Can a nonprofit limit its leaders’ individual liability? Should it? The dual answer to both questions: possibly; and it depends. Based on their corporate structure, nonprofits need directors and officers. Numerous laws apply as guardrails, requiring leaders to act responsibly in their nonprofits’ best interests. Correspondingly, potential risks involved with individuals exercising such responsibilities can be addressed through measures such as insurance, delegation, training, as well as utilizing volunteer service instead of paid work.
This article addresses another risk mitigation option: exculpation. This term can be found in contractual provisions, but it could apply instead (or equally) in nonprofit governance documents like bylaws and articles of incorporation. While bylaw provisions commonly address indemnification, typically consistent with available protections for directors and officers under state law, exculpation provides another governance tool. Exculpation warrants attention in light of recent legal developments addressed below. But because of its significant limitations, exculpation should never be viewed as a substitute for responsible nonprofit governance or other risk management measures and never to provide an undue sense of comfort. Rather, it must be considered against the very broad backdrop of potential liability issues affecting nonprofits and their leaders.
The first few sections below provide a groundwork for understanding exculpation, including exculpatory language in corporate and governance documents, its relation to other risk mitigation strategies, and how it differs from indemnification. Next, the article describes federal and state legal provisions that afford statutory exculpation to organizations, with very significant conditions, qualifiers, and exceptions. This article then further explores key legal developments, focusing on Delaware’s robust corporate act, and wraps up with potential next steps for nonprofit leaders.
Exculpation: What Is It?
Most broadly, exculpation means freeing someone from blame or guilt, the act of excusing a mistake or offense. Through exculpation, particularly with respect to criminal acts or other wrongdoing, the wrongdoer is pardoned, excused, or forgiven. Within the corporate context, which includes nonprofits, exculpation could be addressed in contracts, bylaws, or even articles of incorporation, but with accompanying legal constraints. When used properly, exculpation limits liability of individuals from monetary damages in a way that protects officers and directors while still holding them otherwise accountable to their responsibilities.
Within the nonprofit context, bylaws could provide for exculpation in order to protect directors and officers from personal liability arising from their nonprofit board service. Through such mechanism, their personal assets could be protected from potential liability and loss.
A basic exculpation contract clause might provide as follows:
Owners, officers, and affiliates (“Protected Persons”), shall not be personally liable for obligations under this Agreement. Liability under this Agreement shall be limited to the Parties’ interests in the Assets, not the personal assets of the Protected Persons, and no other assets may be pursued for claims or judgments.
Within the nonprofit governance context, such as for bylaws, is that too good to be true? Yes, and no. Much depends on what type of limitation is involved, what state law applies, and how such limitations are applied.
Exculpation in a Layered Risk Management Approach
As noted above, exculpation is a tool – among many other risk mitigation measures. Effective nonprofit leaders utilize multi-layered risk mitigation strategies to shield their organizations and themselves from potential legal and financial risks. A spectrum of common nonprofit risk-reducing measures include the following:
• Insurance coverage (e.g., Directors & Officers (D&O), General Liability (GL), Cyber, and other insurance coverage);
• Maintaining proper corporate form and formalities, particularly to avoid “piercing the corporate veil” liability;
• Well developed, accurate, and legally compliant governing documents (bylaws, articles of incorporation, and governance policies like a conflict of interest policy);
• Utilizing multi-corporate structures, such as multiple nonprofit corporations or single-member LLCs;
• Using indemnification provisions in bylaws that satisfy applicable state law and best protect nonprofits;
• Engaging volunteer boards (especially to benefit from applicable Volunteer Protection Act coverage); and
• Providing regular and comprehensive training on governance.
Like these measures, exculpation may provide additional risk mitigation benefits for nonprofits looking to protect their officers and directors. All such measures should promote leadership engagement, especially for volunteer directors and officers, to help them serve without undue concern for potential personal liability. Keep in mind though, while a officer or director’s liability may be excused or otherwise minimized, the nonprofit may nevertheless be held liable as an organization.
How does Exculpation Differ from Indemnification?
Indemnification and exculpation are distinct legal protections used by nonprofits to shield their leaders from liability. Indemnification allows an organization to stand in the place of directors and officers when they are acting in those capacities, and with some limitations, pay liabilities incurred by such individuals in their roles as directors and officers. Nonprofit indemnification provisions are most commonly found in nonprofit bylaws, typically as a paraphrase of applicable state law. Exculpation may excuse such individuals acting in those roles from liability altogether.
