When Volunteer Leadership Goes Bad: Personal Liability

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Can nonprofit volunteer leaders ever be held personally liable in relation to their work for an organization?  Unfortunately, the answer is emphatically yes.  Most state nonprofit laws protect directors and officers from personal liability for acts performed in such volunteer capacities, but significant limitations exist.  Leaders need to be attentive to applicable legal requirements, to govern their organizations well, and to pursue available protections such as directors’ and officers’ insurance and other risk management measures. 

Liability for Violating Fiduciary Duties

Under well-established legal principles, leaders of not-for-profit organizations serve as stewards of organizations’ assets and other interests.  Because charitable assets are by definition intended for public benefit, they belong to no private person and thus must be guarded carefully for the public’s interest.  Nonprofit leaders thus owe certain fiduciary duties to their organizations.  The term “fiduciary” simply means that these individuals are entrusted with accountability for the organization’s well-being.  Breaches of their fiduciary duties may result in personal liability.  Thus, wise directors and officers take their duties seriously and strive at all times to act responsibly in the organization’s best interests.  Nonprofit leaders’ fiduciary duties generally fall within the following three categories:

Duty of Care.  The duty of care requires directors and officers to exercise reasonable diligence and due care in conducting the nonprofit’s affairs.  For example, they must stay informed about the activities and finances of the organization by regularly attending corporate meetings, actively examining and evaluating the records made available to them by staff, and understanding how the organization functions under its bylaws.  Board members must act in good faith as they make decisions and seek to avoid the misuse or waste of its assets.  When a decision involves complex matters, the board should engage subject matter experts, community representatives, and professional advisors if the directors lack the requisite skills to make an informed decision.

The duty of care is typically evaluated according to the "business judgment rule,"under which directors and officers are presumed to make decisions on an informed basis and in good faith.  This presumption may be overcome upon a showing of gross negligence or willful misconduct, with resulting personal liability.  (And if they are paid leaders, the legal standard is lowered to “ordinary negligence.”)  To stay within the business judgment rule’s protection, directors and officers must act with the care that an ordinary and prudent person would exercise under similar circumstances. 

One potent example of personal liability within the duty of care is if a director, officer, or other key employee knowingly allows employment tax funds to be used for other purposes.  This is highly problematic because the funds legally belong to the government.  Resulting personal liability may be statutorily mandated, but it results fundamentally from a lapse of a leader’s judgment and responsibility for nonprofit financial oversight – i.e., due care.

Duty of Loyalty.  The duty of loyalty prohibits directors and officers from using their position of trust for personal advantage at the expense of the not-for-profit corporation.  In negotiating business transactions, directors and officers must ensure that their families, friends, or others who have a significant interest in the organization do not receive special benefits due to their own position of trust.  This is not to say that all such contracts are prohibited.  Whenever personal and business relationships co-exist, however, the highest loyalty must be demonstrated to protect the corporation.  The most common transactions that risk a breach of this duty are transactions involving conflict of interest, misuse of the organization’s information or opportunities, and misappropriation of the organization’s assets.  

A strong conflict of interest policy can help the organization guard against such practices by identifying potential problem areas and establishing frameworks to govern how potential conflicts are to be handled.  Through compliance with such a policy, directors avoid activities that might later expose them to liability.

Some conflicts of interest may result in automatic personal liability.  For example, many state nonprofit laws specifically prohibit loans to non-employee directors and officers, due to the inherent conflict of interest regarding use of a nonprofit’s financial resources.  In addition, federal income tax law imposes “excess benefit transaction” penalties on financial transactions that are unduly favorable to a nonprofit insider, and therefore in conflict with the organization’s best interests. Consequently, if a director votes for or assents to such transactions, then he or she may be held personally liable to the corporation for repayment of wrongfully paid funds and other penalties. 

Duty of Obedience.  The duty of obedience requires leaders to adhere to the not-for-profit organization’s corporate purposes.  In a well-run organization, the directors and officers may serve as “bumper guards.” That is, they oversee the staff and make sure that the corporation follows its articulated vision and complies with its legal obligations.  To do so, the board members should be well aware of the corporation’s purposes as stated in its articles and bylaws, they should ensure that the organization’s activities are consistent with these purposes, and they should shape the organization’s plan in accordance with them.  For purposes of potential personal liability, this duty is closely related to the other duties.  For example, authorizing corporate action that is far beyond the nonprofit’s mission could reflect a gross lapse in the duty of care.  In addition, it could demonstrate loyalty to an insider and his or her agenda, rather that to the organization’s narrower mission focus. 

Liability Under State Trust Laws

State trust laws may impose additional, higher legal burdens on nonprofit leaders. For example, while the Illinois General Not For Profit Corporation Act (“NFP Act”) shields volunteer directors from being held personally liable for damages caused by an executive director’s falsification of financial records (absent their own willful or wanton conduct), such limited immunity does not apply to actions against them brought by the Attorney General under the Illinois Charitable Trust Act (“Trust Act”).  Under the Trust Act’s higher standard, a nonprofit corporation and its directors are treated as trustees holding charitable assets for the benefit of the public. As Illinois courts have ruled, directors are thus obligated to act  “with the highest degrees of fidelity and good faith” in carrying out the organization’s purposes. 

Indemnification/Insurance

Indemnification is the legal procedure by which a corporation agrees to hold harmless directors, officers, and other agents, and provide reimbursement for liabilities, expenses, and other losses incurred in the event of a lawsuit or other proceeding.  These important protections should provide great comfort to the organization’s leaders.  Under the NFP Act, a corporation may indemnify certain individuals, including officers, directors, and employees when sued in relation to their role with the organization.

In the case of a suit brought by anyone other than the corporation (a “direct suit”), indemnification is allowed so long as the individual acted in good faith and in a manner he/she reasonably believed to be in (or at least not opposed to) the best interest of the corporation.  In a criminal case, there is an additional requirement that the individual had no reasonable cause to believe his/her conduct was unlawful. These indemnification provisions may be further limited under the NFP Act in cases of a derivative suit (when an individual(s) brings suit based on the rights of the organization to do so).

Additionally, if an individual who may be indemnified is successful in defending an action against him/her, the NFP Act requires the organization to indemnify the individual.  Directors should be aware of this requirement, as it means the organization should be very careful in deciding to sue such individuals.

For optimal protection, these indemnification protections should be buttressed with ample directors’ and officers’ insurance.  Such insurance should cover both potential personal liability and the legal defense expenses that may be required to defend against a lawsuit or other claim. 

Concluding Remarks

Nonprofit leaders need to carefully and responsibly serve their organizations, not only for the organizations’ overall benefit but also for their own legal protection.