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The 3 Legal/Fiduciary Duties of a Nonprofit Board Member
Can a Nonprofit Board of Directors Member be Sued Individually for Actions of the Nonprofit? -Or - Do Nonprofits Need Director and Officer Liability Insurance?
To answer this, let us first get this statement out of the way: Anyone can sue anyone they want, whether they have a valid reason or not. This is not what we are talking about here.
Let us also clarify one more thing: Nonprofits can be sued, but the question I am addressing is, can a board member as an individual, be sued in addition to the nonprofit you serve with being sued?
What I was taught was, if you are acting within your role as a board member, and are acting in good faith, you have no liability. This means if you are acting in your role only, not taking on actions that are not your responsibility; if you act with ordinary care meaning any ordinary person would act similarly under the circumstances; and, if you are acting in a manner you believe to be in the nonprofit’s best interest, you are protected.
Let me give you a few examples where you may, or may not, be protected.
Employees may sue for things such as wrongful termination, discrimination, etc. If you are following your fiduciary responsibilities, this should not happen. Third parties, like vendors, may sue a nonprofit for things like lack of payment and name specific board members. If you pay your bills, this should not happen. One board member may sue another for allegedly violated their duties to the nonprofit, so follow your required duties. Donors may sue a nonprofit if their funds are misused, so follow their restrictions. And, certainly, there are many other situations. But see how these all relate back to if you act in an appropriate manner you cannot be sued? Follow your duties and you greatly minimize liability risk.
Now, let us talk Director and Officer (D & 0) insurance, and is it needed? D & O Liability Insurance protects board members against wrongful acts, which may be honest mistakes or intentionally misleading; omissions, whether intentional or unintentional; neglect; breach of duty, and other similar actions. Specifically, D & O Insurance will cover legal fees, settlements, and other related costs, protecting you individually and your personal assets. So, should your have D & O Insurance?
I have served with nonprofits who have both had, and not had, D & O Liability Insurance. It was comforting to know it was there if needed, but I also do not know of any incident in any nonprofit I have been active with where it has been drawn upon. To answer the question of whether to have D & O Liability Insurance, I recommend you weight the potential liability of your nonprofit with the cost of the insurance, and make your decision based on this.
Yes, there is some potential liability by serving on a nonprofit’s board of directors, but it is likely quite limited. I would strongly recommend your being knowledgeable about this topic when you make the decision of whether to join a board of directors, while at the same time remembering the importance of what nonprofits accomplish in our society.
At the very core of what a nonprofit board member should do, are what is called the three primary “legal or fiduciary duties”. This is by no means a comprehensive list of duties, but they provide the very basic foundation for your work as a nonprofit board member. Here are the three legal, or fiduciary, duties of a nonprofit board member.
Duty of Care: This duty is commonly described as the “care that an ordinarily prudent person would exercise in a like position and under similar circumstances.” This means, in making decisions on behalf of the nonprofit, you will use reasonable care to make the best decisions possible. Some ways in which you exercise your duty of care include attending meetings and activities; being informed including knowing and understanding your nonprofit’s mission and vision; reading materials prepped for meetings; and participating in discussions. These activities will help assure you make the best decisions possible.
Duty of Loyalty: This means your first and only allegiance while acting as a board member is to the nonprofit, and you will act in the best interest of your nonprofit always. This also means putting aside your own personal wants or needs and avoiding any conflicts of interest. Also remember, a Conflict of Interest Policy is a must for all nonprofits and helps define your loyalty to the nonprofit.
Duty of Obedience: This duty refers to assets of the organization which ultimately come from the public. The public trusts you to steward assets, including donations, to the best of your ability; you will follow the organization’s by-laws and policies; you will act in a legal manner; and you will now, and always, be faithful to your organizational mission.
There are many other considerations a board of director’s member must navigate like proper controls of the organization through things like policies and procedures; verification of legal compliance with things such as the IRS Form 990 which is due every year; approving budgets and more. But, if you follow these three most basic duties, the other considerations will easily fall into place.
Tapping into Endowment Funding:
Good Idea or Bad?
Nonprofits are looking at many different options for keeping their nonprofits running until we move beyond the COVID pandemic and the parallel economic recession. Let us think for just a moment about the possibility of tapping into endowment funds to get a nonprofit through. Good idea or not?
First, when I use the term endowment funds, I am talking funds that have been restricted for a specific purpose, like building a building or to start a new program; or funds that are held by the nonprofit with the principal to be held and only the interest to be spent. To put it more simply, these are funds that are consciously restricted for purposes other than general operating.
To me, there are two major considerations when looking at drawing down endowment funds. The first is, can your nonprofit do this? Many nonprofits, when taking restricted donations will have a clause something like, “or to be used in unforeseen emergencies”, or “unless needed for other urgent purposes”. The wording does not matter. It is the donor’s intent and understanding that, if needed, drawing on these funds is a possibility. If you have a similar clause for restricted funds, yes you can consider drawing on the funds.
