NON-PROFIT CORPORATIONS: Director Liability

NON-PROFIT CORPORATIONS: DIRECTOR LIABILITY J. Keith Phifer, Esq., LL.M. Schlossberg, LLC 35 Braintree Hill Office Park, Suite 204 Braintree, Massachusetts 02184 (781) 848-5028 E-mail: [email_address]

SCHLOSSBERG, LLC
Firm History
Schlossberg, LLC has provided specialized legal service to New England business owners for the past 30 years. Schlossberg, LLC has represented a broad range of influential businesses and entrepreneurs that have had a significant effect on the local and regional economy. It is the mission of Schlossberg, LLC to continue to grow its heritage of excellence over the next 30 years and beyond.
Firm Description
Schlossberg, LLC is a full service business law firm located in Braintree, Massachusetts.
Our team of professionals provide comprehensive legal counsel for the closely-held business, charitable endeavor, and individual with a broad range of legal needs.
The Firm’s team of experienced lawyers and support staff is large enough to provide the specialized expertise our clients need, yet small enough to establish a personal rapport with each client.

Welcome to the Board!
Agenda:
Non-Profit Basics
The Function of the Board
Duties of the Board
Taxes and Disclosure Obligations
Director Liability: the Protections

I. Non-Profit Basics

Why the Corporation?
What are the other options?
Charitable Trusts
More Restrictive. Trustees held to a higher standard
Unincorporated Associations
No liability protection.
Separate Legal Entity
Can enter into contracts, employ people, hold title to property, sue and be sued.
Limited Liability
Directors, officers, and employees are not personally liable for obligations of corporation.

Corporations in General (Profit and Non-Profit)
Formed by filing Articles of Organization with Secretary of Commonwealth
http://www.sec.state.ma.us/cor
Bylaws: Rules for governing the corporation
Officers: President, Treasurer, Secretary, Executive Director, CEO, etc. . .
Board of Directors

Profit vs. Non- Profit Profit Officers Directors Shareholders Non-Profit Officers Directors

The Non-Profit Corporation General Form
Governed by Massachusetts General Laws c. 180

Articles of Organization
Names and addresses of the incorporator
Corporation’s name
Purpose for which the corporation is formed
Address of the initial principal office
Names, residences, and post offices addresses of initial directors, president, treasurer, and clerk
Name and address of the registered agent
Fiscal year of the corporation
Articles MAY include provisions eliminating or limiting personal liability of a director to the corporation or its members for monetary damages arising from acts or omissions taken in good faith. Limitations MAY NOT extend to breach of duty of loyalty, acts or omissions involving intentional misconduct or knowing violations of law, or transaction from which director derived improper personal benefit.

Articles of Organization (Continued)
Purpose clause important because it must be recognized under Massachusetts General Laws AND if non-profit is seeking 501(c)3 exemption, must state purpose is “religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition, or for the prevention of cruelty to animals.”
If Members, then also in Articles
Distribution of Assets on Dissolution: Massachusetts Law requires assets on dissolution are distributed for a similar charity.
Powers: A Non-Profit can do anything a profit corporation can do (except issue shares)

Bylaws
How meetings of members and directors are called and conducted
Number of Directors constituting a quorum
How directors and officers are removed and the tenure of their office;
Members: If there are members, what are their rights? What are procedures on voting and on what matters can they vote on?
Directors: number, qualifications, procedure for board meetings
Officers: titles, powers, and functions. This is important when entering into contracts. Who has the authority to bind?
Conflict of Interest Policy. Driven by IRS requirements. Intended to prevent self dealing.
How to revise the Bylaws?

