Many experienced lawyers and successful business persons often second guess their roles as directors of nonprofit organizations. Although most nonprofit directors serve without compensation, with respect to operational matters, they are increasingly held to the same standard as directors of for-profit entities. However, directors of charitable organizations must also address unique questions. Are we being true to our mission? Are we effectively balancing administrative and fundraising costs with program expenditures? Are we properly maintaining restricted funds?
From a legal and financial standpoint, a nonprofit director in Pennsylvania is required to uphold certain fiduciary duties, including a duty of care and a duty of loyalty. In addition, directors must perform these duties with the best interests of the organization always in mind.
Good corporate governance requires nonprofit directors to ensure that the organization has sound financial management, serves the needs of its target population and operates efficiently. To effectively discharge their fiduciary obligations, directors should keep the following guidelines in mind.
Duty of Care
The duty of care requires directors to use reasonable inquiry, skill and diligence in keeping properly informed about the organization and the laws that affect it.
Those who fulfill the duty of care attend and participate in board and committee meetings, make reasonable inquiries into the affairs and finances of the organization and use independent judgment when analyzing issues that confront the organization. This analysis includes reviewing regular financial statements (prepared in accordance with generally accepted accounting principles) and the annual Form 990 which a majority of nonprofits are required to file with the IRS.
A Form 990 provides insight into the organization and how it functions. Once filed, the form becomes a public document that is easily accessible online by potential contributors and investigators, making it imperative for board members to ensure the accuracy of the description of the organization’s mission and the supporting information.
Nonprofit organizations are also required to answer questions about whether key governance policies are in place. These policies include use of outside auditors, gift acceptance, whistleblower protection, document retention and destruction, and conflict of interest. If these critical policies are not in place, directors should consider adopting them before the next Form 990 is filed. Directors should also review the organization’s tax compliance and financial management structure. A good auditor, however, will also pick up these deficiencies in an annual audit.
Board members, trustees and senior management also have a fiduciary responsibility when handling finances and investments for an organization. Fiduciaries who carelessly or negligently invest funds may be personally liable for any losses sustained. Moreover, individuals who have or claim to have special knowledge or skills in the area of investment will be held to a higher standard.
Perhaps the most critical function of a nonprofit board is to hire the executive director and provide oversight to the way in which he or she manages the organization’s staff (and volunteers), finances and programs. Board members should have a good understanding of the compensation paid to its key officers with benchmarks against similar organizations. It is the responsibility of the executive director to run the organization. Some boards have a tendency to “micro-manage” or get involved in the day-to-day decisions that keep the organization running—even though it is not part of their core function. Directors should not be so focused on functions they are performing as “volunteers” (working in a food pantry, tending a community garden) that they lose sight of their obligations to oversee the operation of the organization as a whole.
Duty of Loyalty
The duty of loyalty essentially means that directors must act in the best interest of the nonprofit and are not to pursue private gain at the expense of the organization. Directors should not participate in any decision that involves financial remuneration to them or to an organization they are affiliated with. For example, an accountant on a board of directors should not participate in a decision to hire his accounting firm to perform an annual audit.
Any potential conflict of interest should be disclosed annually by directors or at a minimum, when a situation arises that will result in any benefit, directly or indirectly, to that director. Such transactions should be open and transparent to the organization. It is important for all directors (and senior staff) to avoid even the appearance of impropriety with respect to potential conflicts.
Under Pennsylvania law, a director is “entitled to rely in good faith on information, opinions, reports or statements, including financial statements and other financial data” prepared by employees or experts unless the Director has knowledge covering the matter at issue which causes that reliance to be “unwarranted”. Directors must exercise their objective judgment when analyzing information provided to them. For example, if the Secretary is not taking accurate and timely minutes, directors should act quickly to replace that individual or provide extra support in getting the minutes properly prepared.
Personal Liability for Directors
Before agreeing to sit on a board, prospective directors should ask two key questions:
• Has a Directors & Officers insurance policy been put into place?
• Do the bylaws limit the personal liability of directors and indemnify them for any costs incurred in defending claims? (In Pennsylvania, a bylaw provision can limit a director’s personal liability unless the director is found in breach of his or her fiduciary duties and the breach “constitutes self-dealing, willful misconduct or recklessness.”)
Pennsylvania courts have held directors personally liable for breaching their duty of care. In the recent Lemington Home Care case, for example, the U.S. Court of Appeals for the Third Circuit upheld a jury verdict against the directors of a nonprofit nursing home which held them personally liable to creditors in bankruptcy for their failure to remove the nursing home’s administrator and CFO,(In re Lemington Home Care for the Aged, 777 F.3d 620 (3d Cir. 2015).
The nursing home had been beset by financial troubles for years, but the directors continued to rely upon information provided by the officers in spite of numerous red flags, including two patient deaths under suspicious circumstances. The board continued to pay its administrator a full-time salary knowing she was working a part-time schedule. Furthermore, the Pennsylvania Department of Health determined the same administrator lacked the qualifications and skills to perform her job. Finally, the organization failed to keep accurate financial and clinical records and neglected to collect $500,000 from Medicare. Although the nursing home bylaws had a provision limiting personal liability, the court found that the breach of their fiduciary duties constituted “self-dealing, willful misconduct or recklessness.”
While the facts presented in Lemington Home Care are extreme, directors should be duly warned that they need to perform their duties with “care, skill and diligence” when sitting on any nonprofit board. To ensure you and your board’s actions are in compliance with Pennsylvania law, or to receive additional information regarding your fiduciary duties as a nonprofit director, consider connecting with qualified legal counsel to review your specific situation. •