Category Archive for ‘Nonprofit Law and Governance’

June 22, 2016

Governance vs. Management

by Randy Evans / Posted in Nonprofit Law and Governance

Nonprofit Law and Governance Hazards to Avoid

Hazard #2: Ignoring the Distinction between Governance and Management

Understanding the General Legal Structure of a Nonprofit Organization

Unlike a privately-owned (‘for-profit’) business, a nonprofit organization typically does not have owners. In a privately-owned business, net earnings may be distributed to shareholders, employees, or other persons who have a legal right to participate in the profits of the company. For a nonprofit organization, though, there is no ownership; that is, no individual has the legal ability to profit personally from the organization’s activities (hence, “nonprofit”).

Rather, nonprofit organizations are formed for a specified purpose, other than generating income. Its purpose may be advancing the mutual interests of the organization’s members (a mutual benefit organization) or advancing a religious, educational, charitable, scientific, civic, social, or other recognized “public” purpose (religious and public benefit organizations).

Nonprofit organizations are permitted to earn net revenues (as the saying goes, “nonprofit is a legal structure, not a business plan”), but net revenues must be used for the organization’s programs or otherwise reinvested in the organization; they cannot be distributed to individual persons.

No ownership does not mean no control or no accountability. Control of a nonprofit organization is divided into two areas: Governance, which is the responsibility of the board of directors (or trustees), and Management, which is the responsibility of the senior executives, acting under the authority of the board. Nonprofit organizations are accountable to their members (if the organization has members); its donors, funders, constituents, and the communities it serves; state agencies; the Internal Revenue Service and state taxing authorities; other oversight or regulatory authorities (depending on the organization); and the general public.

Distinguishing between Governance and Management

Corporate governance deals with the big-picture concerns of the organization: defining the organization’s mission, approving the annual budget, ensuring adequate internal controls, adopting governance-related policies and procedures, hiring and overseeing the chief executive, approving major decisions, and the like. Governance is the purview of the board of directors. A corporation’s management relates to the day-to-day administration of the organization’s programs and activities.

Organizations that run into trouble often suffer from one of two extremes. One extreme is the disempowered, disengaged, derelict, or absent board of directors. These are the boards that never hold meetings, or simply “rubber stamp” the desires and decisions of the chief executive. On the opposite end of the spectrum is the micro-managing board, where the directors insist on getting involved in the minutiae of day-to-day management or frequently interfere with the decisions and actions of the chief executive. While boards must be vigilant in fulfilling their governance and oversight roles, they must also be careful not to step over the line and begin managing the day-to-day activities of the organization.

In between those two extremes are a variety of models of effective board governance. Part of the board’s role in fulfilling its duties and responsibilities is to work with the organization’s chief executive to determine the appropriate boundaries dividing governance—the purview of the board—and management, which is the responsibility and realm of the chief executive and senior management, acting under the authority, direction, and oversight of the board.

Just as there is no “one-size-fits-all” model of nonprofit corporate governance, there is no “perfect” balance between governance and management. Each organization must arrive at a workable understanding of the role of the board versus the role of the chief executive and senior management team, taking into consideration the organization’s particular needs and circumstances, and remaining mindful of the legal standards and duties of the board which generally may not be delegated to others.

This should be viewed as an ongoing dynamic process, a dialogue. In a symphony orchestra, everyone works together to pursue a shared goal: interpreting and bringing to life the composer’s artistic expression. The conductor has a very different role than the performers, but they work in concert to make music. In American football, the specific role that a player takes on the field is determined by the player’s position. The quarterback has a very different role than a wide receiver. How the various positions interact with each other will vary from play-to-play, though. It is a dynamic mediated engagement toward a common goal.

