December 29, 2020
By: Laurie A. Martin Montplaisir
“What is the essence of life? To serve others and to do good.” Aristotle
Like many members of your community, you may be volunteering for a not-for-profit organization to make a meaningful contribution and to share a passion with others. Not-for-profit organizations depend on community members to advance their missions and to dedicate time, treasure, and talent to help steward the organizations. As a volunteer board member, it is important to be aware of your obligations, potential personal liability exposure, best practices to mitigate the risk of personal liability, and legal protections afforded to board members of not-for-profit organizations.
Fiduciary Duties to the Not-For-Profit
- What are Fiduciary Duties?
All board members owe fiduciary duties to the not-for-profit organization. These two primary duties are (i) the duty of care, and (ii) the duty of loyalty. In essence, the duty of care consists of an obligation to act on an informed basis; the duty of loyalty requires the board and its directors to maintain, in good faith, the corporation’s and its shareholders’ best interests over anyone else’s interests.
The duty of care requires board members to devote the necessary time to properly serve as a board member. It is not sufficient to simply attend board meetings. Board members must be familiar with the charter documents of the not-for-profit, review board meeting materials, and review financial statements and information. Standards of conduct for board members include properly preparing for board meetings, attending board meetings, planning for the financial viability of the organization, confirming all taxes are properly paid, and ensuring practices are in place for verifying competent employees are hired and appropriately managed according to written employment policies and procedures. Board members must adhere to the not-for-profit’s mission for the organization and work to service this mission. A failure to attend board meetings or inactivity in service to the board will not allow a board member to avoid legal responsibility or liability.
The duty of loyalty requires a board member to be loyal to the not-for-profit organization and act in its best interest at all times, and always ahead of the interest of the board members. A board member may not engage in self-dealing. Further, board members must disclose any conflicts of interest and refrain from using board service for personal benefit. Board members must not usurp a not-for-profit organization’s opportunity; in other words, not take advantage of an opportunity presented to the not-for-profit organization for a board member’s own personal again.
- How can Board Members Satisfy their Fiduciary Duties?
Summarized below are five ways to effectively satisfy your fiduciary duty as a board member as identified by the Office of the Attorney General of Illinois. https://illinoisattorneygeneral.gov/charities/volunteers.html
- Be active. Board members should attend board meetings and attend meetings on any board committees on which the board member serves. Board members must have general knowledge and understanding of the not-for-profit organization operations, and a specific knowledge and understanding of the mission of the not-for-profit. Board members should identify time commitments and meeting schedules, what will be specifically expected of the board member for service, and any specific responsibilities to be assigned to the board member. A board member should also know if he or she will be expected to fundraise. Prospective board members should attend at least one board meeting prior to committing to join the board to gain an understanding of the dynamics of the board, the board leadership and its operations.
- Receive no material profit. Board members are permitted to receive reimbursement for reasonable expenses and costs incurred in carrying out their board responsibilities. Illinois law prohibits loans by the non-profit organization to its directors and officers.
- Avoid conflicts of interest. The duty of loyalty requires that board members give precedence to the organization over personal interests, which means self-dealing must be avoided. Board members should not engage in transactions with the organization in which a board member or relatives, business associates or friends of the board members have a financial or other personal interest. In the event a board member or someone affiliated with a board member enters into a transaction with the not-for-profit organization, there must be full disclosure to the board, the transaction must be fair to the organization and under terms equivalent to an arms-length transaction, and the board member must not vote on the transaction as a board member or be counted in determining the existence of a board quorum. Generally, a board member may not take an opportunity that is available to the not-for-profit organization.
- Exercise judgment in overseeing the organization’s affairs. Board members have an affirmative duty to act with knowledge and deliberation. Good faith is not sufficient. Board members must set organizational policy and regularly oversee its administration by competent staff, be familiar with all financial matters including budget review and resource allocation, and ensure there are regular meetings of the board with adequate minutes maintained. Therefore, board members must regularly attend board meetings and any committee meetings, stay actively informed about the not-for-profit organization’s activities and finances, make reasoned decisions, and consult experts when necessary. Board members should ensure that the organization is adequately hiring and supervising officers and management staff, and that there is an employee handbook and other written employment policies and procedures, and that managers and employees are adequately trained to comply with applicable employment laws.
