“If my nonprofit is sued and I am on the Board of Directors, can I also be sued as an individual?” I get this question all the time from dedicated people who volunteer their time and expertise to help guide nonprofit organizations.

Can you be liable? The answer is, “Yes.”

 However, the risk of you getting sued is low and can be made even lower by knowing the legal principles and complying with certain rules.

It is reasonable for Directors — especially those in higher income brackets – to be concerned about the possibility of getting sued relating to their board service. Furthermore, potential Directors may be reluctant to serve on a board if they think their personal wealth may be at risk. That risk rises in smaller organizations because they have less ability to pay legal claims.

Director Liability

The longstanding legal principle in Minnesota is that corporate Directors are not generally liable for decisions they make and acts they do on behalf of the corporation — if they act according to their fiduciary duties and do not breach them. However, there are exceptions.

The rules are mostly the same whether one is a Director of a for-profit board or a nonprofit board. In most cases, Directors serve on the board of a state-based corporation; in rare cases, it may be a limited liability company (“LLC). In both for-profits and nonprofits, the Board of Directors is in charge of running the organization, with the authority to delegate duties and employ staff to get things done and make some decisions.

Business Judgment Rule

The default position for the Courts is that the Directors are in the best position to decide what is best for their corporations, not the Courts. Courts will not second guess the decisions and actions of directors, so long as the directors have not breached their fiduciary duties.

That is why Courts let most board decisions stand when a plaintiff challenges them. The exceptions happen when they sense something fishy going on. That fishy odor tends to be emitted when directors do bad things.

The Three Fiduciary Duties of Directors:

1. The Duty of Care
2. The Duty of Loyalty
3. The Duty Obedience

The Duty of Care

The Directors of Minnesota nonprofits are expected to take care that they are acting in good faith, making reasonable decisions that will serve the best interests of the organization. They should behave the way any prudent person would behave under similar circumstances.

In most cases, the Duty of Care is the main rule to follow for nonprofit Directors. Directors formally act only as a Board. They have meetings and make decisions, usually in the form of approved motions. Since the Directors manage corporate affairs, the board must to that with proper care.

The Duty of Care at an individual level means that each Director should become acquainted with the issues on the agenda, and attend board meetings prepared to discuss the issues. They do not have to know everything about each matter before them, but they need to know enough to make an informed vote. The opposite of care is exemplified by Directors who show up at board meetings unprepared, uninformed, and in the dark about the items they will vote on. This is one way to breach their Duty of Care.

Careful deliberation and decision-making require good information. Directors should be aware of all information reasonably related to the issue at hand. They need to ask for it if they don’t have it. Once they get it, they need to read it. This doesn’t mean that they have to become experts in everything. It’s okay to rely upon information provided by people who are experts — like accountants and attorneys.

Directors should not vote on an issue unless they are confident that they understand it and have properly discussed the matter in a board meeting. If all of the Directors do this, the end decisions should be protected by the Business Judgment Rule. They have complied with the Duty of Care. In such cases, the Court will likely side with the corporation if a plaintiff files a suit, and there will be no damages to pay.

In summary, Directors can comply with their Duty of Care by actively participating in board matters, getting the information they need, absorbing it, asking good questions, getting good answers, and staying informed. Do not leave the details to some other Director. A Director cannot shift this duty to another person.

Duty of Loyalty

Loyalty means that a Director’s decisions and actions must serve the interests of the corporation. Disloyalty would include working against the interests of the corporation either directly or indirectly, through a conflict of interest that would benefit another organization, yourself, or your family. This means a Director should not steer employment opportunities or contracts to other people, family, or organizations, unless doing so is in the best interests of their nonprofit. Family in this case means your spouse, parents, children, and in-laws.

The Duty of Loyalty is more obvious in for-profit corporations, in which a disloyal Director might compete with their organization by stealing customers and other information for their personal benefit. In the nonprofit setting, this duty is more obscure, but still exists. In nonprofits, Directors are not allowed to actively work against the organization for the benefit of themselves or other nonprofits.

On rare occasions, a Director may in good faith oppose their organization for its own good. In such cases it may be wiser to just resign and join an organization to which you can be unequivocally loyal.

It is a good idea for Boards of Directors to institute conflict of interest policies for this reason and to have certain language in their bylaws about what types of matters that come before the board that a particular director should avoid. For example, if the director’s son is up for the job of executive director, the parent board member has a conflict. They should declare this conflict to the board, stay out of the discussion and not vote on the matter. Doing otherwise is likely a breach of the Duty of Loyalty.

The Duty of Obedience

A Director must obey state and federal statutes regarding the organization, as well as its bylaws. They must also support and carry out the organization’s mission. Breach of this duty would be to actively disobey the law or ignore the bylaws. One example would be to improperly carry out Board elections.

Compliance with the Duty of Obedience requires Directors to be familiar with state and federal statutes and laws relating to nonprofit corporations. Directors must also be familiar with the organization’s own governing documents, such as articles of incorporation, bylaws, and policies and procedures. If a bylaw or a policy proves to be problematic, the proper response is to try to change them rather than just ignore them.

A breach of the Duty of Obedience may require a simple correction, but it could warrant removal from the Board or even filing criminal charges. However, if a “bad apple” remains on the Board, it may taint Board-approved actions. Approved motions based on a director breaching their duties could lose the protection of the Business Judgment Rule and subject the organization to liability.

Indemnification

As long as Directors adhere to the three Fiduciary Duties, Minnesota Statutes for nonprofits provide that those Directors are protected from legal damages as individuals. In such cases the corporation must pay for legal costs, judgments, and other expenses of a Director or officer who is threatened or made party to a lawsuit against the corporation. That is nice for the Director involved, but only if the organization has the money to pay those amounts on the Director’s behalf. If not, and the plaintiff wins, there will be a judgment that needs to be paid along with attorney fees and court costs.  An organization’s bylaws may have language that imposes conditions or limits on the indemnification.

Directors and officers liability insurance

It is a good idea for organizations to explore Directors and officers liability insurance. When a plaintiff suspects the organization may have trouble paying the costs, they may name in the suit Directors with deep pockets. You cannot get blood out of a turnip, you know. But if the organization has Directors and officers liability insurance, it will keep the plaintiff out of the Directors’ pockets. These policies are generally designed for the purpose of indemnification, so long as the policy covers such losses and the judgment and costs are not over the policy limits.

I suggest that all nonprofits review their insurance often. In my experience, many nonprofits and for-profits do not know exactly what their policies actually cover.  For example, a general liability policy is not a Directors and officers liability policy, which must usually be obtained separately. Ask your insurance provider about the perils I describe above and get assurances they are covered. And find out for how much. Let me know if you need referrals to insurance brokers.

Conclusion

Serving on a nonprofit board is a rewarding experience. It is a great way to lend your time and expertise to an organization whose mission you support. In my experience, there are as many unique situations regarding Director and organizational issues as there are nonprofits. Directors can help greatly to forestall liabilities in several ways:

1. Strengthen the organization’s governing documents;
2. Design and implement effective board training; and
3. Assure that Board minutes capture adherence to the directors’ duties

I look forward to discussing your nonprofit’s needs, governance matters, legal issues, bylaws, policies, contracts, and more. Please feel free to contact me.