Lessons in Nonprofit Governance from the Screen

I’ll be presenting a session at the 2023 NAAG/NASCO Charities Conference this Wednesday, October 11. The National Association of Attorneys General (NAAG) and the National Association of State Charities Officials (NASCO) are holding the Conference virtually this year. You can register through Monday, October 9, here ($100).

You’ll need to attend for the pop culture references I may draw from, but below are some of the main substantive areas I’ll be discussing.

Collective Authority, Individual Responsibility

Directors (board members) have collective authority acting as the Board. They generally have little individual authority unless delegated by the Board or through other positions they may hold (e.g., an officer position).

However directors do hold considerable individual responsibility to act in good faith with reasonable care in the best interests of the organization. This responsibility is associated with their fiduciary duties.

Duty Of Care

Meeting a director’s duty of care generally requires acting in a reasonable and informed manner under the given circumstances.  The standard of care is typically expressed as that which “an ordinarily prudent person in a like position would use under similar circumstances.”

Keeping informed (and making reasonable inquiries when appropriate) is a key to meeting a director’s duty of care. It may be prudent to consider the following activities as essential in that endeavor:

  • Regularly attend board meetings;
  • Assure that the directors receive adequate information before taking appropriate board action (e.g., by requesting materials and asking questions);
  • Review the materials provided in connection with board meetings, particularly those used in reference to any contemplated board action;
  • Be familiar with the organization, its legal structure, governing documents (e.g., articles of incorporation, bylaws), exempt purposes (as represented in its governing documents, exemption applications and marketing materials), core values, activities, and key stakeholders (including, but not limited to, staff); and
  • Be familiar with general laws applicable to the organization.

Duty of Care During Difficult Times

A director’s duty of care will generally demand that the director provide more attention in meeting such duty when the organization is going through difficult times. This may include times where the organization is in financial distress, acting out of legal compliance, dealing with serious internal conflicts, managing a public relations crisis, or struggling with change. Key Resources:

Fiduciary Duties of Directors and Officers of Distressed Nonprofit Organizations (Gregory F. Pesce & Neal Paul Donnelly, Kirkland & Ellis)

Steering the Ship Through Choppy Waters: Nonprofit Board Duties During the COVID-19 Pandemic (Robert L. Waldman Yosef Ziffer Christopher N. Moran, Venable)

The Thief and the Nonprofit; What’s a Board To Do? (Thomas P. Donnelly, Antheil Maslow & MacMinn)

Duty Of Loyalty, Conflicts of Interest, & Confidentiality

Meeting a director’s duty of loyalty generally requires acting in good faith and in the best interests of the corporation. The key to meeting this duty is to place the interests of the corporation before the director’s own interests or the interests of another person or entity.

A conflict of interest exists when a director has a personal material interest in a proposed transaction to which the corporation may be a party. Conflicts of interest are neither unusual nor generally prohibited under state law. Indeed, transactions involving a conflict of interest may sometimes be in the best interest of the corporation. For example, it may be perfectly appropriate for a board of a public charity to approve a transaction with a director in which the director is providing the corporation with some good, service or facility at or below market rates. Note, however, boards should also consider compliance with federal laws, including those regarding private inurement, private benefit, and either self-dealing (private foundations) or excess benefit transactions (public charities), in approving such transactions.

From a legal perspective, it is often the manner in which conflicts of interest (even ones that are favorable to the corporation) are handled by the interested director and the board that may determine whether the director’s duty of loyalty has been breached and whether the transaction may be rendered void. It should be noted, however, that transactions involving even a perceived conflict of interest might subject the interested director and the corporation to a serious loss in reputation. Accordingly, corporations should enter into such transactions cautiously where the directors believe that it may be viewed negatively if brought to light by the media. For all these reasons, a conflict of interest policy is highly recommended.

A director should keep the corporation’s private information confidential. In addition, a director should exercise reasonable diligence to help assure that the corporation and all of its agents keep such information confidential. Board discussions intended to be kept in the boardroom should be kept confidential. Contracts may require other information to keep confidential. Also, conversations with the corporation’s attorney may only be protected by the attorney-client privilege if such conversations are kept confidential.

Duty of Loyalty & Mission, Values, and Ecosystem

The duty of loyalty does not contemplate acting in the best interests of the viability of an organization without attention to its mission, values, and ecosystem. Key Resources:

The Four Principles of Purpose-Driven Board Leadership (Anne Wallestad, Stanford Social Innovation Review)

Purpose-Driven Board Leadership, Legally Speaking

Restatement of the Law: Duty of Loyalty

Delegation, Trust, and Reliance

Boards may delegate authority to committees, officers, employees, management companies, and others, but board members may not delegate their fiduciary responsibilities. Accordingly, they must delegate authority with due care and with appropriate oversight. Part of the due care should include appropriate support provided to delegees of such authority. Accordingly, directors should ensure they are acting to provide executives with financial and other resources to be able to reasonably accomplish the goals of their delegated authority.

