DUTIES AND RESPONSIBILITIES OF DIRECTORS

OF CHARITABLE ORGANIZATIONS

 George Chuang

TAF Director, Attorney

            Perhaps because directors of charitable or nonprofit organizations often volunteer their time and services, they often overlook the fact that, like directors of profit-oriented organizations, they have a “corporate responsibility” to the corporations for which they serve.  (California Corporations Code §§ 5231(a).)  This responsibility is certainly not new, but it is one on which the spot light has been re-focused given the flurry of highly publicized corporate scandals involving misuse of positions and powers - i.e., Enron, Adelphia, Tyco, etc.  We therefore present a general overview of the duties and responsibilities of directors of California non-profit corporations.

            Directors of a California nonprofit corporation are responsible for the management of the business and affairs of the corporation, and in doing so, are charged with fiduciary duties of care, loyalty and obedience to the law.  These are duties requiring utmost trust, candor and care.  In discharging these duties, directors must keep in mind the purpose of the non-profit organization that they are serving as well as the State and Federal qualifications that must be satisfied for the organization to maintain its non-profit status in the eyes of the State and the Internal Revenue Service.

 Constituencies:

Unlike for-profit companies where the constituencies to whom the directors must accountable are clear (i.e., the shareholders), the constituencies to whom directors of non-profit organizations are accountable are not as well known.  In other words, there typically are no shareholders to whom directors of non-profit organizations are accountable; however, there are a number of other groups that must be considered.

One of the primary sources of authority to whom nonprofit boards in California must answer is the Attorney General of the State of California.  The Attorney General is charged with representing the public – a concept that is apt as the existence and purpose of non-profit organizations are for the public good.  Therefore, a state’s attorney general is often charged with defending the public against fraud or improper conduct on the part of nonprofit organizations or their boards.

In addition to the Attorney General, non-profit organizations that enjoy favorable tax treatment under the Internal Revenue Code must account to the IRS, which is charged with enforcing the qualifications for tax-exempt status under § 501(c)(3) of the Internal Revenue Code.  In some circumstances, state authorities may also monitor tax compliance of charitable organizations, and to that extent, the organization must also account to those authorities.

Finally, there is a growing body of law indicating that the directors of a financially distressed for profit corporation owe expanded duties of care and loyalty to creditors, in addition to shareholders.  Because this expanded responsibility could potentially apply to nonprofit organizations, their directors and officers should be extra vigilant during times of economic hardship as to how their actions and decisions may impact the creditors of the non-profit organization.

Duties and Responsibilities:

Directors of nonprofit corporations are fiduciaries – i.e., persons who hold a position of trust, confidence and utmost good faith and candor.  As such, they owe important duties, among which are duties of care, loyalty and obedience, all of which must be discharged in a manner the director reasonably believes to be in the best interests of the corporation, and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.  (California Corporations Code §§ 5231(a), 7231(a).)  These duties are arguably heightened when the director is “interested” in the transaction at issue – i.e., when he or she may derive a personal benefit from the decision of the nonprofit’s board of directors.  (See Raven’s Cove Townhomes, Inc. v. Knuppe Dev. Co. (1981) 114 Cal.App.3rd 783; Cohen v. Kite Hill Community Ass’n (1983) 142 Cal.App.3rd 642.)

                        The Duty of Care

A director’s duty of care generally requires that he or she take adequate steps to make informed decisions and to act as an ordinary prudent person would act in the same circumstances.  The following are factors affecting the determination of whether a director has discharged his or her duty of care:

- Active Participation:  A director must actively participate in the management of the organization including attending meetings of the board, evaluating reports, reading minutes, reviewing the performance and compensation of the officers, etc.  Persons who do not have the time to participate as required would be well served by not agreeing to be on the board in the first place.

- Board Actions:  A director must actively participate in board actions.  A director who is present at a meeting when an action is approved by the entire board is presumed to have agreed to the action unless the director objects to the meeting because it was not lawfully called or convened and does not participate in the meeting, or is prohibited from voting on the action because of a conflict of interest.  A director who therefore opposes a board action must affirmatively vote against the action.

- Meeting Minutes:  Written minutes should be taken at every board meeting that should accurately reflect board discussions as well as actions taken at meetings.  A director must review the minutes to ensure that their accuracy.

- Books and Records:  A director should have general knowledge of the books and records of the organization as well as its general operations. The organization’s articles, bylaws, accounting records, voting agreements and minutes must be made available to members and directors who wish to inspect them for a proper purpose.

- Record Keeping:  A director should not only be familiar with the content of the books and records, but should also assure that the organization’s records and accounts are accurate. 

