Personal Liability of Not for Profit Directors

Board membership in a not-for-profit organization is a great opportunity to contribute to the community, but it is also a huge responsibility. It is advisable for a would-be director to look before s/he leaps when considering taking the position.

Although decisions involving the organizations are made by the directors acting as one Board, each director is legally bound to observe three important duties to the organization, namely the duties of care, loyalty and obedience. These duties are legally enforceable, and an erring director may be sued personally if s/he violates them. Legal action may be brought by the State Attorney General, by another director or by members representing at least five percent (5%) of the membership.

Although lawsuits against board member are uncommon, there have been instances when they were personally sued such as when a trade association applicant sued an organization for rejecting its membership bid and when the parents of disabled children sued an organization for breach of fiduciary duty and won a judgment of over $3 million.

Checking Organization Before Joining Board

Aside from looking into the ongoing programs of the organization and checking its reputation in the community, there are a number of things s/he can do before a decision to join the board is made.

Firstly, a would-be director should look at the organization’s basic documents, particularly: (a) the certificate of incorporation; (b) application for federal income tax exemption; (c) by-laws; and (d) board and committee minutes for at least the past year. This would give the would-be director a good idea about the general objectives and concerns of the organization.

Secondly, one must obtain a current list of board and committee members as well as the officers of key staff members of the organization. It would help if the would-be director could talk to current and former board members to learn about the operations of the organization, whether the meetings are well-attended, and find out the reasons why former board members or offices left their posts.

Thirdly, the would-be director must look into the organization’s financials. Many controversies predictably abound where money is concerned. A review of the organization’s IRS Form 990 or 990 PF and audited financial statements during the last two years as well as the latest financial reports will provide a reliable picture of the financial situation of the organization and how it uses its resources.

Duty of Care

The duty of care entails good faith and exercising that degree of diligence, care and skills which ordinarily prudent people would exercise under the same circumstances. In concrete terms, the duty of care means the director should attend all board and committee meetings and participate in deliberations. S/he must read minutes of meetings and all reports, including financial statements. S/he must be familiar with and adhere to the approval process for the organization’s major transactions, such as procurements and compensation packages. Duties must also be delegated to qualified professionals only.

Even if the director observes the degree of care in discharging his/her duties, it will still be prudent to check whether the organization indemnifies directors and officers, and whether it has obtained liability insurance for them.

Duty of Loyalty

The duty of loyalty means the director must pursue the objectives and interests of the organization with undivided allegiance. This duty basically calls for independent judgment, unfettered by any desire for or appearance of personal gain. It comes into play in situations where the directors have fixed the compensation of staff and even the directors themselves; or in “interested party transactions” or other instances of “self-dealing”.

A director should avoid a conflict of interest. A common example is when a director uses the organization’s membership list to promote his/her business.

The rule is that the director must put the interest of the organization first, before his/her own. Directors must avoid entering into transactions with the organization, but if this is unavoidable, the director must make full and complete disclosure of the conflict to the board.

The best situation for all concerned – the directors, officers, employees or staff and the organization itself—is to have a conflict of interest policy in place. This will be the guidepost for any conduct arising from internal dealings with the organization.

Duty of Obedience

The duty of obedience means the director must be faithful to the mission and objectives of the organization. To properly abide by this duty, one must be thoroughly familiar with the organizational structure and accountability system. Delegation of duties, if needed, must be made only to qualified professionals and conversely, conduct must be guided by the mission, objectives and policies as embodied in the organization’s incorporation papers and duly approved Board resolutions.

Directors must insure that the organization complies with all applicable laws and regulations including registration and reporting laws and tax laws. Directors may be personally liable for failing to pay the wages, benefits and withholding taxes on employees’ wages.