Significantly, state nonprofit statutes typically allow for indemnification of directors and officers to varying permitted degrees. Some selectivity may be appropriate in connection with bylaw provisions. For example, Illinois nonprofit law allows for monetary “advances” to a director or officer regarding liability issues, before a final adjudication of such liability. Such allowance may be desired, but not necessarily before an actual issue arises. For example, consider two directors who are accused of violating their duty of loyalty in connection with certain financial transaction involving other directors, and the factions are thus at odds. Should all affected directors receive indemnification – through advances for their legal fees arising from the conflict – or only the directors who have honored their fiduciary responsibilities? The legal answer is the latter – i.e., only the directors who have not engaged in wrongdoing. But it will be extremely painful financially if both factions get access to nonprofit funds, through the “advance” aspect of nonprofit indemnification laws. A better approach may be for the bylaws to provide that such advances are entirely discretionary (as allowed under applicable law), to be decided by the board when an issue arises and based on important considerations such as whether the directors involved appear to be acting in good faith and in accordance with applicable legal requirements.
Note too that some legal protections are inherently exculpatory in nature, such as made available under the federal Volunteer Protection Act and corresponding state laws as follows.
Volunteer Protection Act Coverage and Standards for Personal Liability
The Volunteer Protection Act (VPA) is a federal law that effectively exculpates volunteers of nonprofit organizations and government entities. It shields volunteers from personal liability for harm they may cause while performing their duties, as long as they act within the scope of their responsibilities and do not engage in gross negligence or willful misconduct. The VPA thus fosters volunteerism on nonprofit boards, thereby promoting skilled and diverse leadership and reducing risk of personal liability. State versions may apply as well, depending on state of operation.
In addition to these legal protections available to volunteers accompanying state versions, many states provide a significant degree of protection to volunteers through the applicable threshold for personal liability. More specifically, volunteers may be found personally liable for liabilities accruing to the organization only in cases of gross negligence, as compared to the lower threshold of mere negligence on the part of paid workers, or intentional misconduct. A significant question of “gross negligence” (and perhaps intentional misconduct) thus could arise – possibly for a judge or jury, and potentially reputationally too (i.e., in the court of public opinion). At a minimum, each director and officer owes a legal duty of care and diligence regarding its programs and service to others, all determined according to the “business judgment rule.”
What are the takeaways here? Above all, be careful! Available legal protections such as under the Volunteer Protection Act provide some degree of exculpation, but not full immunity. But with the VPA in mind, it can be disadvantageous overall for nonprofit directors to be paid honoraria or stipends (e.g., $1,000 per year) in recognition of their board service; better to serve as volunteers! That said, directors may be reimbursed for travel or other expenses related to board service, which should not constitute compensation. Finally in this section, note too that some laws impose personal liability apart from the VPA, state corollaries, indemnification provisions, and other protections – such as reflected in certain state employment laws and other very specific statutory provisions. That takes us back to the first principle above, as a warning against complacency and lack of care.
Statutory Exculpation Examples
Delaware General Corporation Law
In August 2022, Delaware amended the Delaware General Corporation Law (“DGCL”) to allow for statutory exculpation of corporate officers, in addition to the statutory exculpation previously available for directors. Since May of 2024, as many as 443 of Delaware’s S&P 500 companies had proposed amendments to their charters adding officer exculpation provisions, and 88% of these amendments had been adopted by stockholders (see referenced article here). Since Delaware is the leading state of incorporation for business entities and a national trendsetter in corporate law, it is likely that other states will follow its example.
Unlike many other states, Delaware does not have a separate statute governing nonprofit entities; instead, the DGCL applies to Delaware nonprofit as well as to Delaware for-profit corporations. Both types of entities are formed by filing a certificate of incorporation with the Delaware Department of State’s Division of Corporations pursuant to Section 101 of the DGCL. Under Section 102(b)(7) of the DGCL, the certificate of incorporation may include director and officer exculpation provisions. In other words, these protections do not apply unless the corporation “opts in” by adopting or amending charter provisions to include these protections. These charter provisions may eliminate or limit “the personal liability of a director or officer to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director or officer,” subject to certain exceptions that will be examined in turn below.
