Powers of Directors and Officers - Module 5 of 5

Powers of Directors and Officers - Module 5 of 5


Module 5: Powers of Directors and Officers

 

Directors and Officers’ Powers – Overview

 

The fiduciary duties of nonprofit directors coincide with certain rights that are necessary to their roles in the governance of the organization. These rights include the right to attend meetings and vote, rights related to decision-making and policy-setting on behalf of the organization, the right to amend the organization’s bylaws and the rules of the board, the right to inspect the nonprofit’s records and certain protections from liability.

Nonprofit directors typically have a statutory right to attend all board meetings and to vote on all board decisions, and to receive copies of all meeting minutes. Directors also have the right to abstain from a vote and to go on the record in the board meeting minutes as having dissented to a board action.  All directors and officers have the right to make decisions on behalf of the organization and to set policy. Rights associated with attendance and voting are typically outlined in the state’s nonprofit corporations act.

In McNally v Sunlakes Homeowner’s Association, a member of the association’s board of directors was prevented from attending executive session board meetings following a vote by the rest of the board. She sued the association, seeking to enjoin the association’s board from preventing her from attending future meetings.  The Arizona court found that neither state law nor the association's bylaws authorized the board to exclude McNally from executive sessions, and that by passing the motion, the board prevented her from performing her duties as a director.  Arizona law required McNally to participate in the management of the association, as did the association’s bylaws. The association board was ordered to allow McNally to attend future meetings.[1]


           
Board members acting together have a great deal of discretion to set internal policy on behalf of the organization, as long as the policy falls within the organization’s purpose and mission. This includes policies and procedures related to the management of the nonprofit, such as board procedures, the formation of committees, codes of conduct, anti-harassment policies and procedures and whistleblower protection policies.[2]

In addition, the board has the right to set the organization’s public-facing policies, which are the official statements and beliefs of the organization about important issues, political positions and actions to be taken by the organization related to those positions, all within the context of the organization’s purpose.  The scope of the policy-setting role of directors is tempered by provisions for staff that handle the day-to-day management of the organization.  The board’s role is to oversee the organization and set policy at a high level, not to run the business of the organization on a daily basis.  This separation of board from the staff also helps maintain the independence of directors, an important feature of their fiduciary duty of loyalty.[3]

The leadership responsibilities of an organization are often split between the board of directors, who are not employees of the corporation, and management, which usually consists of officers who report to the board. Officers such as the chief executive may also have roles on the board of directors, and typically serve at the pleasure of the board.  The chief executive oversees the paid staff of the organization.[4]

 Nonprofit organizations also sometimes rely on the work of unpaid volunteers, including the board of directors itself, and any number of committees, interest groups and individuals that contribute to the mission of the organization.

 Due to their responsibilities of oversight and policymaking, directors have the right to communicate reasonably with the paid management and staff of the organization, though directors and officers generally may not generally interfere with the day-to-day business of carried out by staff. Individual board members may not make requests or demands on an organization’s staff and resources without approval from the rest of the board acting as a body.[5] 

 

Changing or Dissolving the Organization

A nonprofit board has the right to amend the organization’s bylaws. This may be subject to a requirement that a certain percentage of the membership approve the change (such as a majority or 2/3 of the voters). Similarly, they may also vote to amend their own rules.  Rules of the board provide instructions and procedures that build on the corporate governance structure set forth in the bylaws. A quorum, or minimum attendance level of those eligible to vote, is required to make these changes.

However, the right to amend the bylaws is not absolute. In Ferry v. San Diego Museum of Art,[6] a member of the art museum with voting rights sued to prevent the museum board from amending its bylaws to eliminate member voting rights. California law permitted a nonprofit corporation to choose to have no voting members and defined a “member” as a person with voting privileges. Trustees and officers of the museum attempted to amend the museum's bylaws to eliminate voting memberships to reduce the museum’s bureaucracy and operating expenses.   

Normally, such a decision to amend the bylaws would be put to a member vote. However, the officers and trustees sought to revise the bylaws secretly without informing the museum’s members of their activities and of the significance of the revision.  California law also requires that nonprofits provide notice and hearing procedures for “the expulsion, suspension, or termination of corporate members,” and requires a good faith, fair and reasonable process before termination of membership rights.