Non Profit vs. Public Charity
Not all Non-Profits are Public Charities
Non-profits are accountable to the Secretary of State and governed by Massachusetts General Laws Chapter 180
Section 4. A corporation may be formed for any one or more of the following purposes:
for any civic, educational, charitable, benevolent or religious purpose;
for the prosecution of any antiquarian, historical, literary, scientific, medical, chiropractic, artistic, monumental or musical purpose;
for establishing and maintaining libraries;
for supporting any missionary enterprise having for its object the dissemination of religious or educational instruction in foreign countries;
for promoting temperance or morality in the commonwealth;
for fostering, encouraging or engaging in athletic exercises or yachting;
for encouraging the raising of choice breeds of domestic animals and poultry;
for the association and accommodation of societies of Free Masons, Odd Fellows, Knights of Pythias or other charitable or social bodies of a like character and purpose;
for the establishment and maintenance of places for reading rooms, libraries or social meetings;
for establishing boards of trade, chambers of commerce and bodies of like nature;
for providing nonprofit credit counseling services, as defined in section four A;
for encouraging agriculture or horticulture; for improving and ornamenting the streets and public squares of any city or town by planting and cultivating ornamental trees therein and also otherwise improving the physical aspects of such city or town and furthering the recreation and enjoyment of the inhabitants thereof;
for the purpose of purchasing, holding, preserving and maintaining burial grounds in accordance with the provisions of chapter one hundred and fourteen;
for establishing a not-for-profit association of employers as authorized by section twenty-five E of chapter one hundred and fifty-two, including such not-for-profit associations of employers organized as nonprofit corporations.

Non-Profit vs. Public Charity
Public Charities are subject to the oversight of the Attorney General’s office.
Public Charities generally share three characteristics:
They are Non-Profit Organizations
They have a purpose that is primarily charitable
They benefit an indefinite class or number of people.
Public charities must comply with rules and annual filing requirements of the Division of Public Charities of the Attorney General of Massachusetts office.
The Division of Public Charities has the obligations to the public to ensure the proper use and solicitation of charitable funds.
Requirements include: initial filing, Form PC, IRS Form 990, audited financial statement. Also must obtain Certificate for Solicitation.

II. The Function of the Board

How are Directors Chosen?
Membership Corporations
Members elect directors just like shareholders in a corporation elect directors
Usually at annual meeting, as specified in the bylaws. Bylaws establish notice to members before the meeting
Nonmembership Corporations
Incumbent directors elect or re-elect directors
Again, usually at annual meeting, as specified in the bylaws

Period of Service
Generally serve until the next annual meeting
Sometimes staggered or for multiple year terms
Number of Directors
Stated in the Bylaws
Must be at least three (3) by statute.
Always make sure the correct number are serving.

Special Categories of Directors
Ex officio: Sometimes officer of the Corporation is stated in the Bylaws to automatically be a director. Are these directors entitled to the same voting rights as other directors? Depends.
Honorary or Emeritus: Generally not allowed to vote
Removal of Directors
Provided for in Bylaws
With or without cause provisions
Missing meetings

Compensation
Massachusetts law allows directors to get paid
Most serve without compensation
Expense reimbursement ok
Statutory immunity for “volunteers” not available for paid service on the board
Who can serve on the Board?
Articles or Bylaws can specify qualifications
Special background, qualifications or management experience not required
Choosing right people critical for success

What are Functions of the Board?
Priority Number One: Knowing the Nonprofit’s Purpose.
What does it do and for whom?
General Purpose Statement in Articles
Mission Statement
Board’s power is cornerstone of corporate law
Govern enterprise by delegation and oversight of management to officers
Board only acts as a group
Board Functions:
Setting and overseeing policy and overall direction of the Corporation
Remaining reasonably informed of corporate activities
Providing reasonable oversight of management and committees
Review of possible conflict of interest transactions
Delegating functions to committees and officers
Management functions
Developing long term and strategic plans for review and approval by the board
Implementing directives of the Board
Conducting and Managing day to day operations

Board Meetings
Directors generally must meet in order to act.
Meetings can be conducted through electronic means, so long as all “present” can simultaneously hear each other during the meeting (Massachusetts General Law c 156B, S 59)
Board Action can be approved, however, by unanimous written consent. All directors must sign vote.
Minutes
Rights to information
In order to carry out duties, directors have right to inspect books and records of Corporation

Setting Executive Compensation
Balancing fair compensation with non-profit resources and charitable purpose
Pay should be related to performance and based on comparisons of similar executives performing similar duties in comparable organizations
IRS can impose fines on both executives and board of directors for excessive salaries and benefits.

