By Adam M. Beaudoin, Ward and Smith, P.A.
Editor’s Note:Adam Beaudoin is a member of the Business and Community Associations Practice Groups of Ward and Smith, P.A.
Nonprofit Corporation Director Standards of Conduct
People choose to serve on nonprofit boards for a variety of reasons: philanthropy, business and social networking, and betterment of their communities. The North Carolina Nonprofit Corporation Act ("Act") governs the actions of directors of nonprofit corporations and sets forth the duties a director must follow in serving on such a board. The Act requires a nonprofit director to act: (a) in good faith, (b) with due care, and (c) with loyalty.
Duty of Good Faith
The most general obligation of a nonprofit director is the duty of acting in good faith. This requires a director to always discharge the responsibilities of the office of director honestly, conscientiously, and fairly. It also requires a director to make decisions for the nonprofit corporation that are in the best interests of the corporation as an entity.
Often directors are put in the position of having to deliver bad news or say no to requests from members of the nonprofit corporation, which may lead the members to form an unfavorable opinion of the directors delivering the message. As a result, a director might be tempted to avoid or delay informing the members, or even to mislead the members about such news or action in order to avoid falling out of favor with or upsetting them. However, avoiding or delaying an unfavorable message or providing misleading information violates the nonprofit director’s duty of good faith. A director also must keep in mind that what appears to be in the best interests of a large segment, or even a majority, of the members of the nonprofit corporation may not be in the best interests of the corporation as an entity.
Another common violation of the statutorily-required duty of good faith occurs when a director lets personality conflicts, or even the avoidance of such conflicts, get in the way of advising the nonprofit corporation in a conscientious manner. Unproductive debate or personality clashes at meetings can lead to discord on the board and decisions being made that are not in the best interests of the corporation as an entity. On the other hand, a director is not acting in good faith if the director allows avoidance of conflicts to control the director’s actions. Not every vote needs to be unanimous and sometimes the initial lone dissenter ultimately sways a board’s decision by pointing out previously overlooked problems or dangers flowing from the "law of unintended consequences." Serving on a nonprofit board is often not for the meek.
Duty of Due Care: Don’t Act like an Ostrich
Good faith alone is not the limit of a director’s obligation to the nonprofit corporation. In addition, directors are under an affirmative duty to direct and supervise the affairs of the nonprofit corporation with diligence and care. Directors are not allowed to passively stick their head in the sand, turn a blind eye, or simply refrain from misconduct in order to fulfill their duty of due care.
The Act defines the duty of due care as the obligation of a director to act "with the care an ordinarily prudent person in a like position would exercise under similar circumstances." However, if a director has a relevant specialized background, that director’s actions may be judged in light of the director’s specialized background to determine whether that director complied not only with what an ordinarily prudent person would have done in the same situation, but also with what one possessing and using the specialized background and knowledge of the director in question would have done. For example, a director who is a CPA reviewing the corporation’s financial records or a director who is a lawyer reviewing a contract on behalf of the corporation each might be held to a higher standard of care than a non-CPA or non-lawyer director performing the same duties.
Moreover, the obligation to act with due care requires nonprofit directors to make "responsible inquiries" to inform themselves as to the condition of the corporation and the conduct of its affairs. It is no excuse for nonprofit directors to say that they had no knowledge of mismanagement or fraud if reasonable attention to facts or a reasonable inquiry into the affairs of the corporation would have disclosed such mismanagement or fraud. In essence, the duty of responsible inquiry requires nonprofit directors to diligently monitor and reasonably investigate the ongoing operations of the corporation and ask questions when making decisions.
Duty of Loyalty: Don’t Use Your Position for Gratification or Personal Gain
The Act codifies the duty of loyalty by requiring a director to act "in a manner [the director] reasonably believes to be in the best interests of the nonprofit corporation." In effect, a director must act on behalf of the corporation, and the director’s actions must be guided by the best interests of the corporation and its mission and goals. For example, renting out the penthouse of a hotel when attending the nonprofit corporation’s annual meeting and submitting the charge as an expense to the corporation might constitute a violation of the director’s duty of loyalty, especially when the director could have saved the nonprofit corporation substantial funds by staying in more modest accommodations.
This duty also prohibits a director from using the position for the director’s own personal gain and to the detriment of the corporation. For example, a nonprofit corporation may solicit bids for the construction of a new facility at a time when one of its directors owns a construction company. If that director uses the director’s board membership to gain access to information or bids received from other construction companies in order to submit a lower bid on behalf of the director’s company, the director has breached the duty of loyalty to the corporation by using the latter’s private information for the director’s personal gain. This breach is not cured by the submission of the lowest bid. The breach was the use of the information. Besides, if the director had not used the inside information to formulate a bid, the bid from the director’s corporation may have been even lower to the benefit of the corporation.
The duty of loyalty does not, however, preclude all transactions between a director and the nonprofit corporation, even ones that unquestionably benefit the director personally. Certain transactions between a director and the corporation are permissible as long as: (a) such transaction is fair to the corporation, (b) the conflict is disclosed, and (c) all interested directors refrain from participating in the deliberations and votes regarding such transaction. In the above example, if the director who owned the construction company had submitted the bid without prior knowledge of the other bid amounts, had disclosed the director’s interest in the construction company to all other board members, and had refrained from participating in any discussions or votes regarding the bid process, the acceptance of the director’s company’s bid by the remaining board members would not be a breach of the director’s duty of loyalty.
A Director Doesn’t Have to Be "Right"
Despite the duties discussed above, it is important to understand that the Act focuses on the manner in which a director performs the director’s duties on behalf of the corporation, rather than on the correctness or ultimate result of the director’s decisions. Simply put, the Act provides that a nonprofit director will not be personally liable for any action or inaction as a director, whether the result turns out to be good or bad to the corporation, so long as the director has performed the duties of director in compliance with the above standards of conduct.
Summary
Serving on a nonprofit board of directors can be an extremely rewarding experience. But it also can have negative consequences if the person serving is not aware of the duties required or relaxes and refrains from acting with due diligence and care because profits are not at stake and "nothing can go wrong because we just intend ‘to do good.’" Being the director of a nonprofit corporation is serious business, and a good heart and good intentions do not relieve a director from acting in good faith, with due care, and with loyalty.
(c) 2009, Ward and Smith, P.A.
Ward and Smith, P.A. provides a multi-specialty approach to the representation of technology companies and their officers, directors, employees, and investors. Adam M. Beaudoin practices in the Business and Community Associations Practice Groups where he represents clients in a broad range of business transactions. Comments or questions may be sent to amb@wardandsmith.com.
This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.
