Restatement of the Law: Duty of Loyalty

The ALI Restatement of the Law, Charitable Nonprofit Organizations (the “Restatement”) provides: “A fiduciary of a charity has a duty to: … [a]ct in good faith and in a manner the fiduciary believes to be in the best interests of the charity in light of its purposes ….” The Restatement explains:

[W]ith the exception of charities that are beneficiaries of other charities, there are no identifiable beneficiaries to enforce fiduciary duties. Accordingly, unlike in the case of a private trust in which fiduciary duties are owed to the beneficiaries, in the case of a charity, fiduciary duties are owed to the charity’s purposes rather than to a specific person or persons.

A fiduciary’s good faith belief in what is the best interest of the charity must be objectively reasonable in light of the charity’s purposes. Thus, the best interests of a charity may not be in its perpetuation; rather, in some instances, a charity’s purposes may be better carried out by its dissolution and the transfer of its assets to another charity to be used for similar charitable purposes.

Restatement, §2.02 (AM. L. INST. 2021)

The Restatement’s description of the relationship between a board member’s duty of loyalty and a charity’s purpose fits well with Anne Wallestad’s The Four Principles of Purpose-Driven Board Leadership.

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.

In an earlier blog post, Purpose-Driven Board Leadership, Legally Speaking, I also discuss two other key principles of this framework:

  • 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.

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 adverse impacts to these other stakeholders.

Many nonprofits advance their purposes by grantmaking to other organizations and lobbying to legislatures and the general public. They may also advance their purposes through their adopted values, including how such values are reflected in their employment policies and practices. If the values of a nonprofit include equity and justice across diverse categories, the nonprofit may advance its purpose more effectively by operating consistent with such values and, conversely, it may diminish its effectiveness at advancing its purpose by operating in a manner that is inconsistent with such values.

For example, a nonprofit whose specific mission is focused on serving food to persons experiencing homelessness in a particular neighborhood may have adopted a value of diversity, equity, and inclusion (“DEI”). The adoption of this value may have brought in greater support and guided the organization to address potential gaps in services to certain racial and ethnic groups. If, however, the board members of this nonprofit solely focused the organization’s program expenditures on the amount of food it served and did not invest organizational resources in its DEI values, such neglect could jeopardize certain groups of the nonprofit’s intended beneficiaries and also the support it receives from the funding community. Similarly, if the board members failed to invest in diversifying the organization’s board composition in an inclusive manner, such failure could weaken the nonprofit’s ability to serve all of its intended beneficiaries in a fair manner and fundraise in support of its purpose. See, e.g., Atinuke O. Adediran, Nonprofit Board Composition, 83 OHIO ST. L.J. 357 (2022).

In the post Governance Documents: Diversity, Equity, and Inclusion for Nonprofits, I made the case that DEI helps nonprofits advance their missions:

Evidence supports the premise that diversity in the workplace drives innovation and makes us smarter. In addition, DEI provisions may help nonprofits better advance their mission. When the composition of a nonprofit’s board goes against its own values, it weakens its credibility. Therefore, by including DEI principles in governance documents, nonprofits may help advance their own mission by clarifying and supporting their values.

Even for organizations whose values do not include DEI, failing to invest in and advance DEI initiatives within these organizations could harm their ability to advance their purposes. Professor Chris Bruner and former Chief Justice and Chancellor of the State of Delaware Leo E. Strine, Jr. stated in a recent law review article:

Indeed, fiduciary duty requires boards to attend to DEI by monitoring company policies and practices that assure the company’s compliance with important laws that focus on the equal treatment of diverse applicants, employees, customers, communities, and business partners. Not only that, the fiduciary duty of loyalty requires affirmative efforts to promote the sustainable success of the corporation, and directors and managers must try to promote the best interests of the company. Substantial evidence exists that companies with good DEI practices will not only be less likely to face adverse legal, regulatory, worker, community, and consumer backlash from their conduct, but that their boards and workforces will be more effective and their reputation with an increasingly diverse customer base and public will grow, as will trust from institutional investors increasingly focused on sustainable profitability and the avoidance of harmful externalities costly to their clients, who have diversified portfolios tracking the entire economy.

Duty and Diversity, 75 VANDERBILT L. REV. 1, 4-5 (2022)

Wallestad agrees, making an equity mindset a fundamental principle of Purpose-Driven Board Leadership. She explains:

Boards play a critical role in helping organizations understand the context in which they work and how best to prioritize resources and strategies based on that reality. Our American system is rife with inequities that are the outcome of intentional and systemic choices designed to advantage some and disadvantage others. An awareness of how systemic inequities have affected our society—and those an organization’s programs seek to serve—creates powerful opportunities to deepen the organization’s impact, relevance, and advancement of the public good. Conversely, a lack of understanding can lead to flawed strategies and a damaging effect on programmatic participants and the community as a whole.

The Four Principles of Purpose-Driven Board Leadership, STANFORD SOCIAL INNOVATION REVIEW, March 10, 2021