Duties of the Board

Fiduciary Duties
Massachusetts law imposes “fiduciary duties” on both directors and officers of non-profit corporations
2 primary duties are Duty of Care and Duty of Loyalty
“ A Director. . .shall perform his duties as such, including. . .his duties as a member of a committee of the board upon which he may serve, in good faith and in a manner he reasonably believes to be in the best interest of the corporation, and with such care as an ordinarily prudent person in a like position with respect to a similar corporation . . .would use under similar circumstances.” (M.G.L. c. 180, S6C)
Third duty is Duty of Obedience
Not specifically imposed in Massachusetts but is imposed in other jurisdictions
It is likely that Massachusetts Attorney General would take the position that duty of obedience is required

Duty of Care
That degree of diligence, care, and skill which ordinarily prudent person would exercise under similar circumstances
Plainly, thoughtfulness and care
Standard which would be expected by someone with common sense and wisdom, exercising informed judgment and acting under similar circumstances
“ Similar circumstances” takes into account the non-profit nature of the corporation and the expertise and qualifications of the individual director
Applicable to all aspects of a director’s service
Not just specific transactions but also regular governance
Fiduciary Duties

Fiduciary Duties
Duty of Care (continued)
Requires active involvement meaning:
Preparation for meetings by reading materials in advance
Assess the adequacy or insufficiency of information provided, and if insufficient, ask for additional information
Attend meetings and actively participate in discussions and decision making
Inquiry. Ask questions of management and outside advisors that are necessary to fully appreciate issues and decisions
Carefully review financial reports
Maintain confidentiality
Exercise independent judgment

Duty of Loyalty
Conduct performed in good faith and in a manner the director believes are in the best interest of the corporation (as opposed to self interest or in the interest of another)
Director can not unfairly profit form the corporation
Conflicts of interest
Corporate opportunity doctrine
Director must reject corporate opportunities unless that corporate opportunity has first been offered to the Board
Any opportunity to engage in business activity that Director became aware of in connection to his or her role with the corporation, or through the use of corporate information or property, and which the director would reasonably believe to be of interest to the corporation
Fiduciary Duties

Duty of Loyalty (Continued)
Example: Phil is Director at local Private School. Bob owns land next to School. Bob asks Phil if School is interested in buying adjacent land . Phil purchase land directly from Bob without disclosing opportunity to School.
Example: Jane is Director at local Hospital. Hospital is considering entering into contract with financial services company to oversee employee retirement plan. Jane purchases stock of financial services company.
First step is to recognize potential conflict of interest or corporate opportunity exists (not always easy)
Once recognized, Director must disclose
True regardless of whether deal is ‘fair’ or opportunity would not be valuable to corporation
Director should not be present on board deliberations regarding the matter
Fiduciary Duties

Duty of Obedience
Attorney General’s office has stated that Duty of Obedience will apply
Requires directors to ensure that the corporation’s resources are used in a manner that is consistent with mission and that corporations does not engage in unauthorized activities
Specifically, Director must:
Read incorporating documents
Be familiar with the corporate purpose
Perform duties in a manner that ensures the corporations does not engage in activities for which it is not authorized
“ Be true to your school”
Watch out for restricted gifts!
Fiduciary Duties

Liabilities
Who can sue?
If Director breaches any of these duties who has standing to make claim?
Suit by the Corporation
Suit by members, if any
Massachusetts Attorney General
Whenever the attorney general believes that breaches of trust are being committed in the administration of a public charity, and investigation may be conducted with the approval of the trial court.
This authority may also be used to enforce directors’ fiduciary duties.

Liabilities
Liability can arise from many sources:
Corporation
IRS
DOR
Attorney General
Outside Parties

IV. Taxes and Disclosure Obligations

Tax Exemptions
Not all Non-Profits are exempt
Internal Revenue Code has various categories for tax exemptions.
501(c)3 is only section that entitles contributors to a tax deduction for their gifts to non-profits

Tax Exemptions
9 common types of non profits exempt from taxes
Charitable organizations – 501(c)(3)
Social welfare organizations -501(c)(4)
Labor and Agricultural Organizations -501(c)(5)
Business Leagues -501(c)(6)
Social Clubs -501(c)(7)
Fraternal Societies -501(c)(8)
Veterans Organizations -501(c)(19)
Employees Associations -501(c)(9)
Political Organizations -527