Basic Responsibilities of Nonprofit Boards

With this understanding in mind, what are the general roles and responsibilities of nonprofit boards? In his book, Ten Basic Responsibilities of Nonprofit Boards, 3nd Ed. (BoardSource 2015), Richard T. Ingram, president emeritus of the Association of Governing Boards of Universities and Colleges, outlines ten basic responsibilities of nonprofit boards:

  1. Determine mission and purpose. The board is responsible for establishing and reviewing the statement of mission and purpose that clearly articulates the organization’s goals, means, and constituents served.
  2. Select the chief executive. The board is responsible for delineating the chief executive’s responsibilities, and for searching for and employing the most qualified individual for the position.
  3. Support and evaluate the chief executive. The board also must support the chief executive as he or she administers the organization’s programs, both directly and by ensuring that the executive has adequate resources and professional support.
  4. Ensure effective planning. Boards have a duty to actively participate in the organization’s overall planning process, and to assist in implementing and monitoring the plan’s goals.
  5. Monitor, and strengthen programs and services. The board is responsible for determining which programs are consistent with the organization’s mission and for monitoring their effectiveness.
  6. Ensure adequate financial resources. One of the board’s foremost responsibilities is to secure adequate resources for the organization to fulfill its mission.
  7. Protect assets and provide proper financial oversight. The board must assist in developing the annual budget and ensuring that proper financial controls are in place.
  8. Build a competent board. The board also has a responsibility to articulate prerequisites for candidates, help train and guide new directors, and periodically and comprehensively evaluate their own performance.
  9. Ensure legal and ethical integrity. The board is ultimately responsible for the organization’s adherence to legal standards and ethical norms.
  10. Enhance the organization’s public standing. The board should clearly articulate the organization’s mission, accomplishments, and goals to the public and garner support from the community.

Ingram points out that while “…there is no one-size fits all model to governance, [these] are fundamental responsibilities that hold true for almost every board”

 

May 10, 2016

Fiduciary Duties of Nonprofit Officers and Directors

by Randy Evans / Posted in Nonprofit Law and Governance

Nonprofit Law and Governance Hazards to Avoid

Hazard #1: Ignoring Basic Fiduciary Duties

Nonprofit governance refers to the work of the organization’s board of directors (or trustees). This work includes establishing the organization’s mission, charting its general direction, providing oversight, ensuring adequate funding, and creating the organization’s culture. Carrying out these responsibilities requires an understanding of the specific legal duties and standards that apply to nonprofit boards.Team meeting with flipchart

The legal duties and standards for nonprofit boards are established by state law, and generally may be found in a state’s nonprofit corporations act or similar legislation, as well as in court-established common law principles. Each state’s law may vary as to the precise duties and standards that apply.

Most states require that directors discharge their duties (1) in good faith, (2) with the care that an ordinarily prudent person in a like position would exercise under similar circumstances, and (3) in a manner the director reasonably believes to be in the best interests of the corporation. This list of basic duties may be found in the Revised Model Nonprofit Corporation Act (1987), Chapter 8, Subchapter C (Standards of Conduct), § 8.30 (General Standards for Directors).

In applying these statutes, courts have explained that corporate directors have two basic duties: a duty of care, and a duty of loyalty. The duty of care has been described as a duty to exercise the care that a reasonably prudent person in a similar position would exercise under similar circumstances.

The duty of loyalty relates to the prohibition against self-dealing (acting in one’s own self-interest to the detriment of the organization), and requires that directors be able to show that any particular decision or action is fair and serves the best interests of the organization.

Put another way, directors and officers may not enhance their own personal interests at the expense of the organization’s interests, nor may directors personally profit or benefit at the expense of the organization. Rather, they must promote the interests of the corporation to the exclusion of their own self-interest.

In something of a twist, directors who apply these basic fiduciary duties ARE acting in their own best interest. How so? Because a director who complies with these standards generally may not be held liable for any decision or action (or inaction) of the board, even if that decision or action fails to put the organization in a better position. This legal standard is known as the business judgment rule.

In future posts, I’ll cover specific items, including conflicts of interest. In the meantime, below are examples of what can go wrong when boards ignore their fiduciary duties, and some tips and best practices.

Penalty Strokes

So what happens when boards ignore basic fiduciary duties?golf

In cases involving a complete abdication of the board’s responsibilities, conflicts of interest, fraud, bad faith, or decisions that are clearly unreasonable based on facts that are known at the time, directors may be held personally liable for resulting damages to the organization or outside third parties. Federal tax law penalties may also apply in certain circumstances (more on these in later posts).

