Governance and Form 990: Understanding the Why and the What

The Nonprofit Management Center of the Permian Basin, Midland, Texas

This PowerPoint kicks off by exploring the duties of care, loyalty, and obedience; runs through best practices when drafting policies, keeping corporate records, and considering other governance matters; and, finally, enters the red zone with a ‘glance’ at the Form 990, highlighting key considerations of the 11-page core form.

The Fiduciary Duty of Obedience

Director, red card, obedienceIn fulfilling their roles as directors of nonprofit organizations, directors owe fiduciary duties. Breaches of those duties can lead to a red card — removal and even personal liability. That directors of charitable organizations owe the fiduciary duties of care and loyalty owed is unquestioned. A third duty – the duty of obedience – is not as well recognized though the ideas behind it figure prominently in charity fiduciary law. The duty of obedience is the duty to remain faithful to and pursue the goals of the organization. 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. In short, the duty of obedience requires that directors see that the corporation’s purposes are adhered to and that charitable assets are not diverted to non-charitable uses.

The duty of obedience is somewhat unique to the nonprofit context and particularly tax-exempt organizations. Because tax exemption rests in the first part on being organized for an appropriate tax-exempt purpose (be it charitable or social or any other recognized exempt purpose), these organizations more specifically identify their purposes in their governing documents compared to a for profit business which may be organized to conduct all lawful operations of whatever kind or nature. One court has noted the distinction stating that “[u]nlike business corporations, whose ultimate objective is to make money, nonprofit corporations are defined by their specific objectives: perpetuation of particular activities are central to the raison d’etre of the organization.” Manhattan Eye, Ear & Throat Hosp. v. Spitzer, 715 N.Y.S.2d 575, 595 (Sup. Ct. 1999). With the additional level of specificity as to purpose, the decision maker faces a more defined realm of permissible actions. That realm can be even more narrowly defined when funds are raised for specific purposes.

In the context of a nonprofit corporation, the purpose is stated in the organization’s governing documents (Articles of Incorporation/Certificate of Formation/Bylaws) and may be amplified by other documents such as testamentary documents directing the creation of the organization, the application for exempt status filed with the Internal Revenue Service or solicitations for contributions. Each of these sources should be consulted. Once a director understands the purpose for which the organization is organized, or the more specific purpose for which money or other property has been donated, she must ensure the organization’s property is used to further those purposes as opposed to being diverted to non-charitable purposes or other purposes that while charitable, aren’t the organization’s purposes. Of course in making that decision the director exercises her duty of care and her duty of loyalty as well.

 

 

 

 

 

Fiduciary Duties: An Overview

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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.