Nonprofit Board Liability

[Mike Burns]

Nonprofit Board Liability

"Act in good faith." This is the expectation and standard used in the courts to assess the extent of liability and responsibility for actions taken by individual board members.

According to Legal Dictionary.com, acting in good faith is the "honest intent to act without taking an unfair advantage over another person or to fulfill a promise to act, even when some legal technicality is not fulfilled. The term is applied to all kinds of transactions." I should note that the Independent Sector offered a definition of ethical as "doing the unenforceable".

The following article from the Cleveland Jewish News offers some good thoughts on these matters, that is, the matters of nonprofit board liability, acting in good faith, and Directors and Officers insurance.

Safety from suits: Nonprofit board members usually in clear

Posted: Thursday, January 14, 2016 12:31 pm

Safety from suits: Nonprofit board members usually in clear ED WITTENBERG | STAFF REPORTER
[e-mail] Cleveland Jewish News

People who volunteer their time by serving on nonprofit boards at synagogues and other Jewish institutions are subject to legal liabilities, but there are laws in place to protect them in case they are sued.

“The law as drafted is intended to not put nonprofit directors in harm’s way, so there’s a pretty high standard that has to be met or not met for there to be personal liability for a board member,” said Ira Kaplan, partner and executive chairman of the Cleveland-based Benesch, Friedlander, Coplan & Aronoff law firm.

Kaplan, a corporate lawyer, said Ohio law states that board members are required to perform their duties in good faith and “in a manner they reasonably believe to be in the best interests” of the entity they serve and “with the care that an ordinarily prudent person would use.”

A board member shall not be found to have failed to perform his or her duties unless it is proved, “by clear and convincing evidence,” that he or she has not met that standard, Kaplan said.

By the same token, directors who approve of or agree to unlawful distribution of assets of an entity can be held personally liable for doing so, Kaplan said.

“But generally under law, board members are entitled to rely on advice and reports of the counsel offices of the entities’ accountants,” he said. “They are really protected, so even if there is an improper distribution of assets, if they have done their homework and the entities’ accountants have gone through this and have the documents, the board should not have a problem.”

Under not-for-profit law, institutions such as Menorah Park Center for Senior Living, Montefiore and Bellefaire JCB almost always have a provision in their charter documents that directors are indemnified by the entity if they have acted in good faith in a manner not opposed to the best interests of the entity, Kaplan said.

“So, if there is a lawsuit against a board member, generally what would happen is there would be an indemnification provision that would kick in and protect someone from individual liability as long as they have acted in good faith,” said Kaplan, whose three-year term as president of the board of directors at Menorah Park ended Dec. 31.

If a director of a nonprofit board has responsibility for books and records and there is “knowing false entry,” there could be personal liability for that, Kaplan said.

“But that is really unusual, for a board member to have that responsibility,” he said. “It’s usually a staff member, rather than a board member, who has that responsibility.”

Kaplan, a member of The Temple-Tifereth Israel in Beachwood and Cleveland who serves on its foundation board, said he doesn’t believe fear of being sued dissuades many people from serving on nonprofit boards.

“There are not a lot of reported cases (of such board members being sued), so I don’t think it happens very often,” said Kaplan, who also serves on the boards of United Way of Greater Cleveland and Bellefaire JCB. “It has to be something pretty egregious, and I don’t see a lot of it.”

Nonprofit claims more frequent

However, according to Towers and Watson’s 2012 Directors and Officers Liability Survey of Insurance Purchasing Trends, 63 percent of nonprofit respondents reported having had claims against their directors and officers liability policies in the past 10 years.

“Nonprofit claims are more numerous and frequent than for for-profit companies,” said Richard Myers, vice president of professional liability for Insurance Partners Agency Inc. in Solon.

Myers, a past president of B’nai Jeshurun Congregation in Pepper Pike, said most nonprofit boards carry directors and officers liability insurance to protect their members.

But there are some issues that nonprofit directors and trustees need to be aware of, Myers said.

“If a nonprofit becomes insolvent, a director’s or officer’s personal assets are exposed,” he said. “Most nonprofits, such as synagogues, don’t have deep staff resources or human resource departments.”

Myers said some nonprofit boards become liable by voluntarily adopting all provisions of the Sarbanes-Oxley Act of 2002, a U.S. federal law that set new or expanded requirements for all U.S. public company boards, management and public accounting firms.

The act requires nonprofits to “protect whistleblowers” and retain records of minutes and finances for future reference, Myers said.

“If either of these provisions in the Sarbanes-Oxley Act are violated, it puts directors and officers at risk,” he said.

Types of exposures facing nonprofit boards, Myers said, include employment claims; breach of fiduciary duties, such as care, loyalty or obedience; conflicts of interest; government actions and enforcement and allegations of misuse of funds.

Fellow directors and officers can sue one another, Myers said. Others who can sue a nonprofit board include the state attorney general; the Internal Revenue Service, which can threaten a nonprofit’s 501(c)(3) status; donors who don’t like how their funds are being used; employees; and recipients and beneficiaries of the nonprofit’s mission.

It’s important for nonprofit boards to have directors and officers liability insurance because it funds defense for all claims, even though most are groundless or fraudulent, Myers said.

“It also satisfies the organization’s obligation to indemnify board members, and it encourages qualified people to serve on the board,” he said.

Nonprofit board members don’t necessarily think about these things until something happens, Myers said.

“Then it’s, ‘Why am I being sued? I’m just a member of a board,’” he said. “But it doesn’t matter; they are personally liable. Without D and O insurance, they are relying on the organization to indemnify them, and if the (nonprofit) is small, it may not have the finances to do that.”

Myers believes fear of being sued is definitely a consideration when people think about serving on nonprofit boards.

“But having D and O insurance will mitigate that,” he said.

“Remember that regular general liability insurance only covers claims that allege bodily injury or property damage and will exclude most other claims against directors and officers,” he added.