The Fiduciary Duty of Obedience

In 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.