Should You Serve as a Nonprofit Director?

Estate Planner May-Jun 1999

Assume that because of affluence, age, influence, friendship or circumstance you are asked to become a director of a private or public charity, or some other nonprofit corporation. Serving as a director may be prestigious and satisfying, but before agreeing, you need to understand the responsibilities and liabilities that go along with the position.

A director must be completely familiar with the type and range of activities the organization may perform under its governing instruments. These parameters can usually be gleaned from the organizational documents governing the charity’s operation, such as articles of incorporation, bylaws and written internal policies and procedures. These documents provide a useful road map to ensure the proper exercise of the director’s decision-making authority.

Basic Responsibilities Of a Director

Generally, a director must act in the best interests of the charity by exercising a level of care similar to that which would be exercised by an ordinary person under similar circumstances. Here is a close look at a few important aspects of these responsibilities:

Business judgment rule. The directors of a nonprofit corporation can usually fall back on a legal doctrine known as the “business judgment rule.” This doctrine states that if the directors have based a decision in good faith on sufficient and reliable information, they will be protected from liability even if the decision has negative consequences. To be protected by this rule, a director must adhere to these principles:

  • Regularly attend board meetings. Some organizations require frequent meetings. Before accepting, assess whether you are able to attend most of the scheduled meetings.
  • Be informed. Decisions must be based on adequate information. At times, you, as director, must take the initiative because board members will not always receive all relevant information from other representatives of the organization, such as major contributors or office staff.
  • Be deliberate when delegating. As director, you can delegate certain responsibilities. Often this is achieved through the creation of committees. But, take care and be responsible in selecting the delegates; you can’t limit your ultimate exposure merely by allocating responsibilities to others.

Investing funds. Directors must exercise care in investing the organization’s funds. Diversification is usually a prudent course to take, as it spreads the risk of loss of the organization’s funds. However, there is no easy mix, because too conservative of an investment may earn too low of a return to be considered prudent.

Loyalty. A director must avoid conflicts of interest and show primary loyalty to the organization. Generally, this means that you must avoid deriving personal benefit from your position at the expense of the organization. In legal terms, you must avoid acts of “self-dealing.” Courts will examine a director’s duty of loyalty stringently when a conflict of interest exists. The business judgment rule does not protect a director who engaged in a conflict of interest. Therefore, always disclose a conflict of interest. In a case where a conflict of interest does exist, a nonprofit corporation usually requires a majority of disinterested directors to approve the transaction.

Liability Imposed on a Director

A director of a private or public charity can become subject to liability in different ways. For example, you may be the subject of a derivative action, in which someone acting on behalf of the charity (often the state’s attorney general) brings suit against you as director for breach of fiduciary duty. This may occur if there has actually been injury to the charity. If you are considering a directorship, examine both state law and the charity’s policy regarding indemnification. Some charities are required by state law to indemnify a director while others have discretion whether to indemnify. Also, seek counsel to ensure that you are not exposed to unnecessary liability.

Stakes Can Be High

Serving as a director for a nonprofit corporation can provide a person with a great sense of contributing to society, and sometimes even financial reward. A well-educated board of directors not only contributes to a worthwhile charity, but also protects the organization and the directors individually from liability. However, the position is more than an honorary title, and there are risks involved. So make your decision with care, and let us know if we might be of assistance in evaluating the organization you are considering.

Beware of Excess Benefits

A director can also be subject to a lawsuit or sanction by governmental authorities. A recent change in the tax law, for example, imposes an excise tax on excess benefits received by directors and officers, as well as certain other individuals, known as “disqualified persons.” This provision allows the Internal Revenue Service (IRS) to impose a tax equal to 25% of an excess benefit received by a disqualified person. An excess benefit exists when the organization provides an economic benefit to the disqualified person that exceeds the value of services the person performed for the organization. In the case of a private foundation, excise taxes may also be imposed when a director engages in certain “prohibited transactions,” such as a loan, lease or sale of property between the director and the foundation.