Nonprofit directors as fiduciaries what you need to know


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Serving on the board of a nonprofit can be very gratifying. But it can also involve serious responsibilities and potential liability. Become a better board member by understanding your role and how to serve responsibly.

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Nonprofit directors as fiduciaries what you need to know

  1. 1. NONPROFIT DIRECTORS AS FIDUCIARIES January 19, 2010 Eileen Morgan Johnson, Esq.
  2. 2. 2 Overview  Standard of Care  Business Judgment Rule  Liability  Indemnification  Zone of Insolvency  Uniform Prudent Investor Act  Uniform Prudent Management of Institutional Funds Act
  3. 3. 3 Standard of Care Directors must perform their duties (including service on Committees):  In good faith  In a manner reasonably believed to be in the best interest of the organization  With the care that an ordinarily prudent person in a like position would use under similar circumstances
  4. 4. 4 Standard of Care Directors may rely on information from:  Officer or employee of the corporation  Lawyer, CPA, or other person within that person’s professional or expert competence  Committee of the board to which a matter has been referred  Not acting in good faith if they have any contrary knowledge  Immune from liability
  5. 5. 5 Business Judgment Rule Presumption by courts  Directors acted in accordance with statutorily required standard of care  Absent a showing that they acted fraudulently or in bad faith
  6. 6. 6 Liability for Breach of Standard of Care  Breach of the standard of care is enforceable by the corporation  Not by members or donors  Articles of incorporation (charter) may expand or limit the directors’ liability
  7. 7. 7 Indemnification What is indemnification?  Providing reimbursement for expenses of defending against a claim  Must meet requisite standard of care  May also include the advancement of expenses  Often covered by D&O insurance
  8. 8. 8 Indemnification Indemnification options  Source  By statute  Bylaws  Articles of Incorporation  Coverage  Officer or director  Employees and agents
  9. 9. 9 Zone of Insolvency What is zone of insolvency?  Organizations operating in financial distress but not technically insolvent  Usually determined in retrospect  If directors and officers wonder if their organization is in the zone of insolvency, then it probably is
  10. 10. 10 Zone of Insolvency “In the zone of insolvency” when:  Organization is experiencing cash flow problems; or  Liabilities exceed assets; or  Predict problems in the near future
  11. 11. 11 Zone of Insolvency Boards governing corporations in the zone of insolvency:  Additional responsibilities and liabilities  Board’s responsibilities expand to protect interests of creditors, members, employees  Challenge for nonprofit directors  Mission v. duties owed to others
  12. 12. 12 Zone of Insolvency Duties owed by directors of a corporation in the zone of insolvency:  Duty of care  Duty of loyalty  Duty of obedience
  13. 13. 13 Zone of Insolvency Standard of care for directors of a corporation in the zone of insolvency:  Standard of care does not change  Directors must perform duties in good faith  In the best interests of the corporation  Care that an ordinarily prudent person in a like position would use
  14. 14. 14 Zone of Insolvency Prudent person rule requires directors to: a. Adequately supervise executive director b. Read and understand financial reports c. Understand organization’s business activities d. Properly invest and manage assets e. Meet as often as necessary f. Ask questions
  15. 15. 15 Zone of Insolvency Business judgment rule  Courts will not second guess decisions made by board absent a showing of: ● fraud ● bad faith ● gross negligence ● waste of corporate assets ● culpable negligence
  16. 16. 16 Zone of Insolvency May a director resign when a corporation is in the zone of insolvency?
  17. 17. 17 Uniform Prudent Investor Act  Utilize modern portfolio theory to guide investment decisions reducing portfolio volatility and losses  Fiduciary’s performance is measured on the performance of the whole portfolio  Diversification is required unless, due to special circumstances, the trust would be better served without diversification  Fiduciaries may delegate investment decisions  Not adopted in DE, GA, KY, LA, NY
  18. 18. 18 Uniform Prudent Investor Act Prudent Investor Rule:  Trustee shall invest and manage trust assets considering the purposes, terms, distribution requirements, and other circumstances of the trust  Trustee shall exercise reasonable care, skill and caution  Trustee’s investment and management decisions  Evaluated in the context of whole trust portfolio  Risk and return objectives reasonably suited  Part of an overall investment strategy
  19. 19. 19 Uniform Prudent Investor Act Circumstances trustee must consider in investing and managing trust assets:  General economic conditions  Possible effect of inflation or deflation  Expected tax consequences of investment decisions or strategies
  20. 20. 20 Uniform Prudent Investor Act Overall trust portfolio may include:  Financial assets  Interests in closely held in closely held enterprises  Tangible and intangible personal property  Real property
  21. 21. 21 Uniform Prudent Investor Act Additional circumstances trustee must consider in investing and managing trust assets:  Expected total return from income and appreciation of capital  Other resources of the beneficiaries  Need for liquidity, regularity of income, and preservation or appreciation of capital  Assets
  22. 22. 22 Uniform Prudent Investor Act More circumstances to consider:  Trustee shall make a reasonable effort to verify facts relevant to the investment and management of trust assets  Trustee may invest in any kind of property or type of investment consistent with the standards of the Act  Trustee who has special skills or expertise  Duty to use those special skills or expertise
  23. 23. 23 Uniform Prudent Management of Institutional Funds Act Approved by National Conference of Commissioners on Uniform State Laws July 2006:  Enacted in every state (and DC) except: AK, FL, KY, LA, MS and PA
  24. 24. 24 Uniform Prudent Management of Institutional Funds Act Standard of care:  Investment “in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances”  Prudence required in incurring investment costs  Factors considered in investing expanded to include inflation
  25. 25. 25 Uniform Prudent Management of Institutional Funds Act Investment decisions must be made:  In relation to the overall resources of the institution and its charitable purposes  Considering the fund’s entire portfolio  Investment strategy - risk and return objectives “reasonably suited to the fund and to the institution”
  26. 26. 26 Uniform Prudent Management of Institutional Funds Act Investment decisions:  Charitable funds must diversify assets  Institution must review assets within a reasonable time after receipt  Investment experts held to standard of care consistent with their expertise  More precise standards for investment activities and court oversight
  27. 27. 27 Uniform Prudent Management of Institutional Funds Act Criteria for annual expenditures decisions:  Duration and preservation of the endowment fund  Purposes of the institution and the endowment fund  General economic conditions  Effect of inflation or deflation
  28. 28. 28 Criteria for annual expenditures decisions:  Expected total return from income and the appreciation of investments  Institution’s other resources  Institution’s investment policy Uniform Prudent Management of Institutional Funds Act
  29. 29. 29 Restrictions imposed by donors  Modified with court approval  Impractical or wasteful  May impair the management of the fund  Charity must notify state’s chief charitable regulator if it seeks court approval of modification  Modify restriction without court approval  Funds less than $25,000  Funds over 20 years old Uniform Prudent Management of Institutional Funds Act
  30. 30. 30 Uniform Prudent Management of Institutional Funds Act  Preventing restrictions on donations  Catholic Relief Services example: Contributions will be used for the purpose(s), if any, specified by the donor. However, if in the judgment of CRS, such purpose(s) become unnecessary, undesirable, impractical or impossible to fill, CRS may use such contributions for its general purposes.
  31. 31. 31 CONTACT INFORMATION Eileen Morgan Johnson Whiteford Taylor & Preston L.L.P. 3190 Fairview Park Drive, Suite 300 Falls Church, VA 22042 Phone: 703-280-9271 Fax: 703-280-8947 E-Mail: Questions?