Serving on the Board of a Nonprofit: No Good Deed Goes Unpunished?

If you’ve ever considered joining or are currently sitting on the board of a nonprofit corporation, you might have some questions about your potential personal liability. While you may well believe in the nonprofit’s mission, it’s unlikely that you actually want to put all of your family’s assets at risk through your board service.

Because D&O risk management for nonprofit boards is something I’m asked about a lot, I thought I’d take this opportunity to address some of the more frequently asked questions.

While Woodruff Sawyer works with only very large nonprofits, I’m hopeful that smaller nonprofit boards will find the general information presented in this post to be helpful. Of course, you should consult with your regular outside counsel or insurance broker to get advice on your own specific situation.

Do directors and officers of nonprofits need D&O insurance?

Yes, absolutely.

One important reason to buy insurance—or make a good faith effort to purchase insurance—is that the controlling state corporate law may make this a precondition to excusing volunteer Ds and Os from personal liability to third parties.

For example, California Corporations Code Section 5239(a) states that there is to be no personal liability to a third party for monetary damages for a volunteer director or officer so long as:

• the act was within scope of that person’s duties,
• the act was undertaken in good faith,
• the act was not reckless, and
• damages caused by the act are covered by insurance (or good faith efforts were taken to obtain insurance).

Note that there are exceptions to this broad exoneration of liability, including proceedings brought by the state Attorney General. Concerning insurance, also note that the Code offers useful specifics about what counts as a good faith effort to obtain liability insurance (see California Corporations Code Section 5239(h)).

Another reason to buy the D&O insurance for your nonprofit is to pay for legal defense costs should a regulator, for example the IRS, bring a proceeding against an individual D or O for some reason. While this is unusual, it is the sort of situation your insurance can be optimized to cover.

Finally, remember that in the United States, you can be sued by anyone for seemingly anything at any time. Many of these suits will be frivolous. Some of these suits will be brought by folks who have no standing to sue you or have no cognizable claim against you. Insurance can cover the cost of the attorney you retain to get rid of these frivolous cases.

How much insurance should you buy?

You probably do not need very much, even for larger nonprofits. Remember that you are buying these policies mainly for defense costs. How much insurance to buy is a good conversation to have with your trusted outside counsel or insurance broker.

Do suits arise frequently?

Not at all. Nonprofit D&O insurance is relatively inexpensive because it is unlikely to be used (especially compared to public company D&O insurance, for example).

Can I buy nonprofit director liability insurance on my own, or in addition to what my nonprofit purchases?

Yes. Talk to your personal lines insurance broker about adding this important coverage to your suite of personal insurance policies. This is a low-cost (and sometimes no-cost) way to bolster your personal level of insurance coverage.

Another option for directors is to explore the purchase of a wealth security policy, though this type of policy requires that the underlying corporate entity already buys its own D&O insurance.

Who actually sues nonprofit Ds and Os?

In many states, it is the state Attorney General who has standing to sue directors and officers of nonprofits for things like breaches of fiduciary duties. As a practical matter, however, it takes a lot to draw the attention of a state’s Attorney General.

Others can sue Ds and Os of a nonprofit, including regulators (think IRS). In some cases, persons with a special relationship with the nonprofit such as members and beneficiaries can sue the Ds and Os of a nonprofit as well.

NonProfitRisk.org gives a long list of who can sue nonprofits, here. It’s comprised of everyone from insiders, third parties, directors, beneficiaries and more. I will note here, however, that this list is so long in part because it picks up things like employment practices liability (think wrongful termination and sexual harassment) as well as suits by vendors and the like.

In other words, the list far exceeds D&O liability risk per se. A few thoughts on this:

• The employment practices liability risk is real, and can be addressed with “EPL” insurance. This can be purchased in combination with your D&O policy, or on a separate basis.
• Some of the other suits are most likely to be brought against the corporate entity for its business practices (i.e., vendors), and not against individual Ds or Os.
• It’s worth talking to your outside counsel or insurance broker about each of the listed categories to better understand where your insurance will or will not respond.

Legal Protections

As a society, we want people to be involved in the work of nonprofits. To support this goal, the law as a general matter is fairly protective of volunteers, including volunteer directors and officers of nonprofit organizations.

At the federal level, the Volunteer Protection Act limits individual liability for activities that fall within the scope of a volunteer’s responsibilities so long as the harm was not the result of willful, criminal or reckless misconduct or gross negligence (there are exceptions, for example for harm involving operating a motor vehicle).

If the relevant state law requires the purchase of insurance (like in California), the Volunteer Protection Act does not preempt or waive this requirement.

State laws also provide protections for volunteer directors and officers. In California for example, the laws protecting nonprofit board members are found in sections such as 5231 and 5239 of the California Corporations Code. These statutes are quite broad.

Section 5231(c) shields directors from liability so long as they acted in “good faith” and no self-dealing was involved. Section 5231(b) authorizes directors to rely on information provided to the directors by others (such as officers or employees whom the director believes are reliable; also independent counsel and committees of the board on which a particular director does not serve). You can find the full text for both sections at LegalInfo.ca.gov, here.

All in all, there is very little liability exposure in California for volunteer directors and officers of nonprofit boards.

For clarity, I’ve been talking here about the liability of individuals. Nonprofit entities themselves can be liable for the acts of their volunteers. Nothing about the federal or state laws concerning liability for individual volunteer directors or officers changes this. In California, see Section 5239(d) of the Corporations Code.

Good Governance

The other question I often receive when it comes to nonprofit D and O liability is how to manage risk beyond just insurance coverage. Here are four key steps you can take:

1. Familiarize yourself with the nonprofit corporations code of your state. 

This is a short reading assignment that will give you a framework to think about your duties and obligations as a nonprofit D or O.  Also, the corporations codes of some states are surprisingly specific.

For example, it would be a shame if you, as a board member, were to allow your nonprofit to make a loan to a D or O because you didn't know that in your state  nonprofits are prohibited from making loans to their Ds and Os.

Finally, remember that the normal corporate fiduciary duty obligations such as the duty of care (be diligent) and the duty of loyalty (no conflicts of interest) apply in the nonprofit context.

2. Run the organization’s finances in a professional way.

A nonprofit isn’t a hobby. Unfortunately, a lot of nonprofits are not run in a reasonably professional way. Do you have accounting process in place? Are bank accounts being segregated appropriately? Are you paying all the appropriate taxes (see No. 3 below)?

These basic areas of corporate blocking and tackling can, if left unattended, lead to trouble for the Ds and Os – not to mention draw the nonprofit away from fulfilling its mission.

3. If you have employees, take employment procedures seriously.

Like any other organization that has employees, nonprofits benefit from having documented procedures and human resource protocols in place. According to this paper by Zurich, employment practice claims are a leading cause of suits against nonprofit directors and officers.

Finally, remember even nonprofit corporations have to pay all required employment taxes.

4. Make sure donations for the nonprofit are used appropriately. 

You might remember a case where the California Office of the Attorney General brought suit against the Monterey County AIDS project for mismanagement of charitable funds. The final settlement was for $1 million in damages. This area is an easy target for a lawsuit, so make sure it’s in tip-top shape.

In sum, sitting on the board of a nonprofit can be incredibly rewarding. The position also entails serious responsibility. Know your duties, treat the nonprofit organization like a real business and purchase appropriate insurance.

This approach plus the protections offered by both state and federal law will help you mitigate any downside risk to being a volunteer director or officer of a nonprofit corporation.