Directors' risks of personal liability

By WORLDLawDirect  [January 6th, 2013]

Members of nonprofit boards often worry about being sued. It’s one thing to give their time and attention — and even some money once in a while — to a good cause. It’s another to risk unlimited personal liability if something goes wrong.

Although relatively few nonprofit board members have actually been sued — and fewer have ultimately been found liable for damages — their concern about potential personal liability is real and pervasive.

Board members are properly concerned about two kinds of risk. First is potential liability to unrelated third parties for injury or property damage arising from their acts or omissions on behalf of the organization. This type of “tort” liability is substantially the same as they face in their daily activities, where they can be sued for negligent driving that causes an automobile accident, for example, or negligence in leaving a banana peel on the floor that causes a guest to slip and fall during a cocktail party.

Second is the potential for liability to the organization itself for failing to fulfill their “fiduciary” duties. These include the duty of loyalty and the duty of care.

Liability to Third Parties

One of the great benefits of the corporate form is its limitation on personal liability. Normally, an individual is not personally liable for a breach of contract or other improper conduct of the organization itself, or for that of other agents or employees of the corporation. The protection does not apply, however, to the personal conduct of the individual. Every individual is responsible for his or her own actions.

A board member of a nursing home would not ordinarily be personally liable, for example, if a nurse’s aide dropped a resident while trying to transfer the resident to a wheelchair. Although the home might be liable for the negligence of the aide, the board members would not be personally liable for the aide’s conduct. If, however, the board had specifically decided not to train the nurse’s aides in how to make such transfers, knowing that the failure to train created a substantial risk of harm for the residents, a member of the board who had agreed with that decision might be personally liable for the resident’s injury.

Volunteer Protection Laws

During the 1980s and early 1990s, most states passed volunteer protection laws (sometimes called “shield laws”) to reduce the risk of personal liability for volunteers for charitable organizations. Some laws provide complete immunity from lawsuits except in cases of gross negligence or intentional injury. Some, such as the Pennsylvania law, provide that a volunteer will not be held personally liable unless the volunteer’s conduct falls “substantially below” the standard of conduct of “similar persons” “in like circumstances.”

In 1997, Congress passed the federal Volunteer Protection Act, which provides that volunteers for charities and certain other civic groups will not be personally liable for their acts or omissions in most situations if they are acting within the scope of their responsibility for the organization and the harm is “not caused by willful or criminal misconduct, gross negligence, reckless misconduct, or a conscious flagrant indifference to the rights or safety of others.”

If board members are paid for their services on the board, of course, they do not qualify for the protections of the volunteer protection laws. They should consider carefully whether a small payment for attending board meetings is worth the loss of statutory protection.

Fiduciary Duties

The second area of potential liability for a board member is a breach of fiduciary duty to the organization itself.

The duty of loyalty is pretty clear. The board member may not put his or her interests ahead of the interests of the corporation. The most obvious areas of danger involve economic conflicts of interests. Some boards take the position that they will have no financial dealings with any member of the board.

Most boards, however, are not so absolute so long as the conflict is disclosed before the transaction is entered into, the deal is fair to the corporation, and the arrangement is approved by disinterested members of the board or a special committee.

The independent review is particularly important now that Congress has authorized the IRS to impose “excess benefits” taxes under the “intermediate sanctions” provisions added to the Tax Code in 1996

The IRS may tax a board member or other “disqualified person” who gets a benefit from a charity in excess of the value of the goods or services he or she provides in return. The statute was passed primarily to curb unreasonable compensation for executives, but is broad enough to cover any arrangement with a member of the board or certain family members or affiliated entities.

It is critical for the organization to maintain a conflict of interest policy that requires disclosure of any potential conflict to assure that independent decisions can be made.

The duty of care is usually spelled out in the state nonprofit corporation law. Although the exact wording may vary, the statutes generally provide that a board member has a duty to act in good faith, in a manner he or she reasonably believes to be in the best interests of the organization, and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances.

Many statutes provide, in addition, that a board member may rely in good faith on information presented by officers or employees of the corporation, by counsel, by public accountants or other professionals and by committees of the board, so long as the board member reasonably believes them to be reliable and competent.

Some statutes also provide that, in considering the best interests of the corporation, a board member may consider the effects of any action on “any and all groups,” including employees, suppliers and clients of the corporation, and on the communities in which it operates.

As additional protection, some states allow the corporation to enact a bylaw that provides that a member shall not be personally liable for breach of duty unless the breach involves self-dealing or willful or reckless misconduct.

A board member who does the homework, shows up regularly, pays attention, is willing to ask “dumb questions,” and acts in good faith in pursuit of the mission of the organization is likely to survive a suit for breach of the duty of care.

You Need to Know

Although board members can cut the risk of personal liability by conforming their conduct to the appropriate standards, they cannot control whether or not they will be sued. Therefore, they should be sure that the organization maintains proper insurance to protect them against foreseeable hazards, including general liability coverage, professional liability coverage where appropriate, and directors and officers liability insurance.

See also...

Tax Law - Forum

Nonprofit Law and Fundraising

Attorneys, Courts, Litigation