Avoiding Personal Liability While Serving on a Non-Profit Board

Community members are often asked to serve as directors for non-profits, whether because they have a passion for the organization’s mission, particular and desired expertise and/or significant philanthropic potential. Regardless of the reasons that might attract or bring a director to the board, once selected to serve, every director is charged with certain fiduciary duties to the organization – and a failure to discharge any one of these duties can expose a director to personal liability.

Laws applicable to non-profit organizations define a director’s fiduciary responsibilities in three broad categories:

1. Duty of care;

2. Duty of loyalty; and

3. Duty of obedience.

The duty of care requires a director to act with reasonable diligence and in good faith. In practice, this requires the director to be informed of the organization’s activities, actively and regularly participate in board meetings, review materials and hold staff accountable.

The duty of loyalty dictates that a director must put the interests of the organization above his or her own or those of other parties. This prohibits directors from using their position to further their own direct or indirect personal interests; and further requires disclosure of any potential or real conflicts of interest to the rest of the board before the board votes on the matter (and, typically, abstention from the vote itself).

The duty of obedience obligates directors to remain faithful to the organization’s tax-exempt mission and to ensure that it is operated consistent with its Charter and Bylaws and in compliance with applicable laws. Directors who use the organization’s assets for purposes other than in furtherance of its tax-exempt mission, or permit others to do so, may violate this duty of obedience.

Overlying these fiduciary duties is Wisconsin’s “business judgment rule” for non-profit organizations. This rule provides that, subject to some important exceptions, directors will not suffer personal liability as a result of a breach or failure to perform any duty resulting solely from their status as a director. It should be noted, however, that protection from liability is not protection from suit or investigation. Accordingly, even if the accused director is ultimately protected by the business judgment rule, he or she will still suffer the time, trouble and expense of litigation and/or investigation.

The important exceptions to the business judgment rule for non-profits are where the director is found to have: (i) violated criminal law, (ii) willfully failed to deal fairly with the organization, (iii) gained an improper personal benefit, or (iv) engaged in willful misconduct. If an exception is found to apply, the director may be held personally liable. To make matters worse, if any such exception applies, the organization is prohibited from indemnifying the director and, moreover, director and officer (i.e., “D&O”) insurance policies typically contain exclusions to coverage in those instances.

An important note on the pool of potential claimants – unlike in the for-profit world where shareholders are typically the ones making the allegations of fiduciary breaches by directors – directors of non-profits face potentially more formidable claimants. Claims can be asserted by: (i) other directors or officers of the organization itself, (ii) the State Attorney General, (iii) parties that have a “special relationship with the organization” (i.e., donors and creditors), and (iv) the IRS.

Setting all the doom and gloom aside, the risk of personal liability for non-profit directors can be reduced, if not eliminated entirely, by following these simple rules of diligence and prudence:

A. Be informed of the facts at hand and make reasonable inquiries into those facts;

B. Make judgments in good faith and without conflicts of interest, bias, or outside influence; and

C. Make reasonable judgments, founded on a sound, rational and defensible basis, which are in the best interests of the organization.

From a practical standpoint, it is also wise to ensure that the organization maintains director and officer insurance. Again, the business judgment rule may insulate directors from negligent or even honest mistakes, but those determinations are typically made only after the conclusion of costly litigation or investigation; and the organization’s ability to defend and indemnify its directors is limited to the size of its bank account.

In the end, go forth and pursue your passions and/or share your expertise and resources, but do so carefully, thoughtfully and wisely.

Written By:
Attorney Robert M. Charles