Legal Obligations and Best Practices of Board Members

by Bob Moreland CPA, Tax Manager – Ohio Office

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Serving on the board of a nonprofit organization can be an honor; however, it is important to keep in mind that board members can be held accountable for the organization’s actions. Due to the federal government’s increased emphasis on regulatory compliance and False Claims Act enforcement, this responsibility should not be taken lightly. Board members are legally required to be informed and active participants in corporate governance in acting to fulfill the nonprofit’s charitable mission. This article discusses some of the legal obligations and best practices to consider when creating an effective board.

The Fiduciary Relationship

When an individual serves on a board, a fiduciary relationship is created. This fiduciary relationship with the organization is one-sided, meaning that the relationship is designed to meet only the needs of the organization and the board member must act without regard to his own needs. When serving on the board of a nonprofit organization, board members are fiduciaries because they have been entrusted with overseeing the fulfillment of the organization’s mission. They must be principally concerned about the performance of the nonprofit and that its interests are pursued faithfully.

This relationship between board member and the organization is a legal one, and board members have an obligation to monitor and oversee not only the organization’s financial dealings, but also its ongoing regulatory compliance program.

As a board member, the main priority is to ensure that the organization’s resources are used to achieve its exempt purpose and mission. The obligations that govern this include the duties of care, loyalty and obedience.

Duty of Care

A trustee has a responsibility to participate in decision-making on behalf of the organization and must exercise independent judgment while doing so. These decisions must be informed, meaning that the board member should make efforts to become familiar with the relevant, available facts. For instance, members should require management to provide sufficient information to make an independent decision. If the information is invalid or incomplete, the board members are expected to ask questions about it. Additionally, independent advice is required if the nonprofit is buying or selling significant assets, or is entering into a material contract. This is especially important if the organization is entering into a joint venture, sale or merger, or if the company presenting the information stands to benefit from the transaction, such as the continuation of a management contract when management is a company organized separately from the nonprofit organization.

With respect to corporate compliance, the duty of care requires that board members attempt in good faith to assure that a corporate information and reporting system exists and this reporting system is adequate to assure the board that appropriate information, regarding items such as compliance with current regulations or notice of new laws, will come to its attention in a timely manner as a matter of ordinary operations.

Failure to comply with fraud and abuse statutes as well as other federal and state laws can expose a nonprofit organization to significant criminal and civil monetary penalties that could directly impede its ability to carry out its exempt purpose. For example, if a health care organization is in violation of certain federal and state regulations, it may be excluded from participation in Medicare, Medicaid and other federal health care programs for a period of five years or more. Exclusion and the loss of reimbursement payments could be fatal to a hospital or system.

Duty of Loyalty

When acting on behalf of an organization, board members must set aside their own professional or personal interests in favor of the organization’s interest. Simply put, the nonprofit organization must come first. A board member cannot seize an opportunity for his or her own personal gain. Even if it is only part of the organization’s future plans, the opportunity must be presented to the organization first. Similarly, it is a breach of the duty of loyalty to fail to preserve the confidentiality of the organization’s affairs. Disclosing opportunities to outside individuals may lead to loss of opportunity for the organization.

Duty of Obedience

Board members have a responsibility to be faithful to the organization’s stated mission and not to act or use its resources in incompatible ways or purposes.

Complying with these obligations can protect a nonprofit board. As long as decisions of the trustees are made on an independent and informed basis, in good faith and in the best interests of the organization, they are not subject to challenge in court. This presumption is called “the business judgment rule,” and applies unless there is evidence showing a board member has an interest in the transaction or dispute or was otherwise disloyal, uninformed or lacked independence.

Sources:
http://www.huffingtonpost.com/eugene-fram/beyond-the-bylaws-a-clari_b_5625204.html

Ten Basic Responsibilities of Nonprofit Boards (from nami.org)

http://grantspace.org/Tools/Knowledge-Base/Nonprofit-Management/Accountability/legal-duties-of-the-nonprofit-board