Fiduciary Duties of a Board Member for a Nonprofit Organization

by Gary R. Pannone

In most jurisdictions, including Rhode Island, the role of a board member for nonprofit organizations seriously impact policies for governance, financial matters and the strategic planning of their organization. The authority granted to the board member carries a corresponding duty of duty of care, loyalty and obedience when acting on the behalf of the organization.

What is the “Duty of Care?”

The duty of care means that the board member must act: (a) in good faith; (b) with the care that an ordinarily prudent person in a like position would exercise; and (c) with a reasonable belief that the action to be taken is in the best interests of the organization.

Good Faith – Good faith requires honesty and fair dealing and is measured by reviewing objective facts and circumstances related to the decision.

Ordinary Prudence and Due Diligence – Ordinary prudence means that directors need to act with “common sense and informed judgment.” Ordinary prudence does not require a director to have special skills to perform board duties; however, “diligence” requires that a director take an active interest in the organization’s activities which necessarily involves a proactive approach in making decisions on behalf of the organization and exercising oversight. Voting in favor of all requests by officers or simply “rubber stamping” recommendations made by lower levels of management does not satisfy this requirement and may subject the board member to scrutiny.

Best Interests of the Organization – A board member must ask, “Is the decision to be made in the best interests of the organization?” It is permissible for a director of a nonprofit organization to rely upon the expertise of management and/or outside consultants; however, prudent care requires reasonable inquiry and it is the director’s fiduciary duty to be well informed when considering and accepting the opinions of others. As a general rule those who may be relied upon in providing expertise and recommendations include officers, employees whom the director reasonably believes to be reliable and competent in such matters, advice from legal counsel, accountants or outside consultants.

It should be noted that board members are afforded the benefit of volunteer protection statutes and the common law “business judgment rule” when making decisions. The business judgment rule provides a rebuttable presumption that the decision made by a board or its member constituents was in the best interest of that board member’s organization. The policy and rationale behind this rule is that boards function best when informed decisions are not continually disrupted by judicial scrutiny, except of course, in cases of egregious board misconduct.

Duty of Loyalty

The duty of loyalty requires that actions taken by a board member further the organization’s goals over personal interests. This duty prohibits a board member from using his or her position, or information gained from occupying such a position, to secure a personal pecuniary benefit. Statutory guidance is provided in all states dealing addressing the importance of fiduciary loyalty and identifying what constitutes a conflict of interest. Contracts made on behalf of a nonprofit corporation in which a voting board member has a financial interest may be considered void or voidable as it relates to the organization and it is also possible that the Internal Revenue Service may issue sanctions in certain transactions between nonprofit organizations and a “disqualified person.”

The Internal Revenue Code defines a disqualified person as one who is or was in a position to exercise substantial influence over the affairs of the organization at any time during the five years preceding the transaction. This of course, may include, among others, past or current officers, directors, trustees, highly compensated and/or high level employees, department or project managers, major donors and vendors.

Nonprofit organizations should always publish a conflict of interest policy outlining the following at a minimum:

(i)    Determinations regarding conflicts;

(ii)   Scope of the activities to be covered;

(iii)  How the policy will be enforced;

(iv)  Training programs for board members, management and staff; and

(v)   Policy review periods.

An effective conflict of interest policy will be tailored to the specific nature of the nonprofit organization and serves as a guide to be reviewed annually and enforced uniformly.

Duty of Obedience

The duty of obedience requires the board member to comply with both state and federal laws when acting as a board member. As a practical matter this calls for board member compliance with, among other things, tax, civil rights, and non-discrimination and employment laws. While this certainly does not mean that board members must have a law degree and be an active member of their state’s bar, it does suggest that board members should exercise good judgment (duty of care) and seek professional advice when reasonable necessary.

It may require that a board adopt policies and protocol to ensure legal compliance. The duty of obedience also requires that the board member actions always be in conformance with the Articles of Incorporation, Bylaws and Conflict of Interest Policies. The board member’s actions and decisions must always be consistent with the mission statement of the organization and within its organizational authority.

Gary R. Pannone is the Managing Partner of Pannone Lopes Devereaux & West LLC and has been representing closely held business owners for thirty years.

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