Conflicts of Interest – What Hat Are You Wearing?

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Does your nonprofit have established policies for handling conflicts of interest? While such policies have long been recommended by the IRS and state agencies, adoption of a specific corporate conflict of interest policy is not generally a legal requirement.  However, through its newly enacted Nonprofit Revitalization Act, New York now requires its nonprofit corporations to adopt policies regarding the disclosure and handling of potential conflicts of interest.  Other states may follow suit.  Until then, take note:  conflict of interest policies – and accompanying disclosure statements – help promote nonprofits’ “best practices” and legal compliance.

What is a “conflict of interest”?  To understand conflicts of interest, one must first look at the duty of loyalty placed on directors of nonprofit organizations.  Under the duty of loyalty, directors may not use their positions of trust for personal advantage at the expense of the corporation.  All states and the federal government require directors to act in the best interest of the organization, rather than that of a director.  Furthermore, some states place more specific duties on directors.  For example, under the Illinois Charitable Trust Act directors are charged with a duty to avoid self-dealing and conflicts of interest.

As part of the duty of loyalty, directors should be “disinterested” and independent of one another.  Disinterested directors are not uninterested, but are interested in the organization’s benefit rather than personal benefit. Conflicts of interest occur when a nonprofit director acts in a different capacity than his or her capacity as a disinterested, independent director, such that the director is no longer living up to the duty of loyalty.

 If I have a potential conflict, does that mean I can’t be a director?  Not necessarily.  The key question is whether you can act in the best interest of the nonprofit corporation.  Colloquially speaking, how many “hats” are you wearing?  At a minimum, you have your director’s hat, which comes with the duty of loyalty.  You may also have a family member hat, a businessperson hat, a second director’s hat as a director of another organization, etc.  Potential conflicts become actual conflicts of interest when you are unable to take off all the other hats and wear only one hat:  your nonprofit leader hat.

The following are some common scenarios that arise where directors have a potential conflict of interest:

Scenario 1:  You and your spouse (or other family member) are asked to serve on the same board.

May you accept the position as a director?  It depends.  Can you and your spouse each vote independently rather than to please each other?  This may be a particularly tough question with a very small board, such that the two of you will have substantial control of the organization’s affairs.  On a very large board, having two members of the same family may not have as much of an impact. Will either of you be compensated by the organization?  If so, you may still be able to serve on the board, but both you and your spouse should be excused from any vote regarding this compensation.

Scenario 2:  You are asked to serve on the boards of two very similar organizations.

May you serve on both boards?  Once again, the answer is that it depends.  The most likely situation in which this could become a problem is if both organizations go after the same funding, such as specific government grants or a common donor base.  Will you help write grant proposals for both organizations?  You may be able to avoid an actual conflict by stepping back from any responsibilities pertaining to such grants.  What about when you network with the donors targeted by these organizations?  How will you choose which organization to talk about if you have a duty of loyalty to both?  If this is a common situation in which you find yourself, you may need to step down from one of the boards.

Scenario 3:  You are asked to provide services to an organization for which you are a board member.

May you charge the organization a fee for the services?  As above, it depends.  Here the key question is whether the fee is fair to the organization. Will you provide the best price?  Will the organization be getting the best value for that price?  Make sure you point out such a potential conflict and excuse yourself from any vote regarding whether the organization should hire you and how you should be compensated.  The organization should also document how it determined that the cost of your services is a fair price to pay.   You should also consider whether you will be able to take off your businessperson hat when you need to be wearing your director hat.  This can be particularly important for professionals like lawyers and accountants, whose ethical duties to the organization as a client may conflict with their duties as directors.

Whether you can say yes in each scenario depends on the circumstances, but it is important to note that disclosure is key!  Always disclose potential conflicts to the board so that steps may be taken if necessary to prevent potential conflicts from becoming actual conflicts.

What disclosures are appropriate or legally required?  Directors are legally required to disclose when they have an actual conflict of interest that will keep them from being disinterested and from acting solely for the benefit of the nonprofit corporation.  For purposes of limiting liability, other disclosures may be appropriate.   To promote the orderly and appropriate handling of conflicts of interest, all nonprofits should have a written conflict of interest policy.  The policy should explain when such disclosures are necessary and outline the organization’s procedures when a potential conflict arises.

As now required in New York and recommended for all, the organization’s policy should require that directors submit signed disclosure statements – both prior to the director’s initial term and at least annually thereafter.  Such statements should identify whether the director is an officer, director, trustee, member, owner, or employee of any other entity with which the organization has a relationship.  The statement  should establish whether other potential conflicts of interest exist.  Even if not required by law, such disclosure statements can be a great reminder to directors about their continuing duty of loyalty.  They further remind directors to report conflicts of interest that actually arise during their term.

Most importantly, the nonprofit corporation should not just have a policy regarding conflicts of interest; it should also follow it!  Be sure to document in the organization’s minutes when a conflict or potential conflict is disclosed, any action taken to resolve the conflict, any recusal of the interested person(s), and specifically how the nonprofit’s best interests are served.