A Pocket Primer For Young Attorneys Advising Nonprofit Organizations I: The Board's Fiduciary Duties - ABA YLD 101 Practice Series

By Benjamin J. Kimberley

As a result of the recent downturn in the economy, a large number of young attorneys are walking down an alternative career path:  counseling nonprofit and/or charitable organizations.  These opportunities often provide young attorneys with a wealth of experience working closely with an organization's Board of Directors (the "Board") at a young age.  However, beware the changing legal landscape and the pitfalls it represents for your nonprofit organization's Board. 

This article offers a general review of fiduciary duty law related to nonprofit governance.  However, if confronted with a specific legal issue, you should review relevant federal and state law regarding your issue.

I.  The Nonprofit Governance Landscape
In the wake of recent scandals in the nonprofit world, the federal and state government is expanding its scrutiny from solely for-profit corporations to the nonprofit sector.  Although the law regarding nonprofit governance is not nearly as robust as in the corporate sector, there are clear indications that this soon may be the case.  For instance, the recent health care legislation signed into law on March 23, 2010 includes provisions that require increased financial monitoring on behalf of tax-exempt, charitable hospitals.

In many cases the greater scrutiny on nonprofit organizations' behavior stems from problems arising from:

  • Excessive management compensation;
  • Misuse of organizational assets;
  • Failure to properly understand and monitor the organization's finances;
  • Failure to obey organizational mission statements;
  • Failure to adhere to or achieve the organization's long-term values.

With recent legislation increasingly treating nonprofit Boards like their for-profit counterparts, the nonprofit organization that you counsel is likely seeking to understand (1) how it fits into the public corporation governance rules, (2) whether adopting certain elements is appropriate, (3) how to evaluate Board composition and Board effectiveness, (4) how to assess the type and detail of information reported to stakeholders, and (5) concerns regarding liability and reputation.  Although this paper cannot answer all of these questions, it gives you a jumping-off point to seek out the answers to those questions.

II.  Basic Fiduciary Duties
Directors of nonprofit organizations typically have two main fiduciary duties:  the duty of care and duty of loyalty.  Although some jurisdictions discuss the duty of obedience, it exists more as a common-sense extension of the twin duties of care and loyalty.  It is addressed separately here because of the important role that mission and long-term values play in nonprofit organizations.  For example, whereas most stakeholders of for-profit corporations (like shareholders) share a unifying interest in increased profits, stakeholders of nonprofit organizations sometimes hold vastly divergent interests for the organizations.  The one unifying force for the organization may therefore be its mission statement and long-term values.

A.  Duty of Care
The duty of care requires a director to be informed regarding the affairs of the organization and to exercise the care that a prudent person in his or her position would exercise, and to do so in a manner that the director reasonably believes to be in the best interest of the organization.  As a best practice, a director should at least do the following in order to fulfill his or her duty of care:

  • Attend regularly scheduled meetings (usually held monthly or quarterly);
  • Inform themselves of the mission and long-term values of the organization;
  • Inform themselves of the affairs and finances of the organization;
  • Hire qualified leaders and periodically monitor their performance;
  • Exercise independent judgment.

Directors may rely upon information regarding the organization's finances and affairs provided by the organization's staff, including officers, accountants, committees, and other advisors.  However, if the director does rely upon this information, he or she must at least do the following in order to fulfill his or her duty of care:

  • Read or listen to the information provided;
  • Understand that information or actively attempt to understand it;
  • Request additional information if the provided information is insufficient to form an opinion or support a decision.

B.  Duty of Loyalty
The duty of loyalty requires a director to exercise his or her duties in a manner that furthers the interests of the organization rather than his or her personal interest or the interest of another person or organization.  A director must at least do the following in order to fulfill his or her duty of loyalty:

  • Avoid conflicts of interest and, if conflicts arise, report them immediately;
  • Never use information obtained as a director for personal gain or opportunity;
  • Maintain the organization's confidences.

If any actual or potential conflicts of interest arise, a director should immediately reveal it to the Board.  For example, if the director is on the Board of two organizations competing for the same project, he or she must inform each Board.  Similarly, if any family or employment relationships raise the specter of conflicted interests, the Board should be informed of those relationships.

C.  Duty of Obedience
The duty of obedience is a duty to carry out the organization's nonprofit purposes and to obey the law.  The Board is generally tasked with the responsibility for consistently executing the organization's mission through its various programs or projects, developing and overseeing implementation of a strategic plan, and safeguarding the achievement of the organization's core, long-term values.  This duty guides the directors' decisions and manages and protects stakeholders' expectations. 

III.  Conclusion
The legal requirements of Board governance of nonprofit organizations increasingly resemble those of for-profit corporations.  As the advising attorney, you are required to advise the Board of its fiduciary duties and the changing law regarding these duties.  Amid this changing legal landscape, you can become a valuable asset to your nonprofit organization by properly preparing yourself and the Board you advise to face upcoming governance challenges.

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About the Author

Ben Kimberley is an associate in Winston & Strawn LLP’s San Francisco office.  His practice involves fiduciary and business tort issues, including fiduciary duty disputes (which involve directors, officers, trustees, and other agents), managing related corporate investigations, and litigating complex commercial cases.  He is also an active member of the ABA and the Northern California District Representative for the ABA’s Young Lawyers Division.  Mr. Kimberley received a B.A., with Honors, from Northwestern University and a J.D. from the University of California, Berkeley School of Law.

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