If you do not have a similar clause, drawing on these funds creates serious consequences, with the worst consequence being the possibility your nonprofit is reported to the IRS and you lose your nonprofit status. If you do not have such a clause, but feel it urgent to draw down endowment funds, you MUST get permission from your donors. If you wish to pursue this, I recommend personally contacting donors, most likely by phone, and explaining your need whether it is increased need for services, lesser donations coming in, layoffs in staff, or a combination of issues. Then ask if they are willing to help the nonprofit during this difficult time and allow you to draw down some of the restricted funds they donated. You MUST follow the will of the donor with respect to restricted funds.
So yes, there is the possibility of drawing down endowment funds for services or operational expenses as discussed above.
The second major consideration is, should you do it anyway?
First and foremost, let us talk ethics. Is it ethical, based on your nonprofit’s understanding of restricted donations, to draw the funds down if permitted? It may be easy to say, sure, why not? But it is your job as a board member to act on behalf of the nonprofit because it cannot act for itself. Forget the pandemic and recession, if the nonprofit were a cognitive, functioning individual, would drawing down funds be acceptable to it. Board members are charged with acting on behalf of the nonprofit itself, not on their opinions or what might be easier. Is it ethical in the eyes of your nonprofit to do this?
Second, you need to consider what drawing down endowment funds will look like to your donors, volunteers and other stakeholders, as well as to the general public. How this looks to them could have a significant effect on their future involvement with you. Some stakeholders with be okay with this action and others will not. Remember you will have to operate within these consequences in the future.
My opinion? First, you must realize that I am a “black and white person” working in a “gray world”. Your opinion may be different, and you have every right to have that opinion and to act upon that opinion. Having said that my opinion is this: restricted funds are restricted, period. If it is urgent enough to need to draw upon these funds you should do so only with current permission to do so. That means contacting donors individually first and asking if they would consent to releasing some of their restricted donation funds now.
Only your individual nonprofit can make this very difficult decision of whether or not to utilize restricted funds.
What is the Big Deal about Nonprofits and “Transparency”?
A nonprofit, at its very basic, is a tax status. You apply for a tax status [like a 501(c)3 status], and if your organization is set up for charitable purposes as required by the IRS, you receive your charitable tax status. This allows for donations to your organization to be deducted on your donor’s taxes. And this is the reason for transparency.
Having a charitable tax status is not a given, it is a privilege. For that privilege, you in turn must make your financials and, to some extent, your operating structure available to the general public. This is mainly done through the IRS Form 990.
The IRS Form 990 is submitted yearly to the IRS and includes information on your finances for the previous fiscal year, as well as answers to questions like: do you have a conflict of interest policy? How many board members do you have? Plus, there are other organizational questions. You can look up a nonprofit’s most recent IRS Form 990 on the IRS web site.
Another way nonprofits share information is in their yearly Annual Report, or for membership organizations, at your yearly Annual Meeting. Some nonprofits even go to the extent of publishing their yearly financial statements, as well as Annual Reports, on their web sites.
This transparency does two things. First, it assures information is available to the public regarding your operating structure so the public (and IRS) can be sure you are, indeed, operating in a charitable manner. It also provides more information to donors about how your nonprofit is run (i.e., how much of your operating budget is spent on administration) so you can make fully informed decisions as to where you donate your money.
Again, having a charitable status is a privilege, not simply a given. Transparency is the balance which shows the public your nonprofit is operating in a charitable manner as required.
Is Effective Leadership Different in a Nonprofit vs. a For-Profit?
The simple answer to this is both yes and no.
The most effective leaders will change their style of leadership to what will be most effective in the situation, based on the abilities and motivation of the followers the leader must work with. This applies equally to for-profits as well as in nonprofits.
Here is a list of one study’s leadership styles, and an explanation of the need for change in leadership styles.
The Directing Style of leadership provides high directive (how to accomplish tasks), but low support to followers as they accomplish tasks. An example of this could be someone doing data entry. Once they understand how data is to be entered, there is very little else they need support on.
The Coaching Style provides high directive, but also high support. An example of this is being a mentor. A mentor will provide direction, perhaps a job description; but the mentor is also available to the mentee to help them process how to move through – in the best manner they can – these specific tasks. The Coaching Style usually applies to more complex duties.
The Supporting Approach provides low directive and high support. An example of this is hiring someone right out of college who has book smarts but not hands on knowledge. The new employee understands the how, but perhaps needs help in practical application.
The fourth style is the Delegating approach, with both low directive and low support. An example of this is someone who has been in the same position for a long period of time and is perfectly happy doing what they are doing. They already know the process, and they need little support to accomplish their tasks.
An effective leader will use all these leadership styles in different situations. The key is to get to know your followers and understand which leadership style each follower will need. (When supervising a large group of followers, you will need to find the general style the group needs.)
The major difference between leading in a nonprofit vs. a for-profit is that you will need to assess volunteer followers’ needs in addition to staff follower needs which can be very different.
Effective leadership can be complex. But, as always, practice makes perfect. The more time you spend assessing your followers needs and applying the most effective leadership style, the better your leadership capabilities will become.