Purpose-Driven Board Leadership, Legally Speaking

Last month, the Stanford Social Innovation Review published a groundbreaking article on nonprofit governance authored by Anne Wallestad, CEO of BoardSource: The Four Principles of Purpose-Driven Board Leadership. The article focuses on the board’s obligation to prioritize decision-making and direction-setting on the organization’s charitable purpose, even ahead of the organization itself.

Wallestad defines purpose as “a melding of the concepts of mission and vales in pursuit of vision.” For purposes of this post, we’ll follow this expanded definition. The prioritization of purpose over organization requires the board to shift its viewpoint from being organization-centric to ecosystem-centric.

Traditionally, boards are understood to be “mission-driven,” which means the board is responsible for ensuring that the organization does good work that advances its cause. But while being mission-driven is centered on the organization’s role in doing good, we believe boards need to re-center on purpose: the fundamental reason that the organization exists.

Wallestad provides the following illustrations of this shift in perspective:

  • A traditional board asks: What is best for our organization?
  • A purpose-driven board asks: What is best for the desired social outcome we seek?
  • A traditional board asks: How would this impact our organization?
  • A purpose-driven board asks: How would this impact all of the players and dynamics within our ecosystem? Will it help us—as an ecosystem—do the most good?
  • A traditional board asks: What do we* think is best? (*without intentional reflection on how who “we” are informs our perspective)
  • A purpose-driven board asks: Is our board populated in a way that ensures that our power is authorized by and inclusive of the community impacted by the work that we do? Are we doing all we can to listen to what our programmatic stakeholders tell us is most important?

Fiduciary Duties & The Duty of Loyalty

Board members owe fiduciary duties of care and loyalty to the corporation. This is codified in state corporations law in substantively the following form:

A director shall perform the duties of a director, in good faith, in a manner that director believes to be in the best interests of the corporation and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.

The duty of care requires diligence and inquiry on the part of the director – to inform themself, to make prudent decisions, and to take other thoughtful actions. The duty of loyalty requires decisions and actions that are explicitly in the best interests of the corporation.

In a for-profit context, the best interests of the corporation are typically viewed as synonymous with the best interests of the shareholders. For many who follow Milton Friedman’s philosophy of shareholder primacy, board members must act, first and foremost, to maximize shareholder value within the bounds of applicable law. Others have argued that board members can and should also take into account other stakeholders in defining the best interests of the corporation, and this tension in governance philosophies has led to the development of benefit corporations and other so-called hybrid entities with a blended value proposition of profit-making and social good.

In a nonprofit context, where there are no shareholders, the best interests of the corporation must be tied to how well it advances its purpose. Of course, both short-term and long-term impact should be considered. However, a corporation’s perpetual existence is, in and of itself, neither a valid 501(c)(3) purpose nor a possibility. While the nonprofit board may lawfully act to sustain the corporation’s existence, this should be incidental to advancing the corporation’s purpose. If the board determines that the corporation no longer can effectively and efficiently advance its purpose, it should consider dissolving the corporation, even if it holds substantial assets.

The Best Interests of the Corporation

Some may argue that a corporation’s continued existence is an inherent part of its best interests. However, in the for-profit context, we know this is not the case where the corporation’s shareholders want to merge the corporation into another entity or dissolve.

Similarly, we know this is not necessarily the case in the nonprofit context where the board elects to merge with another corporation better positioned to advance both corporations’ common purpose. The board may also dutifully decide to dissolve the corporation and grant its assets to another charity where the board members believe the corporation is no longer best positioned to advance its purpose. Such decision may even be made in advance of the corporation’s establishment. For example, spend-down foundations are created to advance their purposes through grantmaking, but only for a limited period of time.

The question about the best interests of the corporation gets more complicated outside of the merger and dissolution context. For a charity facing a challenging year, a board may need to weigh (1) spending to address current needs against (2) conserving for future sustainability. Spending substantially all of its resources to address current needs might be consistent with the charity’s mission, but it also may ignore considerations of intergenerational equity (i.e., fairness among generations of actual and potential beneficiaries). However, with the protection of the business judgment rule, this is unlikely to be the basis for a successful claim against a board.

