt.entitled to the benefit of the doubt.

– They will be protected from being They will be protected from being “second guessed” and being held “second guessed” and being held personally liable for bad decisions, personally liable for bad decisions, provided that these decisions were provided that these decisions were properly reached.properly reached.

– This is called the “Business Judgment This is called the “Business Judgment Rule.”Rule.”

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• Duty of CareDuty of Care::– Exercise ordinary and reasonable Exercise ordinary and reasonable

care in the performance of their care in the performance of their duties, exhibiting honesty and duties, exhibiting honesty and good faith.good faith.

– Act in a manner which board Act in a manner which board members believe to be in the members believe to be in the best best interests of the organizationinterests of the organization..

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• Duty of CareDuty of Care::– Care that an ordinarily prudent Care that an ordinarily prudent

person would exercise in a like person would exercise in a like position and under similar position and under similar circumstances.circumstances.

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• Duty of CareDuty of Care::– This means:This means:

1.1. Understanding substantive matters;Understanding substantive matters;

2.2. Attending meetings;Attending meetings;

3.3. Asking questions;Asking questions;

4.4. Following up on unresolved issues;Following up on unresolved issues;

5.5. Consulting with experts, if needed; andConsulting with experts, if needed; and

6.6. Reading and understanding reports Reading and understanding reports given to the board.given to the board.

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• Duty of CareDuty of Care::– Stern v. Hayes National Training Stern v. Hayes National Training

School for Deaconesses & School for Deaconesses & MissionariesMissionaries• Financial mismanagement.Financial mismanagement.

• Officers and directors cannot abandon Officers and directors cannot abandon their duty to supervise the conduct of their duty to supervise the conduct of those who are running the day-to-day those who are running the day-to-day business of the nonprofit.business of the nonprofit.

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• Duty of CareDuty of Care::– Francis v. United Jersey BankFrancis v. United Jersey Bank

• Court held that “directional Court held that “directional management does not require a management does not require a detailed inspection of day-to-day detailed inspection of day-to-day activities, but [does require] a general activities, but [does require] a general monitoring of corporate affairs and monitoring of corporate affairs and policies.” policies.”

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• Duty of CareDuty of Care::– Smith v. Van GorkumSmith v. Van Gorkum

• Delaware Supreme Court, imposed Delaware Supreme Court, imposed personal liability on directors who had personal liability on directors who had approved a major corporate approved a major corporate transaction in a sloppy, hasty manner.transaction in a sloppy, hasty manner.

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• Duty of CareDuty of Care::– These cases underscore the need for These cases underscore the need for

decisions to be informed and decisions to be informed and reasoned.reasoned.

– Board members may not always be Board members may not always be correct in their decisions, but the law correct in their decisions, but the law holds them accountable for being:holds them accountable for being:• attentive,attentive,

• diligent, anddiligent, and

• thoughtful in considering and acting on a thoughtful in considering and acting on a policy, course of action, or other decision. policy, course of action, or other decision.

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• Duty of LoyaltyDuty of Loyalty::– A board member must give A board member must give

undivided allegiance when making undivided allegiance when making decisions affecting the decisions affecting the organization.organization.

– This means that a board member This means that a board member can never use information can never use information obtained as a member for personal obtained as a member for personal gain, but must act in the gain, but must act in the best best interests of the organizationinterests of the organization..

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• Duty of LoyaltyDuty of Loyalty::– Requires pursuit of the Requires pursuit of the

organization’s best interest, organization’s best interest, avoidance of self dealing and avoidance of self dealing and conflicts of interests, as well as conflicts of interests, as well as disclosure of potential conflicts.disclosure of potential conflicts.

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• Duty of LoyaltyDuty of Loyalty::– Example #1:Example #1:

• Breach for a director, or another Breach for a director, or another organization with which the director is organization with which the director is affiliated, to profit financially from a affiliated, to profit financially from a transaction with your nonprofit transaction with your nonprofit organization.organization.

• That is unless all the facts surrounding That is unless all the facts surrounding the transaction had been disclosed to the transaction had been disclosed to the board in advance. the board in advance.

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• Duty of LoyaltyDuty of Loyalty::– Example #2:Example #2:

• If a director learns of an opportunity If a director learns of an opportunity that may be of interest to both the that may be of interest to both the organization and the director organization and the director personally, the director must first offer personally, the director must first offer the opportunity to the organization. the opportunity to the organization.

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• Duty of LoyaltyDuty of Loyalty::– It is important to be sensitive to It is important to be sensitive to

and avoid apparent conflicts of and avoid apparent conflicts of interest as well as actual ones. interest as well as actual ones.

– To help avoid conflicts of interest, To help avoid conflicts of interest, the board should adopt and follow the board should adopt and follow a conflict of interest policy that a conflict of interest policy that addresses these issues. addresses these issues.

– Sample conflict of interest policy.Sample conflict of interest policy.

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• Duty of ObedienceDuty of Obedience::– Requires officers and directors to act Requires officers and directors to act

in accordance with the organization’s in accordance with the organization’s articles of incorporation, bylaws, and articles of incorporation, bylaws, and other governing documents, as well other governing documents, as well as applicable laws and regulations.as applicable laws and regulations.

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• Duty of ObedienceDuty of Obedience::– Board members must be faithful to Board members must be faithful to

the organization’s mission.the organization’s mission.– They are not permitted to act in a They are not permitted to act in a

way that is inconsistent with the way that is inconsistent with the central goals of the organization.central goals of the organization.

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• Fiduciary dutiesFiduciary duties::– Board members are obligated to Board members are obligated to

honor these standards with regard honor these standards with regard to all decisions and actions of the to all decisions and actions of the board, and those who do not may board, and those who do not may be subject to be subject to civilcivil and even and even criminalcriminal sanctionssanctions!!