Trust and support of an executive are critical board functions. But a board must also hold the executive accountable. In some cases, this may require a separation. See Firing the Executive Director (Jan Masaoka, Board Cafe). For organizations on a racial justice journey, many equity-based factors may need to be considered. Key Resource: Building Resilient Organizations: Toward Joy and Durable Power in a Time of Crisis (Maurice Mitchell, Nonprofit Quarterly).

Board members may rely upon information, opinions, reports, financial statements and other financial data prepared or presented by board committees, officers, employees, and professionals; provided, however that (a) the director acts in good faith after reasonable inquiry when the need therefor is indicated by the circumstances, and (b) the director reasonably believes that the provider of such information or opinion is competent and reliable with respect to, and authorized to provide, such information or opinion, and that such reliance is otherwise warranted.

Board Composition

The selection of directors is one of the most important duties of the board. And of course directors are expected to meet their fiduciary duties in making these critical decisions. They should recruit, screen, and invite directors based on how they may contribute to furthering the organization’s best interests in light of its mission, values, and ecosystem. See Nonprofit Governance: Board Composition.

Board Resignations, Disqualifications, and Removals

Volunteer directors can resign at any time, with the possible exception of the last remaining director of a corporation, which might require a state regulator’s approval. However, if they choose to resign, this may not protect them from any breaches of fiduciary duty claims arising before their resignations.

Bylaws may provide for certain qualifying criteria to become and remain a director. For example, some directors may be ex officio directors by virtue of holding another office, whether within or outside of the organization. If a director no longer possesses the qualifying requirements, they may no longer be directors without further action by the Board.

Directors may be removed – including without cause under many states’ laws. While many nonprofits fail to include removal provisions in their bylaws, possibly because it seems like a negative-spirited action, a board’s removal power can be an important tool when a director is violating or not meeting their duties. 

In cases where a director is not sufficiently engaged, fails to attend meetings, and does not review financials or other reports, it will probably be in everybody’s best interest for such director to be removed, though it can be done tactfully and in a way that may not create a PR issue for the individual or the organization. Some charities allow these inactive directors to transition onto committees or positions with less responsibility, but possibly associated with added prestige. And some state laws allow boards to declare a vacancy rather than pass an action that’s termed a removal – which can also make it more palatable for those involved.

Succession Planning

Executive succession planning is undoubtably one of the board’s most important responsibilities. Many, if not most, nonprofit boards will need to deal with finding a new executive within the next 5 years. And selecting the individual who will lead the organization’s day-to-day management, implement the organization’s plan, follow the board’s directives, ensure legal compliance, and reflect the organization’s values is perhaps the most critical decision a board will make. See Executive Succession: 10 Tips for Boards.

Succession planning should also anticipate and plan for transition. See Executive Transition and Succession Planning (BoardSource).

Where boards are working with new executives who are potentially entering into “glass cliff” scenarios, in which a woman or BIPOC leader may be the first in the organization’s history, directors must be particularly diligent in recognizing and providing the necessary support. See Avoiding the Glass Cliff: Advice to Boards on Preparing for and Supporting New Leaders of Color (BoardSource).

Prohibited Private Benefits

The private benefit doctrine is derived from the requirement under section 501(c)(3) of the Internal Revenue Code that an organization be organized exclusively and operated primarily for one or more qualifying exempt purposes (e.g., charitable, educational, religious). A 501(c)(3) organization will fail this requirement if it confers private benefits upon an individual or entity that are more than incidental, quantitatively and qualitatively, to the furthering of its exempt purposes. See Private Benefit Rules – Part I: Private Benefit Doctrine; Part II: Private Inurement Doctrine; Part III: Excess Benefit Transactions.

Boards must be diligent to ensure their organizations do not engage in any form of prohibited private benefit. They must pay particular attention where one of the directors may be involved. Violations can result in loss of 501(c)(3) status, penalties to an interested director and to other directors who approved the excess benefit transaction. In addition, there may be state law remedies for self-dealing and diversions of charitable assets. And sometimes, the most serious penalty is the public relations hit an organization and its directors can attract, even if the regulators don’t pursue a particular private benefit infraction (perhaps because it doesn’t directly involve money). A tip many boards follow when approving a transaction that could possibly be viewed as conveying an excessive amount to such insider, follow the federal rebuttable presumption of reasonableness procedures. See Rebuttable Presumption of Reasonableness Procedures.

Governance and Charitable Solicitations

State regulators are particularly concerned with charities that make misrepresentations when fundraising, especially when the funds are used for a purpose unrelated to the one prompting the donations or grants. Boards must also be diligent in overseeing all solicitations for their charities whether by the charity, by commercial fundraisers, by commercial coventurers, or by others. They should also be aware of existing laws regarding registration and purpose restrictions and new and proposed laws affecting charitable fundraising platforms, donor privacy, donor advised funds, and political activities. Key Resources:

State Charity Provisions (as of July 13, 2021) (NASCO)

Fundraising (National Council of Nonprofits)

State Filing Requirements for Nonprofits (National Council of Nonprofits)

Regulation of Nonprofits and Philanthropy Project (Urban Institute)

Charitable Trust Doctrine

Online Giving Donor and Consumer Guide (NASS, NAAG, NASCO)