The primary effect of these exceptions is to allow director and officer exculpation for breaches of their duty to exercise reasonable diligence and due care in conducting the nonprofit’s affairs. Most of these exceptions apply with equal force to both directors and officers, but not all of them do. It is especially important that Delaware nonprofit leaders currently benefiting from such exculpatory protections understand how each exception may or may not apply to them in their specific role, as a director or officer or both.
ABA Amendments – Precursor to Additional State-Protected Exculpation?
In February of 2024, the Corporate Laws Committee of the ABA Business Law Section approved amendments to the Model Business Corporation Act (the “MBCA”) allowing for exculpation of corporate officers for certain breaches of their fiduciary duties. This extension of exculpation to officers had already been implemented in the ABA’s most recent version of the Model Nonprofit Corporation Act (“MNPCA”), Fourth Edition, Section 202(c), published in 2022.
Legislatures often look to the ABA Model Rules, such as the MBCA and the MNPCA, as guides for drafting and amending their own statutes, reflecting best practices and modernizing their legal frameworks. While the ABA's adoption of new model rules doesn't necessitate new state laws, it often influences legislative changes. States frequently adopt or modify their statutes to align with these models, ensuring consistency and best practices across jurisdictions.
Under the proposed language of the MBCA and the current language of the MNPCA, a corporation may adopt provisions in its articles of incorporation providing its directors – and now officers too –no personal liability to the corporation or its shareholders/members for monetary damages in certain breach of fiduciary duty claims. This protection had previously only applied to directors, and the extension of this protection to officers would represent a significant development in corporate law.
Other State Limitations on Liability
Several states authorize nonprofit limitations on liability but stop short of expressly providing director or officer exculpation, as seen with Delaware:
• In Illinois, §108.75 of the Illinois Nonprofit Corporation Act allows nonprofits to limit or eliminate personal liability of directors for monetary damages, except in cases of willful or wanton misconduct or gross negligence; however, the act primarily relies on indemnity provisions and does not expressly permit exculpatory provisions in governing documents.
• Similarly, the South Carolina Nonprofit Corporation Act does not authorize exculpatory provisions in articles of incorporation but offers protections such as indemnity and conditional immunity for officers and directors.
• Michigan’s Nonprofit Corporation Act provides liability protection for both directors and officers under specific sections (§ MCL 450.2581- MCL 450.2584, § MCL 450.2541, and § MCL 450.2545) but has yet to explicitly allow for exculpation.
• In Minnesota, liability protection for nonprofit directors and officers is primarily through indemnification provisions outlined in §317A.255, with no current provision for exculpation in nonprofit entities.
In these states, while nonprofits may incorporate exculpation provisions in their governing documents, the applicability of such clauses will be likely limited to claims of liability as between the individual director and the nonprofit. In other words, the provisions for exculpation would typically apply if the nonprofit were to otherwise seek recovery from the director.
The use of exculpation clauses in these and other similar states warrants careful drafting of language in the applicable clauses to ensure that appropriate exceptions balance accountability to the organization with safeguards to the individual director or officer, as discussed in the following section.
Delaware – Examples of Important Exculpation Exceptions
The next section briefly summarizes important exceptions under the new Delaware statute (DGCL) that are helpfully applicable in other state contexts. Exculpation is a powerful risk mitigation tool, but it must be properly constrained to safeguard nonprofit’s interests and related legal considerations as follows.
Breaches of the Duty of Loyalty
Exculpation does not apply to breaches of a director or officer’s duty of loyalty, which is the duty to act in the interest of the corporation and its stockholders. (See our related blog on the duty of loyalty, for more information about this critically important fiduciary responsibility.) Of course, nonprofits – known as “nonprofit nonstock corporations” under the DGCL – have no stockholders. However, Section 114 of the DGCL provides that all references to “stockholders” in the DGCL shall be deemed to refer to “members” of nonstock corporations. Therefore, if a plaintiff claims that a nonprofit’s directors or officers have breached their duty of loyalty to the nonprofit or its members, statutory exculpation from monetary damages may not be available.
This exception would apply in a variety of contexts, including conflicted transactions – where directors or officers make decisions in which they have conflicts of interest without first disclosing and cleaning those conflicts. For example, if a plaintiff is claiming that a director or officer has breached his or her fiduciary duties by awarding a corporate contract to a family member, exculpation may not be available.