Tax Exemptions
501(c)(3) Organizations
Must be organized exclusively for charitable, religious, educational, literary, or scientific purposes
Earnings can not inure to private individuals
No substantial activities to influence legislation
No participation in political campaigns

Tax Exemptions
Application
Must apply (Form 1023)
Churches and corporations with less than gross receipts of $5,000 need not apply.
Public Charity vs. Private Foundation
Private Foundation subject to additional restrictions
No self dealing
Minimum requirements for distribution
Limits on ownership interests in other entities
Prohibition on certain investments
Excise taxes

Tax Exemptions
Unrelated Business Income
If trade or business is “unrelated” to its exempt purpose, then taxable
If substantial, the nonprofit may lose its exemption
Does not include passive income –rents, dividends, interest, etc.
Potential Strategy is to set up for profit subsidiary
Subsidiary is fully taxed
Dividend to Non-Profit is a dividend not considered unrelated business income

Tax Exemptions
Maintaining Exempt Status:
Limit unrelated business activities
Private Benefit
No net earnings can inure to private individual
No excess compensation
Purchase of goods at higher than fair market
Use of corporate assets without paying
Can result in penalty taxes for “Disqualified Persons”
Special Rules for Hospitals

Disclosure Requirements
Informational Filings
File Form 990 with IRS
Annual Report with Secretary of State
Annual Filing with Division of Public Charities
Public Disclosure
Application for Exemption
Copies of Informational Returns

V. Protections

Liability Protection By Statute
Provided the Director acts in accordance with their Fiduciary obligations (Duty of Care, Duty of Loyalty, and Duty of Obedience), Massachusetts law provides protections
Directors may rely on outside experts, if such reliance is reasonable
Must be critical
Volunteer Protection
If Director serves without compensation, “no civil damages for actions relating solely to the performance of his duty as an officer, director or trustee. . .”
Grossly negligent acts or omissions are not protected nor are activities that are primarily commercial in nature
No protections for actions relating to operation of an automobile.
Massachusetts General Law C. 231, S. 85W
Federal law is similar (42 U.S.C. S 14501)

Business Judgment Rule
Applies to all corporations (profit and non-profit)
Director will not be found liable for an honest mistake or error in judgment
Requires actions in good faith after due consideration

Statutory Exculpation
Massachusetts allows nonprofits to limit the liability of directors in lawsuits brought by the corporation or on its behalf (M.G.L. C. 156B S 13(b))
Limitation MUST BE STATED IN THE ARTICLES OF ORGANIZATION
Helpful, but significant gaps remain
Director can still have to pay own legal fees to defend himself or herself
Does not apply to suits by outside parties or government regulators

Indemnification
Corporation can indemnify the director
Corporation would pay for the cost of defense and costs of legal judgments or fines
Indemnification language should be in Bylaws
Only as good as corporation’s ability to pay

Directors’ and Officers’ Insurance
Best protection
Business judgment rule and exculpatory language only protect against suits by the corporation
Indemnity only as good as corporation’s ability to pay
D & O insurance has 2 aspects:
Reimbursement of individual directors’ liability to the corporation or outside parties (if the director is not indemnified)
Funding of the corporation’s indemnification obligations if the director is indemnified

Directors’ and Officers’ Insurance
D & O policies are indemnity vs. liability
Paid reimbursements after insured is required to make payments
Exclusions:
Pollution and environmental claims
Claims involving intentional conduct (employment discrimination, defamations, securities fraud)
Payment of fines
Penalties and punitive claims
Matters in which director realized profit
Umbrella Policies
May have coverage, but need to disclose

QUESTIONS? J. Keith Phifer, Esq. Schlossberg, LLC 35 Braintree Hill Office Park, Suite 204 Braintree, Massachusetts 02184 (781) 848-5028 E-mail: [email_address]

NON-PROFIT CORPORATIONS: Director Liability

by The Non-Profit Toolbox on Apr 04, 2011

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NON-PROFIT CORPORATIONS: Director Liability — Presentation Transcript