In case you missed it, I suggest starting with Part 1. Then, if you haven’t yet resigned from the board, dive into this Part 2, where we look at your legal duties as a board member. In case I haven’t yet shocked you into resigning, reading about your duties just might do the trick.
In all the cases that I have handled in my career where nonprofits have been embroiled in scandal, have been embezzled, have had to close their doors, and even where people went to prison, there were smiling, blissful board members who didn’t have a clue as to their duties or the personal strength of character to follow them. So you’ll pardon me if I’m a little blunt here: if you don’t have a clearheaded understanding of what your responsibilities are as a board member, learn them now, or resign. You’ll have a brilliant future as a volunteer for the celebrity auction committee.
Your Duties as a Board Member
The reason you have the rights I described in Part 1 is because they are essential in enabling you to carry out your duties as a trustee of the organization.
Here they are, in a nutshell:
Duty of Care
As a board member, you are required by law to discharge your duties with the care an ordinary prudent person in a like position would exercise under similar circumstances. In other words, you must engage your gray matter and not simply rely on the nods and grunts of fellow board members when deciding something. If you have doubts about the wisdom of an action, resolve those doubts, if you can, before assenting. If you can’t, don’t assent. Ask questions. Do your homework. If necessary, be a pain in the butt. But don’t vote on something if you haven’t got the foggiest idea whether or not it really makes sense.
Active Participation. Being a good board member doesn’t mean you always must be right. Remember, even prudent persons get it wrong sometimes. But it does mean you are actively thinking about the pros and cons of a thing, and making sure you have enough information to make your best decision. Did you get that? Active participation is the key here. If you are not attending board meetings, you are not actively participating. If you are not receiving reports, minutes, and performance charts and other relevant information in advance of meetings where you are expected to vote in reliance on them, chances are you won’t know what you’re voting about. So insist on receiving these kinds of materials at least a few days before the meeting, and review them before coming to the meeting. Do not vote simply in the hope that nothing is amiss; do not simply go along, lemming-like, with the other seat-warmers on the board. Assume they’re even more clueless than you. And as I wrote in Part 1, if you encounter resistance that cannot be overcome in receiving these materials at least a few days ahead of the meeting, resign—since you cannot meet your responsibilities without the opportunity to consider the materials in advance of the meeting.
Reasonable Inquiry. If you’re not receiving the information you need to make an informed decision, or if you’ve discerned even an inkling of officer or employee theft, embezzlement, or mismanagement, listen carefully: investigate aggressively. Inquire like a bulldog. Where needed, get professional advice. It is the failure to carefully follow up when information doesn’t add up or where it appears on the face of it that something is seriously amiss, that leads to disaster. And sometimes YOU, as an individual board member, will be held legally and financially accountable. In some cases, even directors and officers liability insurance won’t help you, as with fraud and embezzlement that you had a duty to have prevented.
Duty of Loyalty
Remember how I said, in Part 1, that the assets of the organization are held in trust and that you are a trustee? That was not a euphemism. I was being literal. Because you are a trustee, you must be loyal to the organization, meaning that you must not have divided loyalties when it comes to the organization’s activities, funds, and assets. That is because decisions you make must promote the organization’s public purpose, and not a private interest—yours or anyone else’s.
Conflicts of Interest. One of the most treacherous areas of divided loyalty is where board members, their families, or their businesses enter into transactions with the organization. States typically do not impose a flat prohibition against such things, and at times such transactions might even be favorable to the organization if the board member is giving favorable terms to the organization. However, if you as a board member wish to enter into such a transaction, you will have the burden of establishing that the contract or transaction is fair and reasonable, that you fully disclosed the conflict, and that the other board members approved it in good faith. Your fellow board members have the obligation, when voting on such a transaction, to do so only if it is clearly in the best interest of the organization. Of course, you should not be voting when it is your transaction; in fact, you should not even be present during the discussion.
Written Conflicts-of-Interest Board Policy. It is not enough simply to have some sort of informal understanding about these things. Board policies with respect to divided loyalty, sometimes referred to as conflicts of interest policies, should be clearly spelled out in writing and adopted as policy by the board. The board policy document should address disclosure of financial interest, the requirement that the interested party not be present for discussion, and the requirement that the interested party not be present for the vote. It should also require that these procedures be carefully documented in the minutes. An enlightened policy document would require more than a majority vote—perhaps a two thirds majority vote—as well as an annual disclosure form be completed by each board member upon joining the board, and annually thereafter.
Tip: Don’t make the mistake of requiring annual disclosure forms, then failing to review them carefully.
Loans to Officers or Board Members. One kind of divided-loyalty transaction is almost always prohibited or at least heavily restricted under state law: loans by the organization to an officer or director. Don’t do it.
Corporate Opportunity. Sometimes temptation rears its ugly head in the form of a business opportunity that you learn about through your service on the board. The opportunity is for the organization, but might also be great for your own business or profit. You absolutely must avoid diverting such an opportunity for your own benefit unless the opportunity is first presented to the organization and the organization decides to pass. In deciding to pass, the organization’s board should follow the procedures of the board’s written conflict-of-interest policy.
The duty to avoid divided loyalties also can play out when you serve on two or more boards of organizations. For example, when you learn of an opportunity, to which organization do you present it? The key here is full disclosure to all organizations on whose boards you serve. Often you should recuse yourself from board discussions and votes with respect to such opportunities.
Duty of Obedience
As a director, he must be more than familiar with the articles of incorporation and bylaws of the organization. You must follow them. Scrupulously. You also must ensure that the organization’s mission is at the forefront of all of your decisions. All organizational funds and other assets must be used for lawful purposes.