The court held that the California statute requiring fairness and reasonableness in termination of membership rights included the termination of members' voting rights, and that the procedure undertaken by the board was unfair and unreasonable, thus nullifying the vote to terminate member voting rights.

The dissolution of a nonprofit corporation may have a negative impact on the public, and as such, notice requirements, and often voting requirements of the members, are imposed by law.

Similarly, though the board has a right to vote to change the purpose of a nonprofit, changing the purpose of a nonprofit organization may be scrutinized under state and federal law due to the special relationship nonprofits have to the public good. To change the purpose of the organization, at a minimum, the board must give the Secretary of State and the Internal Revenue Service notice of the intent to change its purpose and file appropriate state and federal documentation. Approval from membership may be required under state law as well.[7]

Organizational Records

Nonprofit directors have the right to inspect the organization’s records, including financial records, contracts and employment records. However, this right is limited in two ways. First, the requested inspection must be reasonably related to the performance of the director’s duties. Second, the director must not use the information in a manner that would violate a duty to the organization. There may be other legal considerations specific to some organization, such as privacy in education and healthcare rules that may limit access. Nonetheless, the right to inspect records where the records relate directly to the director’s duties has been typically upheld by courts.

For example, in one case, the board of trustees of Penn State University voted to not review the sensitive background data related to a controversial report on the university’s handling of a sexual misconduct investigation of former assistant football coach Jerry Sandusky, citing the fact that the records contained highly sensitive material, including confidential witness statements.

Several of the trustees sued to have access to the underlying report data, under Pennsylvania Nonprofit Corporation Law, which provides that directors shall have the right, “to the extent reasonably related to the performance of the duties of the director,” to inspect and copy corporate records and documents. The law also provides that if the corporation refuses, the court “shall” summarily order disclosure of the information unless the corporation proves that the information is not reasonably related to the director’s duties or that the director is “likely to use the information in a manner that would violate the duty of the director to the corporation.” 

The university argued that the trustees were likely to use the information in a manner that would violate their duties as directors. However, the court held that the trustees did have a right to inspect the report as it related to their duties to the organization, but limited the review of the report by ordering the board to review and discuss the report data exclusively in executive session, and to keep the contents confidential.[8]

Nonprofit boards must adopt whistleblower policies pursuant to Sarbanes-Oxley.[9] While the paid staff of an organization are protected from termination in retaliation for blowing the whistle under federal law, it is less clear to what extent directors and officers are protected under such policies. Bylaws may stipulate that a director or officer may be removed without cause by vote of the rest of the board or it may limit the circumstances under which a director may be removed.[10]

In Donovan v. Dan Murphy Foundation, Donavan, a former director of the nonprofit foundation sued for injunctive relief to be reinstated as a director of the foundation and requested that the court monitor the financial activities of the foundation.  The director alleged he was wrongfully removed after voicing concerns over the financial management of the foundation. The appellate court upheld a lower court’s decision to deny Donovan’s request, holding that the board violated no law with respect to Donovan’s removal, which was properly executed within the procedures set forth in the organization’s bylaws, which stipulated that he could be removed without cause by a majority vote. That is actions were taken in good faith to protect the organization was immaterial.[11] 

Indemnification

Indemnification is the payment of legal expenses, including costs, settlements and judgments related to litigation, by an organization to a director or officer. Directors have a right to indemnification under certain circumstances. Most states allow organizations to advance litigation expenses.[12] In fact, organizations sometimes purchase “directors and officers” to protect it from having to cover the expenses of litigation. This insurance may cover judgments against the director, when a claim arises out of actions taken by the director on behalf of the organization.

