Coalitions and a Director’s Loyalties

Here's a request I received from a reader regarding an issue that has become increasingly important with the proliferation of collaborative efforts among nonprofits:

Q:  We are starting up a new organization and my board members are all leaders in other organizations that have an interest in the issues this new organization will be addressing.  I want it to be the case that, when they vote on board matters for our new organization, they do so with primary attention to this new organization’s mission and not with a big eye on the interests of the organizations they work for.  Are there any laws addressing this issue?

A:  A director of a nonprofit corporation owes a duty of loyalty to such corporation.  While acting in the capacity of a director, the director must act in the best interests of the corporation and not in his or her own best interests or those of an employer or other entity.  California Corporations Code Section 5231(a), which applies to directors of California nonprofit public benefit corporations, is typical of state laws codifying a director's fiduciary duties:

A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such 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 prohibition against private benefit codified by federal tax laws may also apply to 501(c)(3) organizations.  The regulations state that a 501(c)(3) organization must "establish that it is nor organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests."  Such prohibition, of course, extends to the private interests of the organization's directors and their employers.

Where the corporation represents a coalition of nonprofit organizations (Coalition), the director's duty of loyalty to the Coalition applies even if (1) the director's employer is a voting member of the Coalition, and (2) the director was appointed by his or her employer to the Coalition's board.  If the director has a potential conflict of interest between his or her duties to the Coalition and his or her employer, the director generally should disclose the potential conflict and abstain from any vote regarding the conflict.  Where there is no conflict, while acting as a director of the Coalition, the director must act in what he or she perceives to be the best interests of the Coalition even if that may not be consistent with the general principles of the director's employer.

The director's employer and Coalition member should also be made aware of the potential exposure to ascending liability if it instructs the director to make specific decisions in his or her capacity as a director of the Coalition or otherwise has the director serve as its agent while serving as director.  For this reason, member organizations of a Coalition will typically deny any authority as the principal of the director.  Nonetheless, if the director is coerced to make certain decisions as a director due to actions of his or her employer, the employer may find itself defending an action for the director's actions.  Moreover, in such case, a 501(c)(3) member of the Coalition may find its own exempt status in jeopardy if the Coalition engages in activities prohibited by IRC 501(c)(3) (e.g., endorsing a candidate for public office).