Not only that, but as a board member you must be familiar with federal and state laws as they pertain to governing your organization:
Federal Law. I know it sounds somewhat ridiculous to mention this, but you must make sure that your organization has been recognized as exempt from taxation by the Internal Revenue Service. Failing to be exempt means that organizational income will be taxed at normal rates, and donors to the organization may not be able to deduct their contributions on their income tax returns. Yes, I have had to represent board members who served on boards in defending against fraud allegations where the organization solicited contributions but was not recognized as exempt by the Internal Revenue Service.
State Law. State laws vary, of course, but chances are your organization must register and file a report each year with the attorney general’s office. For space reasons I am not able to give a state-by-state iteration of what’s required; the point is that YOU should find out what YOUR state requires to ensure that your organization is in full compliance with state filing requirements each and every year. In this regard, an attorney competent in the field of tax exempt organizations should be consulted.
Mission and Procedures. You have a duty to follow the organization’s articles of incorporation and bylaws. When is the last time you read them? Make sure you do. You should make sure that the procedures as outlined in these documents are followed, such as that regular meetings are held, that proper notice for meetings is given, that directors are properly appointed to the board, and that the organization’s mission is being pursued.
Still serving on that nonprofit board? Okay, let’s keep going.
Additional Duties and Obligations
Besides the duties of care, loyalty, and obedience, there is a bundle of other duties and obligations that you, as a board member, must be aware of. As a board member, you must ensure that your organization is compliant with the following:
Corporate Documents and Records. I mentioned that you should be familiar with the articles of incorporation and bylaws of your organization. You actually have an obligation to ensure that the organization actually has articles of incorporation and bylaws, that they are regularly reviewed and updated, and that the reflect organization’s current mission and procedures. If necessary, these documents should be amended in accordance with state and federal law as well as the articles of incorporation.
It is particularly critical that the organization keep minutes that accurately reflect the business of the board as conducted in its meetings, as well as all actions taken by committees of the board. Ask to review the corporate minutes, just to be sure. Really. Do it.
Financial Controls and Records . You have an obligation to ensure that the organization has its financial affairs in order, which includes adequate internal accounting systems and controls. My focus in tax-exempt organization law is handling fraud cases. So when I tell you that you have an obligation to ensure that there are adequate reporting and control systems, I am not kidding. Quite frankly, embezzlement from nonprofit organizations is increasing and individual board members—honest folks who simply were asleep at the switch—have been held financially accountable for failing to do their jobs as board members. Don’t be one of them.
So, at the very least, the board you serve on should be carefully scrutinizing the annual budget. You should be receiving, typically from the chief executive, regular income and expense statements, balance sheets, and budget reports. As mentioned above, they should be received in advance of the board meeting so that you have a reasonable opportunity to scrutinize them and formulate questions. If you are on a board of a larger organization, where the finances are too complex for you to verify through your own diligence, insist on an annual audit and be sure to rotate audit firms periodically. Remember that I said that you have the right to insist on the engagement of outside advisors where necessary? If you have any question about the finances, insist that the board engage an auditor to review the financial records and report to the board; if you were thwarted in your request, resign. There is no upside to staying on a board where you have doubts about the veracity of the financial records and where you’re also being prohibited from your own diligence in getting to the bottom of it.
I should mention that, as a board member, the IRS could hold you personally responsible for violating federal tax law. This arises in one of two primary areas:
- The organization fails to perform mandatory payroll withholding. This can arise either with bona fide employees, or when someone is hired as a consultant who should have been classified as an employee. Quite frankly, if I were you, I would insist on being shown documentation from the organization’s accountant of proper payroll withholding.
- Paying excess compensation to someone, or paying unreasonable amounts for goods or services to someone who is essentially an insider to the organization (the IRS calls them “disqualified persons”). I have already discussed this issue above but if you have any doubt about this, insist that legal counsel advise the organization on any given transaction. If you encounter any resistance on this that you cannot overcome, resign.
Safeguarding. The board should adopt policies designed to prohibit large transactions from taking place without board approval or other safeguards. It should also consider whether or not to require dual signatures on all checks, as an additional safeguard. It should also ensure that all the assets are invested prudently, a standard which is defined by state law—typically the Uniform Prudent Management of Institutional Funds Act as adopted by your state.
Adherence to Donor Restrictions. When a donor makes a charitable contribution to your organization, and places restrictions on the contribution’s use, you have an obligation to ensure that the organization adheres to such restrictions. Remember when I said that you are a trustee? Well, trustees are required to adhere to the restrictions donors place on gifts. This is a bedrock principle in trust law, and states predominantly follow trust law when looking at whether board members breached their duties to the organization.
You should insist that your organization establish, and adhere to, a written gift acceptance policy that governs the solicitation and application of charitable contributions. If it doesn’t, resign.
Adhering to Solicitation Laws. This is a huge subject that can be boiled down to this: most states require that organizations soliciting funds register to do so on an annual basis. Not only is your organization required to register in its own state, but also register in any state in which it is soliciting contributions. There are plenty of firms, both law firms and others, that specialize in advising organizations on registration requirements and in actually handling the filing paperwork. Make sure that your organization has a review performed by one of these firms and receives advice on whether it is required to register, and where.
If your organization hires a fundraising firm, make sure that such firm is properly registered, as well.
I have not pulled any punches. I make no apologies, for I have seen far too many good, well-meaning people come to grief by failing to understand and follow their duties as board members. I intended this as shock treatment. Maybe it will wake up some folks who need to be woken up.
And please forgive me for having to state the obvious, but neither I, the editors, the staff or volunteers, nor CharityChannel LLC are rendering legal advice in this article, and no attorney-client relationship being formed. I have written in generalities, and I will tell you that there are plenty of exceptions to some of what I’ve written as facts and circumstances vary widely. You should consult with an attorney competent in the law of tax-exempt organizations on any important questions of law as they pertain to you or the organization you serve.