- Comply with applicable governmental regulations. Not-for-profit organizations are governed by local, state and federal laws and regulations. Board members are responsible for ensuring legal compliance. In addition, it is important for a board member to be familiar with the best practices that are specific to the industry of the not-for-profit organization, so a board member should do research on these best practices. For example, in a not-for-profit involving children, there are privacy considerations that are critical.
Additional Personal Liability Situations
There are situations in which board members can be held personally liable as an individual. Whilst unusual, it is important to be aware of these situations. First, board members can be personally liable for torts, which is damage, injury or harm caused to another. Board members may have liability for injuring someone or causing someone to be injured.
Second, board members can be personally liable for the not-for-profit organization’s failure to timely file and pay payroll taxes. The IRS aggressively enforces payroll tax liability, so board members should ensure payroll taxes are timely filed and paid. It is also important to be certain workers are not improperly classified as independent contractors if they are employees, which is another area of aggressive IRS enforcement.
Business Judgment Rule
The standard of conduct for a board member is generally reviewed pursuant to the common law based “business judgment rule,” under which board members have the presumption that decisions are made in good faith and on an informed basis. The business judgement rule is a review by the courts that focuses on the board’s process in making a decision, rather than the decision itself.
In order to receive the protection of the business judgment rule, a board member must take the same care that an ordinary and prudent person would exercise under similar circumstances. In determining whether the board members have satisfied their fiduciary duties, a court will not substitute its own judgment for the board’s judgment and will generally give deference to the board even if a decision or an outcome was not a good one, provided the board members acted on an informed basis, in good faith, and in the rational belief that the decision made was in the best interests of the organization.
Volunteer Protection Acts
The federal Volunteer Protection Act (VPA) of 1997 and similar state protections are in place to encourage volunteerism and protect volunteers by making nonprofit volunteers immune from civil lability when acting within the scope of the volunteers’ authority. The VPA protects volunteers, including voluntary board members, from personal liability from lawsuits arising from the day-to-day operations of the not-for-profit organization caused by their actions or omissions if board members act within the scope of their responsibilities and provided the harm was not caused by willful, wanton conduct or gross negligence (together with other narrow and specifically identified carve outs).
Generally, in Illinois, a board member for a not-for-profit organization is not liable “for damages resulting from the exercise of judgment or discretion in connection with the duties or responsibilities of such director, unless: (1) such director earns in excess of $25,000 per year from his duties as director, other than reimbursement for actual expenses; or (2) the act or omission involved willful or wanton conduct.” 805 ILCS 105/108.70. It is important to check the volunteer liability statute in your state. If your state statute provides less protection than the VPA, the VPA provisions will provide board members the greater protection.
Indemnification and Insurance
Indemnification provisions offered by a not-for-profit organization and proper insurance can help protect a board member from liability and damages, including attorney fees and costs of defense.
A board member will want to ensure that charter documents of the not-for-profit organization provide indemnification to the fullest extent permitted by the law. Indemnity is defined by Black’s Law Dictionary as “a duty to make good any loss, damage, or liability incurred by another.” Practically, an indemnification clause in the bylaws of the not-for-profit organization protects board members from liability by agreeing to compensate for any loss incurred by the board member due to the acts of the organization, the board or any other party. Under indemnification provisions, the organization agrees to cover legal fees and other costs associated with legal action against a board member. Board members should confirm the bylaws provide for advances for expense for defense. Indemnification provisions protect board members only when acting in good faith.
Not-for-profit organizations can purchase directors and officer’s liability insurance (“D&O Insurance”) to protect board members. D&O insurance covers individuals for claims made against them while serving as a board member of a not-for-profit organization. A D&O Insurance policy can protect the board members when the company cannot indemnify the individuals and will reimburse the organization when it indemnifies the individuals, thus protecting the company’s financial position. A board member should confirm that D&O insurance and understand the policy coverage and limits.
Serving on a nonprofit board of directors is an important contribution to your community and can be an enriching and rewarding experience. It is important, however, to be aware of the potential risk of personal liability in order to minimize these risks by being aware of the legal responsibilities, actively exercising diligence, and making informed and educated decision on matters before the board of directors.