The same argument might be made about weighing (1) spending to advance the corporation’s purpose with broader considerations of its ecosystem against (2) spending to advance the corporation’s purpose with a dominant internal focus. Granted, this is not typically a binary decision, and, of course, mission impact and organizational health are often aligned and not diametrically opposed. However, for purposes of understanding Wallestad’s premise from a legal lens, it may be helpful to examine the following spectrum of competing interests with two extremes:

Greater mission impact ———————————————————————-Lesser mission impact

Greater adversity to org ——————————————————————Greater well-being to org

On one end, the board can make decisions that will result in greatest impact but at the greatest adversity to the organization’s existence. This might be exemplified by a board that decides to grant out all of its assets to another organization and dissolve, which sometimes occurs with the retirement of a founding executive and lack of succession planning. While one might question whether the board members had been diligently observing their fiduciary duties during the executive’s tenure, the decision to dissolve and transfer remaining assets to another organization better positioned to advance the dissolving organization’s mission may be perfectly reasonable and defensible.

On the other end the board can make decisions that will result in minimal mission impact but will greatly increase the organization’s financial health. This might be exemplified by a board that decides to spend a minimal amount on charitable programs while emphasizing wealth creation for the corporation. Many boards make such decisions with their investment assets even if UPMIFA, a prudent investor law generally applicable to charities in 49 states, allows for consideration of the charitable purpose of the organization. Such boards typically defend their decision stating that they are thinking about sustaining and enhancing their organization’s ability to advance its purpose in the future.

But there are times when short-term mission impact and spending more immediately to create such impact, even at some expense to long-term organizational health, may be completely reasonable. A common example of where this focus should apply is in the area of climate change, the argument being that there is greater bang for the buck if we spend now on preventative efforts than if we spend more later on restorative efforts. The same might be said for an organization that includes racial justice among its values and purpose.

The Ecosystem and Equity

A nonprofit can certainly advance its purpose indirectly through other actors in the ecosystem. This includes employees, other nonprofits, for-profits, and governmental bodies. It can also unintentionally set back its purpose through impacts to these other stakeholders.

For example, a nonprofit may advance its purpose by grantmaking and lobbying. If equity is a core value, it can also do so internally through its employment policies and practices. And, conversely, it can set back this value through its grantmaking, lobbying, and employment policies and practices if it fails to truly incorporate equity in its strategies and decisions.

Wallestad provides the following example of how this should change a board’s perspective:

  • A traditional board asks: How will our strategy advance our mission?
  • A purpose-driven board asks: How will this decision or strategy create more equitable outcomes? Are there ways that it would reinforce systemic inequities, and—if so—what are we willing to do to avoid that?

I hope that a strong majority of nonprofits have formally embraced equity as a core value. So, when they look to further their missions, they consider the impact of the organization’s activities on various groups, their ability to identify and understand variances in impact across groups, and the differing needs of these groups.

According to Wallestad, nonprofit boards are currently: preoccupied with fundraising above all else, disconnected from the communities and people they serve, ill-informed about the ecosystems in which their organization is operating, and lacking in racial and ethnic diversity.

Conclusion

Purpose-Driven Board Leadership is a mindset characterized by four fundamental principles that define the way that the board sees itself and its work:

  • Purpose before organization: prioritizing the organization’s purpose, versus the organization itself.
  • Respect for ecosystem: acknowledging that the organization’s actions can positively or negatively impact its surrounding ecosystem, and a commitment to being a respectful and responsible ecosystem player.
  • Equity mindset: committing to advancing equitable outcomes, and interrogating and avoiding the ways in which the organization’s strategies and work may reinforce systemic inequities.
  • Authorized voice and power: recognizing that organizational power and voice must be authorized by those impacted by the organization’s work.

In responding to questions about how this is consistent with a board member’s duty of loyalty, Wallestad offers the best explanation (though I add one edit at the end):

The duty of loyalty is one of a board’s three essential legal duties, a legal perspective aimed at avoiding self-dealing and conflicts of interest. In practice, however, the duty of loyalty is often interpreted as the responsibility to think only of the organization when making governing decisions. This interpretation unnecessarily focuses board members on loyalty to the organization as a corporate entity. Instead, boards should focus their loyalty to the organization’s purpose or reason for being, fidelity to the reason that the organization exists and—by extension—to the people and communities its work impacts. What is best for purpose and community is not always synonymous with what’s best for the [organization’s own viability].”

Disclaimer: I am a proud board member of BoardSource.