Breaches of the Duty of Obedience
Exculpation provisions should be drafted to exclude actions or omissions (1) not undertaken in good faith, (2) involving intentional misconduct, or (3) involving a knowing violation of law. This exception may be stated broadly as a director or officer’s breach of the fiduciary duty of obedience, and often related to good faith issues. For a nonprofit corporation, this would include a director or officer’s duty to abide by the exempt purposes of the nonprofit, as stated in the nonprofit’s governing documents. Accordingly, if – for example – a plaintiff claims that an executive director has applied a nonprofit’s charitable funds to a cause directly opposed to the purposes of the nonprofit, that executive director may not benefit from exculpation, even if exculpatory provisions are included in that nonprofit’s certificate of incorporation.
Unlawful Dividends, Purchases, or Redemptions by Directors
Exculpation is also not available to a director who approves an unlawful dividend payment or stock purchase or redemption. For Delaware nonstock corporations, this language would apply to redemption of membership interests in, for example, a social club. Under Section 160 of the DGCL, membership interests may only be redeemed if authorized by the certificate of incorporation, and then only in accordance with the terms of the certificate of incorporation. A nonprofit director who votes to approve a redemption not in keeping with these requirements loses the protection afforded by any exculpation provisions included in the certificate of incorporation.
Improper Personal Benefit
A director or officer also cannot benefit from exculpation if the claim relates to a transaction from which the director or officer derived an improper personal benefit. This consideration is similar to the duty of loyalty exception discussed above, except it depends to a greater degree on the results of a given transaction than to the nature of the related claim. The language connotes a financial benefit, such as through usurpation of a corporate opportunity or misuse of corporate funds. Such issue also raises substantial concern for Section 501(c)(3) tax-exempt organizations, such they may necessary be organized for public benefit and not for private benefit under applicable IRS requirements.
In its official comments to the parallel provision of the MBCA, the ABA points out that – in some circumstances – a director or officer may be deemed to have received an improper benefit when that director or officer caused a benefit to be directed to another person, such as a family member or affiliate. Thus, in the Delaware nonprofit context for example, this exception may be triggered when a director or officer directs an interested donor away from supporting the corporation, in favor of supporting another person or entity of interest to the director or officer.
Derivative Claims Against Officers
Finally, exculpation is not available to an officer when an action is brought against the officer by – or in the right of – the corporation. Generally speaking, breach of fiduciary duty claims must be brought by the person or entity to whom the duty is owed. However, in the corporate context, stockholders (or members, as the case may be) generally have two options for bringing breach of fiduciary duty claims. They may bring their own personal claims against directors and officers, arguing that there has been a breach of a duty owed to them as stockholders (members). Alternatively, they may bring derivative claims on behalf of the corporation, arguing that there has been a breach of a duty owed to the corporation.
In the nonprofit context specifically, it may be easier for a member to successfully make a derivative claim of breach of fiduciary duty rather than a personal claim, because nonprofits (unlike for-profit entities) often exist to serve purposes other than the benefit of their members. However, derivative claims typically require board approval. Therefore, the exception here protects officers from most breach of fiduciary duty claims not approved by the board, while still allowing the members and the board to hold the nonprofit’s officers accountable.
Concluding Remarks and Caution
Plainly speaking, exculpation means being excused of potential liability. Within the nonprofit context, its availability may provide powerful incentives for nonprofit leaders to serve. But remember that as legally applied, extensive caveats and exceptions apply. Nonprofit leaders can face personal liability within a variety of contexts. Depending on the situation, they most certainly should be held accountable for misconduct. Consequently, all nonprofits should carefully vet prospective leaders, make sure they are well equipped and well qualified, and follow through with training and other accountability measures. That makes good sense, especially to guard a nonprofit’s reputation and long-term viability.
Within such considerations, responsible nonprofits should pursue risk management strategies such as insurance coverage and other options as listed at the beginning of this article. If a director were to be accused of wrongdoing, it would be helpful to have legal defense available through insurance coverage. These protective layers should be prospectively encouraging to a person invited to serve on a nonprofit, as well as practically helpful when and if such an issue arises. Nonprofit leaders should be mindful too that we live in an increasingly litigious society in which anyone can sue, and it is all too common for a plaintiff and other claimants to include individuals as putative wrongdoers. These options for exculpation thus warrant attention as well as steadfast and conscientious attentiveness to excellent governance, sound program operations, and thorough accountability.
