How to be a Responsible Nonprofit Director: Do’s and Don’ts - Avoiding
Punishment for Good Deeds
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The well-publicized scandals involving Enron, WorldCom and Adelphia moved
corporate governance to the forefront. Scandals have also affected the public’s
perception of nonprofits and recent studies indicate that the public has
lost confidence in charitable organizations. The public will be looking
to directors of nonprofits to act as responsible stewards, which will require
directors to have knowledge of the duties they are expected to carry out.
As a result, directors of nonprofit organizations should be aware that expectations
“...the recent congressional hearings on tax-exempt
organizations may produce legislation that will have significant
impact on the non-profit sector.”
To date, compensation has been the focus of much of the enforcement activity.
Excessive compensation was involved in problems at the United Way of the
Capital Area and Adelphia University. The Nature Conservancy was the subject
of a Congressional investigation and an IRS audit. Problems in the nonprofit
sector led to the enactment of Intermediate Sanctions, legislation that
focuses on excessive compensation. In September, 2005, the IRS issued new
regulations on the possible impact of excessive compensation on an organization’s
Congressional reaction includes the passage of the Sarbanes-Oxley Act
(“SOA”) in 2002, addressing accounting and corporate compliance issues.
While most of SOA is applicable only to public companies, certain provisions
of SOA are applicable to nonprofits, including setting forth comprehensive
standards for directors. A number of state attorneys general have proposed
that states should adopt laws similar to SOA regarding nonprofits. Legislation
for this was introduced, but not enacted, in the New York State legislature
in 2003. California enacted in 2004 a law requiring large organizations
to prepare audited financial statements and create an audit committee.
Though congressional action on charity governance reforms in the near
future now seems unlikely, the recent congressional hearings on tax-exempt
organizations may produce legislation that will have significant impact
on the non-profit sector. The report presented to the Senate Finance Committee
by The Panel on the Non-Profit Sector earlier this year aims to help tax-exempts
increase accountability and integrity by outlining steps to ensure that
directors understand and can fulfill their ethical and financial duties
in promoting the charitable mission of the organization they serve. What
follows is a refresher course on what is expected of the directors of non-profits.
1. Duties of Directors — What a Director Must Do.
Directors must fulfill the “duty of care.” To fulfill this obligation
directors must be reasonably informed and must participate in decisions
in good faith with the care of a prudent person. Directors must regularly
attend meetings of the Board. Sporadic attendance should be grounds for
removal of the individual as a director.
Each director must exercise his or her independent judgment. A director
should not base his or her vote solely on the positions of others. Decisions
must be in the best interests of the organization even in the case where
a director “represents” another entity. A director may not permit the interests
of even other charities to enter into the process.
Directors must comply with the “duty of loyalty.” A director may not
take advantage of a corporate opportunity by using the information for personal
gain. A director who does so has breached the duty of loyalty. As part of
this duty, directors must disclose conflicts of interest.
Many states have laws codifying some or all of these common law duties.
The statutes contain similar provisions on the standard of care required
of a director. The statutes generally provide that duties must be discharged
in good faith, with the care an ordinarily prudent person in a like position
would exercise under similar circumstances and in a manner the director
reasonably believes to be in the best interests of the corporation. A director
who acts in accord with the statute can preclude personal liability.
2. How does a Director Fulfill these Duties?
There are some concrete items that a director can focus on to fulfill
these obligations. For example, the directors should establish a “mission”
for the organization. The directors should not only determine the mission
of the organization, but also how the organization can accomplish the mission.
This must include determining if the organization has resources adequate
to meet the mission.
The planning must include considerations for the sustainability of the
organization. This requires consideration of whether the goals are within
reach of the organization in light of available resources. If the answer
is they are not, then the directors must consider if the goals should be
reduced to make them attainable. This may also involve allocating resources
between current users and future users. This is a topic of great current
interest as some prominent organizations have recently chosen to spend down
their assets for current charitable needs, leaving future beneficiaries
to the generosity of generations to come.
The directors must also establish governance policies. These policies
should include a statement of the duties and responsibilities of the individual
directors, including the expectation of time and financial commitments,
qualifications for membership on the board of directors, and policies to
evaluate directors performance. The directors should also create a conflict
of interests policy and make sure that the policy is enforced. The directors
should establish necessary committees, including an audit committee. California
law now requires charities with revenues of $2,000,000 or more to establish
Governance policies should determine what level of responsibilities should
be delegated to executives and other staff. Directors should prescribe policies
and responsibilities required for the staff to carry out day-to-day duties.
Directors, other than executives of the organization, need not be involved
in supervising day-to-day activities, but they should maintain oversight
of staff activities through frequent periodic reports.
3. Liability Shields.
Many state statutes provide limitations on liability of volunteers who
provide services to, or on behalf of, a charitable organization. Statutes
provide an exemption from civil liability for any act, or omission to act,
which results in personal injury or property damage if:
- The volunteer was acting in good faith within the scope of the volunteer’s
- The volunteer was acting as a reasonably prudent person would have
acted under similar circumstances, and
- The injury or damage was not caused by any wanton or willful misconduct.
The Federal Volunteer Protection Act of 1997 provides that no volunteer
of a nonprofit organization is liable for harm caused by an act or omission
if the volunteer was acting within the scope of his or her duties at the
time and harm was not caused by willful or criminal misconduct, gross negligence,
reckless conduct, or a conscious flagrant indifference to the rights or
safety of the individual harmed.
These limitations affect the personal liability of the volunteer director.
A nonprofit corporation is not shielded from liability by these laws.