Indemnification of directors may be permissive or mandatory. A nonprofit organization may indemnify a director where the director acted in good faith, reasonably believed his actions were in the best interest of the organization and had no reasonable belief that his conduct was unlawful. A nonprofit corporation may be barred from indemnifying a director where the director failed to live up to the standard of care for directors prescribed by law. Statutes and case law often cite the special relationship between nonprofits and the public good as a reason for prohibiting the indemnification of directors that act with gross negligence or willful misconduct.[13]

            A nonprofit organization must indemnify where an officer or director successfully defends a lawsuit. A nonprofit corporation is required by most state nonprofit acts to indemnify to the extent the director or officer was successful, whether or not on the merits, in the defense of any proceeding to which the director or officer was a party, related to his role in the organization, unless limited by the articles of incorporation.[14]

             In Neal v Neumann Medical Center, a nonprofit hospital brought suit against former officers for negligence, breach of fiduciary duty and tortious interference with contract. Neumann Medical Center sought damages that it claimed to have incurred from the officers' mismanagement of the organization.  The officers countersued for an injunction to delay prosecution of the case against them until Neumann advanced the officers’ defense costs, in accordance with an indemnification agreement. The bylaws provided for mandatory indemnification of officers to the full extent allowed by state law, including advancement of expenses, subject to a finding of no breach of fiduciary duty.

 The court held that the former officers were entitled to the advancement of costs to defend themselves from the lawsuit, subject to reimbursement if the officers were ultimately found not to be entitled to indemnification due to a breach of their fiduciary duties.[15] 

             In addition to indemnification, unpaid directors and officers may have protection under provided to nonprofit volunteers.[16] These protections are afforded to encourage people to volunteer for nonprofits organizations. They recognize that the country depends on the goodwill and support of volunteers in organizations that provide social programs and infrastructure that the government is unable to provide. As such, it rewards volunteers with some protection from tort liability when engaged in volunteer activities, except where harm is caused by “willful or criminal misconduct, gross negligence, reckless misconduct, or a conscious, flagrant indifference to the rights or safety of the individual harmed by the volunteer.”[17]

 

Right to Sue on Behalf of the Organization

When something goes wrong with the governance of a nonprofit organization and there are tangible losses to the nonprofit, those associated with the organization may seek to file suit on its behalf. However, only members may bring derivative suits against the organization. Directors and officers who are not members may not bring such suits, even where the organization has no members at all. In some states, unlike in the cases of for-profit corporations, derivative suits against nonprofits may not be authorized at all. 

For example, in Doermer v Callen, a director of a small nonprofit family foundation in Indiana sought to bring a derivative suit on behalf of the foundation against two co-members of the board who had received a gift from the organization, alleging that the nonprofit was no longer lawfully constituted under the Indiana Nonprofit Corporation Act.  Under Indiana law, the director was not a “member” of the nonprofit corporation, which in fact, had no members as nonprofit corporations are not required by Indiana law to have members.  In that case, neither the relevant Indiana nonprofit act, nor any other Indiana statute or case, authorized a non-member director of a nonprofit corporation to bring a derivative suit on the corporation’s behalf.  The court thus held that the director had no standing to sue, and his case was dismissed.[18]

Conclusion

Thank you for participating in LawShelf’s video-course on nonprofit corporations. We hope you will also take advantage of our other courses on business law and business organizations. Please let us know if you have any questions or feedback.

 


[1] 382 P.3d 1216, Court of Appeals of Arizona, Division 1

[3] Id.

[4] Id.

[5] Id.

[6] 180 Cal.App.3d 35, Court of Appeal, Fourth District, Division 1, California.

[8] In re: application by nonprofit corporation trustees to compel inspection of corporate records: Accessed at https://www.psu.edu/ur/newsdocuments/Court_Decision_Nov_19.pdf

[9] 15 U.S.C.A. § 7201

[11] See Ct. of App., CA, Second Dist., Div. 4, No. B246735

[12] Fishman, James J. and Schwarz, Stephen, Nonprofit Organizations, Cases and Materials, 4th Ed. pp 160-161

[13] See UT ST § 16-6a-906;

[14] Model Nonprofit Corp. Act (3d ed.)  § 8.52. 

[15] 667 A.2d 479, Commonwealth Court of Pennsylvania

[16] 42 U.S.C.A. § 14501; State Law Example, See CT ST § 52-557m, Connecticut General Statutes Annotated, Title 52.

[18] 847 F.3d 522; United States Court of Appeals, Seventh Circuit.

 

 

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