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FinancialFinancialResponsibilitiesResponsibilities

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• Financial responsibilitiesFinancial responsibilities::– After an organization qualifies for After an organization qualifies for

exempt status, it must continue exempt status, it must continue to act in furtherance of its to act in furtherance of its exempt purposes to keep its tax-exempt purposes to keep its tax-exempt status.exempt status.

– The board leads the way in The board leads the way in ensuring compliance.ensuring compliance.

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• Financial responsibilitiesFinancial responsibilities::– Although 501(c)(3) organizations Although 501(c)(3) organizations

are exempt from paying income are exempt from paying income tax, they nonetheless must file an tax, they nonetheless must file an annual return with the IRS: a annual return with the IRS: a Form 990Form 990..

– On June 8, 2011, the IRS stripped On June 8, 2011, the IRS stripped 275,000 nonprofits of their tax-275,000 nonprofits of their tax-exempt status due to failure to exempt status due to failure to file annual returns!file annual returns!

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• Financial responsibilitiesFinancial responsibilities::– Five types of activities that can Five types of activities that can

jeopardize that tax-exempt status: jeopardize that tax-exempt status: 1.1. Private benefit/inurement.Private benefit/inurement.

2.2. Lobbying.Lobbying.

3.3. Political campaign activity.Political campaign activity.

4.4. Activities generating excessive Activities generating excessive unrelated business income.unrelated business income.

5.5. Failure to comply with annual reporting Failure to comply with annual reporting obligations.obligations.

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• Financial responsibilitiesFinancial responsibilities::– Develop policies that assure Develop policies that assure

financial responsibility of the financial responsibility of the organization.organization.

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• Financial responsibilitiesFinancial responsibilities::– Keep accurate and complete Keep accurate and complete

records of income, expenses, records of income, expenses, investments, and minutes.investments, and minutes.

– Develop budget as a blueprint for Develop budget as a blueprint for program plans and all spending.program plans and all spending.

– Develop fundraising goals and Develop fundraising goals and assist the acquiring adequate assist the acquiring adequate resources.resources.

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VolunteerVolunteerLiabilityLiability

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• Volunteer liabilityVolunteer liability::– When the nonprofit does not know When the nonprofit does not know

about, approve of, or benefit from about, approve of, or benefit from those actions, as long as the those actions, as long as the volunteer appears to outsiders to volunteer appears to outsiders to be acting with the nonprofit’s be acting with the nonprofit’s approval.approval.

– Called “apparent authority.”Called “apparent authority.”– What a third party would What a third party would

reasonably believe under the reasonably believe under the circumstances.circumstances.

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• Volunteer liabilityVolunteer liability::– Nonprofits are liable for the Nonprofits are liable for the

activities of volunteers (e.g., activities of volunteers (e.g., contractual promises) that have contractual promises) that have the apparent authority of the the apparent authority of the nonprofit.nonprofit.

– Even if a volunteer does not in Even if a volunteer does not in fact have authority to act in a fact have authority to act in a particular manner!particular manner!

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• Volunteer liabilityVolunteer liability::– The law will hold the nonprofit The law will hold the nonprofit

liable if third parties reasonably liable if third parties reasonably believe that the volunteer had believe that the volunteer had authority.authority.

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• Volunteer liabilityVolunteer liability::– Nonprofits must to take Nonprofits must to take

reasonable stepsreasonable steps to ensure that to ensure that the scope of its volunteers’ the scope of its volunteers’ authority is clear to third parties.authority is clear to third parties.

– Volunteers are not able to hold Volunteers are not able to hold themselves out to third parties as themselves out to third parties as having authority beyond that having authority beyond that which has been vested in them by which has been vested in them by the nonprofit.the nonprofit.

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MinimizingMinimizingthe Riskthe Risk

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• Help minimize the risk byHelp minimize the risk by::1.1. Being thoroughly and completely Being thoroughly and completely

prepared before making prepared before making decisions.decisions.

2.2. Becoming actively involved in Becoming actively involved in deliberations during board deliberations during board meetings.meetings.

3.3. Requesting legal consultation on Requesting legal consultation on any matter that has unclear legal any matter that has unclear legal ramifications.ramifications.

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• Help minimize the risk byHelp minimize the risk by::4.4. Requesting that the nonprofit’s Requesting that the nonprofit’s

accountants assess and evaluate accountants assess and evaluate any matter that has significant any matter that has significant financial ramifications. financial ramifications.

5.5. Obtaining and carefully reviewing Obtaining and carefully reviewing both audited and unaudited both audited and unaudited periodic financial reports of the periodic financial reports of the nonprofit.nonprofit.

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• Help minimize the risk byHelp minimize the risk by::6.6. Reviewing from time to time the Reviewing from time to time the

nonprofit’s articles of nonprofit’s articles of incorporation, bylaws, and other incorporation, bylaws, and other governing documents.governing documents.

7.7. Avoiding completely any conflicts Avoiding completely any conflicts of interest in dealing with the of interest in dealing with the nonprofit and fully disclosing any nonprofit and fully disclosing any potential conflicts. potential conflicts.

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• ConclusionConclusion::– If a nonprofit’s board conforms to If a nonprofit’s board conforms to

these and other guidelines, they these and other guidelines, they may be shielded from personal may be shielded from personal liability.liability.

– Also, the nonprofit likely will be Also, the nonprofit likely will be afforded maximum protection from afforded maximum protection from the financial and other the financial and other management improprieties that management improprieties that have plagued nonprofit have plagued nonprofit organizations in recent years. organizations in recent years.

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AnyAny

Questions?Questions?

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