- Trust Property:  A director has the duty to protect, preserve, invest and manage the corporation’s property and to do so consistent with donor restrictions and legal requirements. 

- Investigations:  A director has a duty to investigate warnings or reports of officer or employee mismanagement.  In some situations a director may have to report misconduct to the appropriate authorities, such as the police or the Attorney General. Where appropriate, a director should consult an attorney or other professional for assistance.

            The Duty of Loyalty:

A director’s duty of loyalty requires that he or she place the interests of the corporation above his or her own, and act in a manner that he or she reasonably believes is in the best interests of the organization.  (California Corporations Code §§ 5231(a), 7231(a).)  The director’s loyalty must be complete and undivided.  For a non-profit organization, the director must act to advance and achieve the organization’s purposes, and must guard against using his or her position or the organization’s assets in a way that would result in monetary or other personal gain for the director.

“Loyalty” means placing the corporation’s interests ahead of any other business or personal interests.  This duty is generally encountered in connection with things directors must not do - i.e., they must not compete with the corporation, take personal advantage of “corporate opportunities,” act with any conflict of interest, etc.  For example, each director should consider the following:

- Conflicts of Interest:  A director may not enter into transactions on behalf of the non-profit organization in which the director has a material financial interest or other conflict of interest.  Under certain limited circumstances, such a transaction is acceptable; however, if the transaction is challenged, the director will have the burden of establishing that the contract or transaction was fair and reasonable, that there was full disclosure of the conflict and that the contract or transaction was approved by the non-interested directors in good faith.

- Loans:  A nonprofit corporation may not lend money to a director or the director’s family members unless the loan may reasonably be expected, in the judgment of the entire board, to benefit the corporation.

- Corporate Opportunities:  A director may not divert corporate business opportunities for his or her personal gain.  This means that a director may not engage in or benefit from a business opportunity that is available to and suitable for the corporation unless the corporation decides not to engage in the business opportunity and he or she follows conflicts of interest procedures.  (See Industrial Indemnity Co. v. Golden State Co. (1953) 117 Cal.App.2nd 519.)

Directors, in discharging their duty of loyalty, must be guided by the fact that they are serving an organization, and have a duty to follow the organization’s governing documents (articles of incorporation and bylaws), to carry out the organization’s mission and to assure that its funds are used for lawful purposes. 

The Duty of Obedience:

A director’s duty of obedience generally requires that he or she abide by the state and federal regulations governing the non-profit organization that he or she serves.  For example, each director should: 

-  Be familiar with state and federal statutes and laws relating to nonprofit corporations, charitable solicitations, and related employee and tax considerations.

-  Comply with deadlines for tax and financial reporting, for registering with the Attorney General, for making social security payments, for income tax withholding, etc. 

-  Be familiar with their organization’s governing documents and follow the provisions of those documents.  Directors should be sure proper notice is given for meetings, that regular meetings are held, that directors are properly appointed and that the organization's mission is being accomplished.

In instances where necessary or appropriate, obtain the opinions of outside professionals such as legal counsel or accountants.

Directors’ Liability:

Directors who abide by their obligations will be afforded the protection of various laws designed to shield them from personal liability for any damages or penalties assessed in such a suit.  Therefore, except for “self-dealing transactions,” a director who performs his or her duties in accordance with the statutory standard of care “shall have no liability based upon any alleged failure to discharge the person’s duties as a director.”  This is true even when the director’s acts or omissions exceed or defeat the corporation’s charitable purpose.  (See California Corporations Code §§ 5231(c), 7231(c), 9241(c).) 

Directors who do not abide by their obligations may be subject to personal liability.  In other words, directors who comply with their obligations to the non-profit organization that they serve are protected while those who do not are exposed.  In fact, in addition to the statutory protections discussed above, non-profit organizations may or will often indemnify the director for defense and other costs if the director acted in good faith, with the care of an ordinary prudent person, and in a manner he or she believed to be in the best interests of the organization.  Moreover, various other statutory provisions insulate uncompensated (or “volunteer”) directors and officers of specified nonprofit corporations from monetary liability for negligent acts or omissions in the performance of their duties, provided certain conditions are satisfied.  (See California Corporations Code §§ 5047.5, 5239, 7231.5, 9247.)

Conclusion:

Given the current environment concerning corporate responsibility, directors of nonprofit organizations should (and indeed, must) re-evaluate how they exercise their oversight responsibilities and discharge their fiduciary duties, and whether they are being faithful to their many constituents, regardless of their personal goals or concerns.  Adherence to their obligations benefits not only the organization they serve, but ensures that directors of non-profit organizations will not be exposed to personal liability for their charitable actions and volunteer services.