This post is the first in a series about fiduciary duties of directors and officers of nonprofit corporations. Future posts will continue from this overview with a more in depth look at various aspects of fiduciary law in this context.
Federal tax law often grabs the focus of directors of nonprofit organizations. Complying with the requirements of the Internal Revenue Code and understanding the regulatory role of the IRS is (or should be) an ever-present consideration for the board. However, that is only one consideration in complying with legal requirements imposed on directors. The other consideration comes under state law. State law, with the state attorney general as the regulatory authority, governs many aspects of the life of a nonprofit and its board. From governance to charitable solicitation to reporting requirements, directors must be familiar with the laws imposed on nonprofit organizations in their state.
Perhaps the most critical area in which state law dictates requirements for directors is in the area of governance where state law imposes certain fiduciary duties on the directors (and officers) of nonprofit organizations. All decision makers owe certain fiduciary duties to the organizations they serve. A fiduciary duty is simply a duty to act for someone else’s benefit — putting the other’s benefit before your own. Fiduciary law developed at common law, though many states, including Texas, have codified various fiduciary requirements in their business organizations codes.
Corporate fiduciaries stand in the unique position of being the keeper of the organization’s assets and the guardian of the organization’s mission. This unique role plays itself out in the duties of care, loyalty and obedience. Whereas directors are charged largely with making strategic decisions, evaluating, reviewing, overseeing and approving, officers are charged with implementing the decisions and policies established by the board. Nevertheless, the three primary duties remain the duty of care, duty of loyalty, and duty of obedience.
The duty of care most simplified is a duty to stay informed and exercise ordinary care and prudence in management of the organization. With respect to nonprofit corporate directors and officers, the duty of care under Texas law mandates that the decision maker act (1) in good faith, (2) with ordinary care, and (3) in a manner he or she reasonably believes to be in the best interest of the corporation.
The second significant fiduciary duty owed by decision makers of nonprofit organizations under Texas law is the duty of loyalty. The duty of loyalty requires that the decision maker act for the benefit of the organization and not for her personal benefit, i.e. the duty of loyalty requires undivided loyalty to the organization.
To satisfy her duty of loyalty, a corporate decision maker must look to the best interest of the organization rather than private gain. Courts have noted that the duty of loyalty requires an extreme measure of candor, unselfishness, and good faith. The director must not usurp corporate opportunities for personal gain, must avoid engaging in interested transactions without board approval, and must maintain the organization’s confidential information.
Along with the duties of care and loyalty, decision makers of nonprofit organizations owe the additional duty of obedience, the duty to remain faithful to and pursue the goals of the organization and avoid ultra vires acts. In practice, the duty of obedience requires the decision maker to follow the governing documents of the organization, laws applicable to the organization, and restrictions imposed by donors and ensure that the organization seeks to satisfy all reporting and regulatory requirements. The duty of obedience thus requires that directors see that the corporation’s purposes are adhered to and that charitable assets are not diverted to non-charitable uses.
Understanding these three duties, and how to satisfy these duties in the context of governing a nonprofit organization, is the foundation of good governance. The duties inform what decisions should be made (or must be made), how those decision are to be made, and when the issues are ripe for decision. Breach of these duties can do harm to the organization and create personal liability to the breaching director or officer (note, while the board governs, the duties are owed individually). The next posts in this series will take a more in-depth look at each of these three duties in turn. The series will conclude with an examination of standing to complain about breach of these duties.