Understanding your fiduciary duties is the first step in becoming a successful leader and board member.
Serving on a nonprofit organization’s board of directors can be exciting – and daunting. You likely have a strong interest in the organization’s mission and are passionate about what the organization can accomplish or the social issues it tackles. You want to make a difference, give back to your community and change the world for the better. But even with the most altruistic intentions, individuals who agree to serve on nonprofit boards often do not fully understand their legal duties.
If you serve or are considering serving on a nonprofit board, it is important to embrace these duties and recognize potential pitfalls before they occur. This is particularly true today, as increasingly, nonprofit organizations’ public images and reputations are being influenced by leadership’s integrity and strength.
Three Fiduciary Duties
When you agree to serve on a nonprofit organization’s board, you assume a number of responsibilities to the organization and a series of fiduciary duties (legal obligations) on its behalf. Specifically, a director is obligated to fulfill three primary fiduciary duties – loyalty, care and obedience.
Directors must act in the organization’s best interest. The duty of loyalty creates a relationship of trust between the director and the organization. As such, a director cannot use that relationship to benefit themselves, family members, friends or other interested parties. It is not uncommon for a director to have external business or professional connections that could be useful to the organization. Directors must ensure, however, that when their personal business or professional connections intersect with their director role, their loyalty to the nonprofit organization is prioritized.
A director can be in breach of the fiduciary duty of loyalty for any of the following:
POTENTIAL PITFALL - CONFLICTS OF INTEREST
- Issue - A conflict of interest may arise when a director receives an improper personal or financial benefit from a transaction involving the organization’s assets. A director’s conflict of interest, however, may not always be improper or constitute a violation of the duty of loyalty.
- Solution - An engaged board of directors can take steps to help ensure the organization’s best interests are being served and help a director avoid breaching the duty of loyalty by creating a “Conflict of Interest Policy,” which might require all directors to complete a conflict of interest disclosure form annually.
Directors are required to use due diligence, care and skill in fulfilling their board responsibilities and must exercise exemplary stewardship of the organization’s assets and resources. To properly exercise their duty of care, directors should:
- Understand the organization’s foundational documents (i.e., bylaws, articles of incorporation, trust agreements, indentures);
- Stay informed of its activities and programs;
- Attend board meetings regularly;
- Make informed decisions concerning the use of the organization’s assets; and
- Maintain a familiarity of its current policies and procedures.
Board directors should also be knowledgeable about the organization's required federal, state and local tax obligations and filings, insurance coverage for the board and the organization, and employer-employee obligations.
POTENTIAL PITFALL - FAILING TO SEEK THIRD-PARTY EXPERTISE
- Issue - In most states, nonprofit directors are held to the business judgment rule or an equivalent standard, which gives directors wide latitude in their decision making. One area where directors do not have any latitude is with respect to paying state and federal payroll taxes. Directors with corporate signatory authority may be held personally liable for the organization’s failure to collect these payroll taxes and some states also may extend liability for failing to collect and remit sales tax and unemployment insurance contributions.
- Solution - When directors encounter matters beyond their areas of expertise, they should seek outside experts to help the board make informed decisions. If a complex transaction goes awry and litigation ensues, directors may be held liable for failing to seek third-party expertise and advice.
Directors must ensure the organization adheres to its charitable mission and purposes. A nonprofit that strays substantially from its mission and purposes will be required to modify its governing documents and notify the IRS of the changes in its exempt status. To safeguard the organization’s mission and purposes, directors must be engaged enough to steer the organization away from potentially competing or tangential interests.
POTENTIAL PITFALL - STRAYING FROM THE ORGANIZATION'S MISSION OR PURPOSE
- Issue - Two typical examples of directors violating their duty of obedience are engaging the organization’s development staff to solicit donations for an activity outside the organization’s charitable purpose; and funding initiatives or programs beyond the geographic scope of the organization’s mission.
- Solution - An organization’s initial vision and purpose may evolve over time or as circumstances change. When this occurs, directors should undergo a deliberative and strategic process to reframe the organization’s mission and purposes. Substantial changes may require the organization to update its by-laws and state incorporation documents, and notify the IRS.
Serving as a nonprofit board member can be demanding and time-consuming. Fortunately, there are many benefits and satisfying aspects, and you likely will be amazed by the good will generated by your commitment. Once you have become familiar with your roles and responsibilities, you will be able to lead by example and feel confident that the organization and its constituents will benefit from your diligence.
Questions for Consideration
- Does your organization have the proper policies and procedures in place to address conflicts of interest?
- How is your nonprofit safeguarding its confidential information and intellectual property?
- Do you have your directors and employees sign confidentiality and nondisclosure agreements?
- Before agreeing to serve on the board, did the organization provide a statement of board member expectations?
- Is there a committee that regularly informs the board of their legal obligations?
- Are board members instructed on their role as stewards of the organization’s charitable assets?
For more detail on nonprofit directors' responsibilities and best practices, read Know and Grow: Fiduciary Duties and Best Practices for Nonprofit Directors. And to learn more about how Northern Trust can put its expertise and resources to work for your foundation, endowment or other nonprofit organization, please visit us at https://www.northerntrust.com/FIA.