Indemnification in the context of nonprofit bylaws generally refers to how the nonprofit will protect its directors and other agents in the event they are sued for acting in their capacity as agents of the nonprofit. More specifically, indemnification is an assurance by the organization to make good an individual or group of individuals against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with any proceeding in which they have become involved by reason of the fact that they are or were an agent of the corporation. So, where indemnification is required or lawfully authorized, the indemnifying party (the nonprofit) will pay for the expenses of its agent in defending that lawsuit or other proceeding.
Indemnification: Required, Prohibited, or Discretionary
In some cases, a nonprofit may understandably be required to indemnify its agents. Under the California Nonprofit Corporation Law, if an agent gets sued merely for being an agent and is successful on the merits in their defense of such lawsuit, the nonprofit must indemnify its agent.
In some cases, a nonprofit may be prohibited from indemnifying its agent. Under the California Nonprofit Corporation Law, if an agent gets sued, even if acting in their capacity as agents of the nonprofit, and has not met the applicable standard of conduct, the nonprofit may not indemnify the agent. For most lawsuits from a third party (other than the Attorney General), to qualify for indemnification, the agent must have acted in good faith and in a manner they believed to be in the best interests of the corporation. However, for lawsuits by or in the right of the corporation (derivative lawsuits), for actions regarding a director’s self-dealing, and for breaches of charitable trust brought by the Attorney General or someone with relator status, the agent must have acted: (1) in good faith, in a manner the person believed to be in the best interests of the corporation; and (2) with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.
In other cases, whether a nonprofit can indemnify its agents may depend on: (1) the indemnification provisions in the organization’s governing documents (e.g., articles of incorporation, bylaws) or (2) the board’s discretion, to the extent it’s consistent with the organization’s governing documents. A nonprofit may provide more certainty about this category of indemnification by maximizing its indemnification protections in its bylaws, and this is often desired by knowledgeable nonprofits who see the value in recruitment and retention of directors, officers, employees, and other agents. A prospective director may be much more inclined to join the board of a nonprofit that maximizes its indemnification protection rather than leaves it up to the discretion of the board should the director be sued for acting in their role as a director.
Some nonprofits choose to maximize the indemnification protections offered to directors and officers but not to employees and other agents. For organizations that include equity among their core values, such distinction may be problematic.
Language in the bylaws maximizing indemnification often substitutes the term “may indemnify” with “shall indemnify, to the maximum extent of the law”.
While indemnification provisions may be seen as protective of a nonprofit’s agents, if a nonprofit doesn’t have the resources to provide such indemnification, the provisions may not be protective at all. To address such issue as well as to increase the organization’s attractiveness to recruit and retain directors, officers, employees, and other agents, a nonprofit may decide to purchase appropriate insurance.
Types of Insurance
Among the most common types of insurance products obtained by nonprofits:
- Commercial general liability. Typical core coverage. May provide coverage for negligent acts resulting in bodily injury, property damage, personal injury, or advertising injury to a third party.
- Directors & officers. May provide coverage for actions by the board resulting in harm. A good D&O policy should provide broad coverage for employment-related actions such as wrongful termination, discrimination, and harassment. Because the vast majority of D&O claims are employee related (90% according to some carriers), some experts generally assure very small nonprofits with no employees and small budgets that it is not always necessary to obtain D&O. However, the cost of D&O coverage may be offset by a valuable board member recruit who will only serve if the nonprofit has such coverage.
- Workers compensation. May provide coverage for employees who get hurt on the job. Mandatory in most states.
- Errors & omissions. May provide coverage for negligent acts resulting from professional services (i.e., malpractice). While best known as the type of coverage obtained by doctors and attorneys, there are many types of E&O policies, including for management consulting and social service work.
- Automobile. May provide coverage only for liability resulting from damages caused to third parties or may include coverage for physical damage to the insured’s car.
- Property. May provide coverage for damages to physical property the insured owns or leases, such as buildings, equipment, furniture, and fixtures.
- Employee Dishonesty. May provide coverage for an employee’s criminal act, such as embezzlement.
- Cyberliability. May provide coverage for data breaches, ransomware, cyber-attacks, and other cyber-related events.
Sufficient insurance can help protect individual agents of the nonprofit where a harmed party is able to be made whole through coverage provided by the insurance and consequently may not need to seek remedies from individual agents who might otherwise be partly responsible for the harm.
California Nonprofit Public Benefit Corporation Law, Section 5238
(a) For the purposes of this section, “agent” means any person who is or was a director, officer, employee or other agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise, or was a director, officer, employee or agent of a foreign or domestic corporation that was a predecessor corporation of the corporation or of another enterprise at the request of the predecessor corporation; “proceeding” means any threatened, pending or completed action or proceeding, whether civil, criminal, administrative or investigative; and “expenses” includes without limitation attorneys’ fees and any expenses of establishing a right to indemnification under subdivision (d) or paragraph (3) of subdivision (e).
