The duty of care requires a director to act with the care that a reasonably prudent person would in a similar situation. The duty of care also requires that a director be active in the organization’s affairs by attending board meetings and meetings of committees on which the director serves. Directors are also required to act with knowledge and with adequate deliberation. Some ways for directors to meet their duty of care include:
- Understand the organization’s mission and review its governing documents.
- Prepare for and attend board and committee meetings.
- Participate, ask questions and seek information necessary to make informed decisions.
The duty of loyalty requires that directors refrain from engaging in personal activities that would injure or take advantage of the organization. Directors are prohibited from using their positions of trust and confidence to further their private interests. They should not engage in any transaction that is adverse to the organization; engage in any competing enterprise to the detriment of the organization; divert an organization’s opportunity for personal gain; or derive any kind of secret profit or other advantage in dealing with or on behalf of the organization.
The duty of obedience mandates that board members be faithful to the organization’s purposes and comply with its governing documents. They also have a duty to be familiar with the laws that apply to the particular organization and to comply with state and federal laws that relate to its business operations. The directors may be liable if they authorize an act that is beyond the powers conferred upon the organization by its articles of incorporation, its code of regulations, or by the laws of the state of incorporation.
Directors are presumed to have acted properly and to have satisfied these three basic duties if the business judgment rule is satisfied. This rule recognizes that not all decisions of boards will result in benefit to the organization, and it holds that directors will be personally liable for loss to the organization only if the elements of the defense are not satisfied. The business judgment rule provides protection for directors:
- If they acted with a good faith belief that their decision was in the best interest of the organization
- If they reached an informed decision after making a reasonable effort to investigate and ascertain all relevant information and after deliberating the decision with fellow directors
- Who are interested and independent with respect to the action in question
- Against claims for wrongful acts, but not against claims for failure to act unless it is a result of a conscious decision not to act
- Against honest mistakes of judgment. The rule does not provide protection for decisions that cannot be supported by some rational basis.
The directors of a nonprofit organization must comply with the basic duties and fall under the business judgment rule, or subject themselves to potential personal liability from various constituencies. When a conflict of interest does arise, there should be full disclosure by all of the participants followed by an in-depth discussion with interested persons. Thereafter, the organization’s governing body should deliberate there without the interested person in attendance. They should then make a good-faith determination in the best interests of the organization.
Conflicts of interest are easier to address if there is a written policy for handling them before they arise. Typically, a written policy would either be included in the organizational documents of the nonprofit or adopted by the board of directors. A written policy also enhances the organization’s ability to obtain directors’ and officers’ liability insurance coverage at a reasonable cost.
Conflicts of interest may create an embarrassing situation for both a nonprofit and the individual involved. They may also subject the parties to financial exposure. As you serve on nonprofit boards, insist on being educated on your duties and be diligent in fulfilling them.
JAMES R. MOATS chairs the Commercial Practice Group of Carlile Patchen & Murphy LLP and regularly counsels the executives and directors of nonprofit organizations. His practice also focuses on commercial transactions and the representation of privately-owned businesses. Reach him at (614) 628-0777.