Notwithstanding the statutory limitations on responsibility, a director
should be familiar with any right to indemnification. Directors should review
the articles of incorporation and bylaws of the corporation to determine
the extent to which indemnification would be available. The board of directors
of a nonprofit corporation should consider the need for directors’ and officers’
liability insurance. If there is insurance, a director should review the
policy for policy limits, retention amounts, covered persons, definitions
of a claim or loss and exclusions.
4. Intermediate Sanctions.
Prior to the Taxpayer Bill of Rights enacted in 1996, the IRS’s only
weapon against “private inurement” was revocation of tax exempt status.
In practice, the IRS rarely revoked the exempt status of a Section 501(c)(3)
organization. For a number of years, the IRS sought authority to assess
penalties against the recipients of excess benefits from Section 501(c)(3)
organizations. Intermediate Sanctions legislation was enacted in 1996 as
Section 4958 of the Internal Revenue Code. An excise tax is imposed on the
“excess benefit” received by a “disqualified person.” In September, the
IRS finally issued new proposed regulations to provide guidance on when
revocation of exempt status should be considered by the Service, either
(a) because excess benefit transactions are so extensive as to call into
question whether the organization has a true exempt purpose or (b) because
the organization operates for private, not public, benefit, even where no
excess benefit transaction has occurred.
Excess benefit is the receipt of compensation in excess of reasonable
compensation, a purchase of property by a disqualified person for less than
fair market value or a sale of property to a Section 501(c)(3) organization
by a disqualified person for more than fair market value. A “disqualified
person” is a person who has substantial influence with respect to the organization,
including officers, directors and substantial contributors. The excise tax
is initially imposed at a rate of 25% of the excess benefit. That tax is
imposed on the recipient of the benefit. There is also a tax of 10% of the
excess benefit imposed on the “organization’s managers,” including directors,
with a cap of $10,000 per incident. If the amount of the excess benefit,
plus interest on the amount of the excess benefit, is not returned to the
organization by the recipient of the excess benefit, an excise tax of 200%
of the excess benefit is imposed.
The Treasury Regulations provide for a “rebuttable presumption” that
can be created that compensation is reasonable or a transaction is at fair
market value. The rebuttable presumption arises if (1) the compensation
or transaction is approved by a body of the organization of independent
persons with no interest in the transaction, (2) the approval is made after
comparability data has been reviewed, e.g., compensation surveys compiled
by independent firms, information about what other persons are paid for
similar positions, even by for-profit organizations, or independent appraisals,
and (3) the Board or other body documents the basis of the decision in records
that indicate the terms of the transaction, the members of the body that
approved the transaction and the data that was used. Minutes of the meeting
will serve this purpose.
5. Conflicts of Interest.
“Detecting and correcting actions that could put the
organization’s exemption at risk should be done by the
The term “conflict of interest” describes two situations: (1) where a
director has a personal interest in a proposed transaction or payment or
(2) where a director has a duty of loyalty to two organizations, where the
decision of the board of directors can benefit one organization and hurt
another organization. If the non-profit organization is publicly supported,
the job is not to eliminate persons with conflicts of interest, but to have
the tools to handle the conflicts as they arise. If the organization is
a private foundation, directors should be aware that many transactions that
could otherwise be handled fairly under a conflict of interest procedure
will still be prohibited by the more stringent “self-dealing” prohibitions
contained in the Internal Revenue Code.
The fact of the conflict should be disclosed to the board or the committee
approving the contract or transaction and the transaction should be approved
by a vote that is sufficient to approve the matter without counting the
votes of the interested directors. In addition, the contract or transaction
should be fair and reasonable to the organization.
The IRS has published a model Conflict of Interests Policy for health
care organizations. The IRS model policy requires that the policy be distributed
to directors and that each director annually sign a statement that he or
she has received a copy of the policy. The IRS model policy is more restrictive
than some state laws, as it requires that the director with the conflict
not participate in the discussions on the matter and precludes the conflicted
director from voting.
Good practice is to obtain information about conflicts in advance of
problems. Directors should be required to annually submit information to
the organization listing the other organizations in which they are involved
and providing information about possible conflicts. A conflict of interests
policy should be adopted and followed on a regular basis.
6. Checklist for the Responsible Nonprofit Director.
- Is each director actively involved?
- Do almost all of the organization’s regular activities further its
tax exempt purposes?
- Does the organization serve the general public rather than a limited
group of individuals?
- Is the organization careful to ensure that officers and directors
do not receive “excess benefits” or other benefits from the organization
that are substantial and recurring?
- If excess benefits have occurred, have they been small relative to
the size and scope of the organization’s exempt activities, and been quickly
and adequately corrected?
- Are there written and disseminated policies and procedures in place
to prevent excess benefits and inappropriate uses of funds (including
If the answer to any of these questions is “no,” the responsible director
should take action promptly to enlist fellow directors in the effort to
protect the organization. Detecting and correcting actions that could put
the organization’s exemption at risk should be done by the organization
itself. Waiting for the IRS to do so will simply not help the organization
maintain its exemption.
This Alert was written by
Tracy Green Landauer of the New York office
and Harry J. Friedman in the Phoenix office. Please contact Ms. Landauer
at 212.801.6863 or Mr. Friedman at 602.445.8352 or your Greenberg Traurig
liaison if you have any questions regarding the subject matter of this Alert.
© 2005 Greenberg Traurig
For more information, please review our Tax Practice description, or
feel free to contact one of our attorneys.
This GT ALERT is issued for informational purposes only and is not intended
to be construed or used as general legal advice. Greenberg Traurig attorneys provide
practical, result-oriented strategies and solutions tailored to meet our clients’
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