In less severe situations, the business judgment rule ordinarily protects directors of nonprofits from personal liability for a breach of the duty of care. But there are cases when directors of nonprofits have been held personally liable simply for failing to provide appropriate oversight. Two recent examples:

  • In 2015, a U.S. Court of Appeals upheld a $2.25 million jury verdict against the directors of a nonprofit nursing home. The directors were held personally liable for breach of their duty of care, based on their failure to remove the nursing home’s administrator and CFO “once the results of their mismanagement became apparent.” See In re Lemington Home for the Aged, 777 F.3d 620 (3d Cir. 2015).
  • In 2010, the California Attorney General filed suit against nonprofit and former officers and directors, based on alleged misuse and misappropriation of funds; lack of appropriate controls and oversight. One significant aspect of the complaint is that it did not merely accuse the former directors and officers of affirmative wrongdoing, but suggested they were at fault for failing to provide appropriate oversight. The case was eventually settled. See California v. Monterey County AIDS Project, et al (Monterey County Sup.Ct. No. M105979) (Complaint filed May 21, 2010) (“Complaint”), available at http://oag.ca.gov; see also Attorney General Kamala D. Harris Announces Settlement, Funds Recovered to Benefit HIV/AIDS Patients (Cal. Atty. Gen.), Jan. 20, 2012.

Staying on Par: Tips and Best Practices to Comply with Basic Legal Duties

Below are general tips and best practices for complying with board duties.

  • Understand and adhere to requirements and procedures in governing documents (articles of incorporation and bylaws)
  • Attend board meetings regularly
  • Review meeting minutes, committee reports, and other materials prepared for board meetings in advance; prepare questions and discussion points in advance of the meeting
  • Review financial statements, Form 990 (Annual Information Return), audit reports, and reviews and management letters prepared by the organization’s auditors
  • Request that experts be retained when the board must make a decision on a matter that exceeds the collective expertise of the directors and chief executive
  • Insist on compliance with applicable laws and internal controls, even if compliance may increase the organization’s operational costs or result initially in negative publicity
  • Promptly disclose conflicts of interest; adhere to the procedures in the organization’s conflicts of interest policy
  • Understand and adhere to policies and procedures of the organization that may involve the board (e.g., confidentiality policy, document retention and destruction policy, etc.)
  • Keep sight of the governance role of the board, and avoid crossing the line into the day-to-day management of the organization (micro-managing)
  • On the other side of the spectrum, take steps to ensure that the board is fulfilling its governance and oversight functions, and avoid simply turning everything over to the executive director
  • Establish committees or working groups to carry out the board’s activities and fulfill its oversight role in particular areas (e.g., audit committee, finance committee, board recruitment committee, etc.)
  • Be proactive in creating a sustainable growth mindset and a culture of openness, transparency, accountability, and mission-mindfulness

Next up: Ignoring the distinctions between a privately-owned business and a nonprofit organization

 

May 6, 2016

Common Nonprofit Law and Governance Hazards to Avoid

by Randy Evans / Posted in Nonprofit Law and Governance

Introduction: Avoiding Common Law and Governance Hazards While Keeping Your Organization On Par

Golf is a mission-focused sport. But while the mission may be easily defined, the actual feat is anything but easy. The same can be said about governing a nonprofit organization. Your organization’s mission may be easy to define (though even that can be a challenge golf ball in sandtrapsometimes), but staying on course and advancing the organization toward its intended purpose can be as exasperating as a round of mid-afternoon golf in the scorching heat of an Arizona summer.

Among the many aspects of golf that make the game so challenging are the hazards—features of the course such as waterways and sand traps that present a particular challenge or difficulty. Special rules apply any time the ball lands in a hazard. These rules instruct the player on what is permitted and prohibited and what penalties may apply.

Nonprofit governance has its own hazards: features that present particular challenges or difficulties. An organization’s directors and officers are expected to understand the rules that give rise to and apply to these hazards. Some hazards present the risk of penalties. As in golf, landing in these hazards and running afoul of the rules can deter the organization from moving toward its ultimate mission.

Over the next several weeks, I’ll be offering some practical insights on how your board can advance the organization’s mission while steering clear of common nonprofit law and governance hazards.

Want to learn more now? There are numerous resources available that can help your board implement good governance practices and increase your effectiveness. Here are two that you might find helpful:

Is your board ready to go beyond good governance to implement TransFORMational Governance?

Are you overloaded with information, ideas, and advice, but still not clear on what works best for YOUR organization? We can help with that!

Questions:

  • What ONE resource have you found most helpful for your board?
  • What ONE practice has your board implemented that has had the biggest impact on your organization’s mission?