(b) A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any proceeding (other than an action by or in the right of the corporation to procure a judgment in its favor, an action brought under Section 5233 [relating to self-dealing], or an action brought by the Attorney General or a person granted relator status by the Attorney General for any breach of duty relating to assets held in charitable trust) by reason of the fact that the person is or was an agent of the corporation, against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred in connection with the proceeding if the person acted in good faith and in a manner the person reasonably believed to be in the best interests of the corporation and, in the case of a criminal proceeding, had no reasonable cause to believe the conduct of the person was unlawful. The termination of any proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner which the person reasonably believed to be in the best interests of the corporation or that the person had reasonable cause to believe that the person’s conduct was unlawful.
(c) A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action by or in the right of the corporation, or brought under Section 5233, or brought by the Attorney General or a person granted relator status by the Attorney General for breach of duty relating to assets held in charitable trust, to procure a judgment in its favor by reason of the fact that the person is or was an agent of the corporation, against expenses actually and reasonably incurred by the person in connection with the defense or settlement of the action if the person acted in good faith, in a manner the person believed 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. No indemnification shall be made under this subdivision:
(1) In respect of any claim, issue or matter as to which the person shall have been adjudged to be liable to the corporation in the performance of the person’s duty to the corporation, unless and only to the extent that the court in which the proceeding is or was pending shall determine upon application that, in view of all the circumstances of the case, the person is fairly and reasonably entitled to indemnity for the expenses which the court shall determine;
(2) Of amounts paid in settling or otherwise disposing of a threatened or pending action, with or without court approval; or
(3) Of expenses incurred in defending a threatened or pending action which is settled or otherwise disposed of without court approval unless it is settled with the approval of the Attorney General.
(d) To the extent that an agent of a corporation has been successful on the merits in defense of any proceeding referred to in subdivision (b) or (c) or in defense of any claim, issue or matter therein, the agent shall be indemnified against expenses actually and reasonably incurred by the agent in connection therewith.
(e) Except as provided in subdivision (d), any indemnification under this section shall be made by the corporation only if authorized in the specific case, upon a determination that indemnification of the agent is proper in the circumstances because the agent has met the applicable standard of conduct set forth in subdivision (b) or (c), by:
(1) A majority vote of a quorum consisting of directors who are not parties to the proceeding;
(2) Approval of the members (Section 5034), with the persons to be indemnified not being entitled to vote thereon; or
(3) The court in which the proceeding is or was pending upon application made by the corporation or the agent or the attorney or other person rendering services in connection with the defense, whether or not the application by the agent, attorney, or other person is opposed by the corporation.
(f) Expenses incurred in defending any proceeding may be advanced by the corporation prior to the final disposition of the proceeding upon receipt of an undertaking by or on behalf of the agent to repay the amount unless it shall be determined ultimately that the agent is entitled to be indemnified as authorized in this section. The provisions of subdivision (a) of Section 5236 do not apply to advances made pursuant to this subdivision.
(g) No provision made by a corporation to indemnify its or its subsidiary’s directors or officers for the defense of any proceeding, whether contained in the articles, bylaws, a resolution of members or directors, an agreement or otherwise, shall be valid unless consistent with this section. Nothing contained in this section shall affect any right to indemnification to which persons other than the directors and officers may be entitled by contract or otherwise.
(h) No indemnification or advance shall be made under this section, except as provided in subdivision (d) or paragraph (3) of subdivision (e), in any circumstance where it appears:
(1) That it would be inconsistent with a provision of the articles, bylaws, a resolution of the members or an agreement in effect at the time of the accrual of the alleged cause of action asserted in the proceeding in which the expenses were incurred or other amounts were paid, which prohibits or otherwise limits indemnification; or
(2) That it would be inconsistent with any condition expressly imposed by a court in approving a settlement.
(i) A corporation shall have power to purchase and maintain insurance on behalf of any agent of the corporation against any liability asserted against or incurred by the agent in such capacity or arising out of the agent’s status as such whether or not the corporation would have the power to indemnify the agent against that liability under the provisions of this section; provided, however, that a corporation shall have no power to purchase and maintain that insurance to indemnify any agent of the corporation for a violation of Section 5233.
(j) This section does not apply to any proceeding against any trustee, investment manager, or other fiduciary of a pension, deferred compensation, saving, thrift, or other retirement, incentive, or benefit plan, trust, or provision for any or all of the corporation’s directors, officers, employees, and persons providing services to the corporation or any of its subsidiary or related or affiliated corporations, in that person’s capacity as such, even though the person may also be an agent as defined in subdivision (a) of the employer corporation. A corporation shall have power to indemnify the trustee, investment manager or other fiduciary to the extent permitted by subdivision (f) of Section 5140.