The Fiduciary Duty of Care

In a previous post I described the three basic fiduciary duties owed by officers and directors of nonprofit organizations — the duties of care, loyalty, and obedience. This post will focus on the duty of care.

Designing football play on chalkboard

One of my law partners likes to say the duty of care is the duty to show up, to suit up and to speak up (or to get out). He talks like that because he’s a former athlete (which he’s happy to talk about — he even has old footballs and pictures from his playing days’ in the 60s all over his office). But he’s right. If you’re not willing to be all in participating as a part of the team, you don’t need to be on the team. Let someone else who is willing to be fully engaged serve that part. It’s a good short-hand way to remember what’s required by the duty of care, but I’ll try to flesh it out a bit.

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 (where I practice) 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. This standard developed at common law but has actually been codified as a part of the Texas Business Organizations Code.

Good faith

Texas law doesn’t define “good faith” in the context of fiduciaries. Broadly, the term describes “that state of mind denoting honesty of purpose, freedom from intention to defraud, and, generally speaking, means being faithful to one’s duty or obligation.” BLACK’S LAW DICTIONARY 693 (6th ed. 1990). Whether a director acted in good faith is measured objectively based on objective facts. “Good faith” can be contrasted with “bad faith” which usually means being motivated by self-gain.

Ordinary care

“Ordinary care” requires the director to exercise the degree of care that a person of ordinary prudence would exercise in the same or similar circumstances. If a person has a special expertise (e.g., accounting expertise, legal expertise, etc.), ordinary care means that degree of care that a person with the same expertise would exercise in the same or similar circumstances.

Best interest of the corporation

Finally, decision makers must make decisions they reasonably believe to be in the best interest of the organization. Reasonableness is based on the objective facts available to the decision maker. Determining whether a proposed action is in the best interest of the organization requires weighing varied factors including the short-term interests, the long- term interests, the costs, the benefits, etc.

Business Judgment Rule

Under Texas law decision makers of nonprofit corporations are not insurers and thus are not liable so long as those persons exercise their business judgment in making decisions on behalf of the organization. The Texas Business Organizations Code says a decision maker will not be liable for errors or mistakes in judgment if she acted in good faith with reasonable skill and prudence in a manner she reasonably believed to be in the best interest of the corporation. This is obviously a restatement of the duty of care, but the courts have generally refused to impose liability upon a disinterested director absent a challenged action being ultra vires, tainted by fraud or grossly negligent.

Satisfying the duty of care

To satisfy the duty of care, the director should be reasonably informed with respect to the decisions she is required to make. This means the decision maker must understand the purposes of the organization (i.e. she has to read and have familiarity with the organization’s governing documents) and make decisions in line with those purposes. The same is true for management of the organization, policies of the organization, and any financial data relevant to the decisions she is making. Having this type of familiarity and knowledge requires the director to attend board meetings and actively seek the information necessary to make an informed and independent decision regarding which course of action is in the corporation’s best interest. A director should be careful to personally weigh the benefits and detriments of the course of action to the corporation rather than simply voting with the majority. While a director may rely on the counsel of advisers, the director must nevertheless exercise her own independent judgment in making decisions as to what is in the corporation’s best interests.

Duty of Care Checklist

Decision makers of nonprofit corporations that engage in ongoing operations should understand that their duty of care goes beyond financial or business decisions to reach all decisions made in the course and scope of their duties as directors. The following checklist is provided to aid decision makers in satisfying the duty of care.

All decision makers should know the following:

  • Legal form of the organization
  • Mission of the organization
  • Provisions of Articles of Incorporation/Certificate of Formation
  • Provisions of Bylaws
  • Any policies affecting decision makers (e.g. Conflict of Interest Policy)
  • Financial Picture (budget and financials)
  • Most recent 990
  • Existence/operations of related entities
  • Where the organization is conducting activities
  • Tax status and applicable legal requirements of the organization
  • Activities being conducted by the organization
  • Management structure
  • Key employees
  • Committee Structure
  • How directors and officers are selected

A director should seek to do the following:

  • Faithfully attend meetings
  • Read materials and prepare for meetings
  • Ask questions before, during and after meetings
  • Exercise independent judgment
  • Rely on appropriate sources of information
  • Review minutes of the board
  • Seek to stay informed as to legal obligations and good governance
  • With other members of the Board, develop schedules for review and approval of the strategic direction of the organization, executive compensation, legal compliance, and budget

The Mission: Create a Climate for Effective Governance

The Mission: Create a Climate for Effective Governance, Tarrant County Bar Foundation Nonprofit Pro Bono Summit, October 22, 2012

This seminar presentation identifies various governance issues applicable to nonprofit organizations, particularly those that are exempt under Section 501(c)(3) of the Internal Revenue Code. The theme of this seminar presentation is creating a climate in which governance can thrive.