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Eleven Steps Toward Worry-Free Nonprofit Corporate Board Service

Eleven Steps Toward Worry-Free Nonprofit Corporate Board Service

Directors (also called trustees) of nonprofit corporations don't serve to get rich. They serve out of a sense of civic obligation or belief in a cause. Nonprofit directors are willing to give of their time, talent and treasure. But they don’t want to end up with tattered reputations or depleted bank accounts. Concerns about nonprofit board service have been heightened by a series of business and nonprofit scandals where directors were attacked for failing to do their job – or worse.

The good news is that the law provides significant protection to nonprofit corporate directors who do their job. Listed below are eleven steps that you – as a nonprofit director – can take to be sure you have done your job, protecting both your own and the nonprofit’s interests.

1.  Take Care. Every nonprofit director owes a duty of care to the nonprofit. This duty requires that you act in good faith and exercise the care an ordinarily prudent person would exercise under like circumstances. Some steps to assure that you meet the duty of care are:

  • Attend Meetings. You cannot exercise your fiduciary duty if you do not attend meetings. Further, you are still responsible even if you don't attend meetings.
  • Do Your Homework. Familiarize yourself with key documents. Read the Articles of Incorporation and Regulations. Before a meeting, review the minutes from the prior meeting. Insist meeting materials be provided with enough lead time. If you think you need additional materials ask that they be provided.
  • Don't be a Rubber Stamp. Think, speak and vote independently.
  • Ask Questions. If you don't understand something, chances are most of the other Board Members don't either. Remember, it's easier to ask questions if you have done your homework. Don't Rush. Take time to make decisions in a business like manner.

2.  Be Loyal. Each nonprofit director owes a duty of loyalty to the nonprofit. This duty requires that you act in a manner you believe to be in, or not opposed to, the best interests of the corporation. At its heart, the duty of loyalty requires that you be free from conflicts of interest.

Nothing generates scrutiny like conflicts of interest – or the appearance of a conflict. While it is best to avoid conflicts of interest, in the real world, some conflicts are inevitable. To assure that conflicts are appropriately addressed, nonprofits should adopt a conflicts of interest policy. (If the nonprofit is a private foundation, be sure not to violate the IRS self-dealing rules.) This policy should require that the following minimum steps be taken:

  • Full and timely disclosure. The interested director must make full and timely disclosure of the materials facts of a conflict of interest. If you aren't sure if a conflict exists, err on the side of more disclosure. An annual conflicts questionnaire is a good way to remind the Board about the conflicts policy and flush out potential conflicts of interest.
  • Independent Determination. A determination of whether a conflict exists must be made by disinterested directors.
  • Independent Vote. If a determination is made that a conflict exists, then the conflicted person may have an opportunity to make a presentation, but should not be present for discussion or vote on a matter involving that person.

3.  Don’t Take What Isn’t Yours. As a nonprofit director, you will be privy to confidential information about the nonprofit’s business plans. You must not disclose or make personal use of the nonprofit’s confidential information. Further, you must not take advantage of a business opportunity that you believe to be of interest to the nonprofit. Rather, you must first offer the opportunity to the nonprofit.

4.  Be Obedient. All nonprofits have a mission. That mission should be found in the governing documents – the Articles of Incorporation and Regulations. Because nonprofits change with the times – but documents may not – be sure that the nonprofit's governing documents reflect its mission. If the mission does not match the governing documents, change the governing documents. If that is not possible, then scale the mission to match the governing documents. Whenever the Board is considering a major initiative, it should always ask how that initiative ties to the mission.

5.  Know Your Rights. Nonprofit directors have rights to help them do their job. These rights include the right to ask questions of management, the right to inspect the nonprofit’s books and records (including minutes), the right to ample notice of board and committee meetings you are expected to attend, and the right to dissent and have that dissent recorded. While you need to be reasonable, do not be shy in exercising your rights.

6.  Follow the Money. Directors are stewards of the nonprofit’s assets. Be sure that the nonprofit has mechanisms in place to keep it fiscally sound. These steps might include setting a realistic annual budget, adequate internal financial controls, regular financial reporting from management to the Board, and considering the value of an annual audit. Also, be sure that adequate controls are in place to assure the proper use of any restricted funds.

7.  Governance Matters. The IRS has gotten serious about good governance for nonprofits. The IRS has issued a Report outlining good governance policies and practices for Section 501(c)(3) charities. The IRS Report reflects a number of recommendations found in the October, 2007 Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations by the Panel on the Nonprofit Sector. The IRS’ good governance recommendations have teeth. The new IRS Form 990 requires nonprofits (charities, trade associations, chambers of commerce and private clubs) filing that form to disclose governance practices. Nonprofits that file a Form 990 showing weak governance practices will be more likely to face audits. And nonprofits (even those that do not have to disclose governance practices on a Form 990) with weak governance practices should, if audited, expect stricter scrutiny.

8.  Put Your Best Face Forward. Some nonprofits spend many hours and thousands of dollars producing glossy Annual Reports. At the same time, they treat the Form 990 – the annual IRS information return – as a bothersome administrative filing to be handled by the accountants. Given its recent changes, the importance of the Form 990 has increased dramatically. For charities, the Form 990 is publicly available on Guidestar.org. And the Form 990 is one of the first things a regulator, reporter or grantmaker reviews when examining a nonprofit. The Form 990 is a legal filing and needs to be completed accurately and with care. But nonprofits should also view the Form 990 as an important tool to spread their message and put their best face forward.

9.  Contemplate Before You Compensate. Many nonprofit governance scandals concern excessive executive compensation. Nonprofit executives work hard and need to be paid fairly. To help prevent abuse, nonprofits should follow three steps the IRS has outlined for setting executive compensation. These steps will help protect the nonprofit, the executive and the Board from criticism and, potentially, substantial penalties. A summary of the three IRS steps follows:

  • Objectivity. Base the compensation on objective criteria. For smaller organizations, this might involve a review of the compensation paid by five similarly sized organizations. (Remember Guidestar.org has material concerning the compensation paid by other nonprofits.) For large organizations, objective criteria might include a professional compensation study. Once the objective criteria are gathered, the Board (or the compensation committee) should set the compensation at a reasonable level. Remember that a charity’s executive compensation is publicly available, so you should be comfortable publicly defending the compensation package.
  • Independence. Those setting the compensation must be independent of the executive. They should not be employees of the nonprofit, do business with the nonprofit or be family members of the executive. The executive should not be in the room when his or her compensation is established.
  • Minutes. Matters concerning the compensation, including who participated, the objective criteria that formed the basis for the compensation as well as any conflicts and how they were addressed should be fully documented in meeting minutes. The minutes should be prepared promptly after the meeting.

10.  Do D&O. Most nonprofits should have a directors and officers liability insurance policy. (Before joining a Board, ask for a copy of the D&O policy and proof that it is still in force.) In our lawsuit happy society, claims happen. D&O insurance pays to cover the cost of defending and settling those claims, even if there is no fault. The type of D&O policy and the amount of coverage will depend on the nonprofit’s activities. Because D&O coverage varies widely, shop around. But don’t just look at cost and the amount of insurance. Often, whether a claim is covered is more important than the amount of coverage. If your nonprofit has not reviewed its D&O coverage for a few years, now is a good time to ask for a review.

11.  Document. It is important to fulfill diligently your duties as a nonprofit director. Proof that you fulfilled those duties is also important. Corporate minutes are a vital (and often the only) tool in documenting the Board’s deliberations. Be sure your nonprofit treats minutes as important documents. Minutes need not be a transcript of Board meetings – and are usually more effective if they are a thoughtful summary. Be sure to read the minutes and, if needed, ask for corrections.

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Mark F. Sommer is FBT’s Tax, Benefits and Estates Practice Group leader, focusing on state, local and federal tax, incentives, tax controversy and litigation. He has successfully handled thousands of audits, protests, appeals, and transactional matters.

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