Piper Academy
November 13, 2013
The Legal, Ethical, and Fiduciary
“Ins & Outs” of Nonprofit Board Service
Dennis Mitchem
Ron Stearns
Craig McPike
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Board Policies and Practices
• Board Member Welcome Packet
• Fiduciary Duties
• Business Judgment Rule
• Third-Party Reliance
• Role in Management – Oversight vs. Involvement
• Conflicts of Interest
• Liability and Insurance
Maintaining Tax-Exempt Status and Unrelated Business Income
Financial Management
Three G’s of Board Service
Board Member Welcome Packet
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An informed, engaged board facilitates
effective governance
Being “informed” includes understanding
how the organization works
Board member welcome package
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Articles, bylaws, tax-exempt documents
Various policies
Committee charters
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Director and officer information
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©2011 Snell & Wilmer L.L.P.
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Overview of Fiduciary Duties of Directors
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Statutory Duties of Directors
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Under Arizona law, directors are required
to discharge their duties
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in good faith
with the care an ordinarily prudent person in
a like position would exercise under similar
circumstances (the "duty of care")
in a manner the director reasonably
believes to be in the best interests of the
corporation (the "duty of loyalty")
©2013 Snell & Wilmer L.L.P.
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Practical Suggestions in
Discharging the Duty of Care
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Generally, act in a reasonable and informed
manner when participating in the board’s
decisions and its oversight of management
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Guidelines for a specific transaction or other
decision
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Time commitment and regular attendance
Careful deliberation among directors
Directors should avoid not only haste, but the
appearance of haste, in making decisions
Major decisions should be made only after
directors have had an opportunity to digest
available information, which may require more than
one meeting
Review material information in advance of
meetings
©2013 Snell & Wilmer L.L.P.
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Practical Suggestions in
Discharging the Duty of Care (cont.)
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Consider the advice of outside advisors, when
appropriate
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Internal advisors may be relied upon, but certain
circumstances may support using outside advisors
Outside advisors may be appropriate for legal,
accounting and finance, among others
Evaluate potential bias of outside advisor
Directors should be convinced that the board's
advisors are competent, were chosen with
reasonable care and are providing reliable advice
Ask questions to make an informed decision
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Actively probe and test all information presented
Actively judge its reliability and accuracy, and
Request additional information, if necessary
©2013 Snell & Wilmer L.L.P.
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Duty of Loyalty
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Requires directors to exercise their
powers
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In the best interest of the organization
Not for their own self-interest or the
interest of another
The duty of loyalty primarily relates to
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Conflicts of Interests
Corporate Opportunity
Confidentiality
©2013 Snell & Wilmer L.L.P.
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Business Judgment Rule
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Business Judgment Rule
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Common law doctrine expressly adopted by
Arizona
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A director is presumed in all cases to have
discharged his or her duties in accordance with
the statutory requirements of good faith, care
and loyalty
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“Clear and convincing evidence” required to
successfully challenge a director's action or
failure to act before the presumption is
rebutted
©2013 Snell & Wilmer L.L.P.
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Third-Party Reliance
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A director is entitled to rely on information, opinions,
reports, or statements (including financial statements
and other financial data) prepared or presented by
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Management: Officers and other Associates whom the
director reasonably believes are reliable and competent
in the matters presented
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Experts: Legal counsel, public accountants or other
persons as to matters the director reasonably believes
are within the person's professional or expert
competence
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Committees: A committee of the board of which the
director is not a member, if the director reasonably
believes the committee merits confidence
A director is not acting in good faith if he or she has
knowledge contrary to the third party’s input
©2013 Snell & Wilmer L.L.P.
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Role of Directors in Management of the
Corporation – Oversight Function vs. Strategy
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Under Arizona law
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All corporate powers shall be exercised by or under the authority of
the board of directors
The affairs of the corporation shall be managed under the direction
of its board of directors
Director Oversight
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Do oversee management1
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Do not directly engage in day-to-day operations
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Directors not personally responsible for acts/omissions of
management/third parties if prudently selected and reliance is
reasonable
Actual operations are a function of management
Directors’ responsibility is limited to monitoring and overseeing
management
Increasing board focus on strategy
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Strategic planning tops “wish list” of public-company directors2
54% of public-company boards discuss strategy at every meeting3
Good benchmark for nonprofit boards
©2013 Snell & Wilmer L.L.P.
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Risks of Action Outside Typical
Responsibilities and Duties
Action by directors that
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Is outside normal scope of director duties
Is outside established lines of communication
Impinges on specific functions of a committee
could result in increased risk of liability for corporation
and directors, and
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Could violate the reasonable-care standard
Could violate the duty of care
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May not be based on full available information
May void protections otherwise available, such as the ability to
rely on third-party information
Could result in delay or failure to put the matter before
the proper person or committee
©2011 Snell & Wilmer L.L.P.
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Risks of Action Outside Typical
Responsibilities and Duties (cont.)
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Could result in loss of attorney-client privilege or
other important privileges otherwise available
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Could result in loss of control of written material
(dissemination to outsiders)
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Could result in statements, writings or actions
harmful in future governmental proceedings or
litigation
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Could result in confusion of responsibilities and
blurring lines of authority
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Could cause the board to lose sight of the largerscale monitoring that it is intended to provide
©2011 Snell & Wilmer L.L.P.
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Heightened Scrutiny –
“Disqualified Person” Transactions
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Excess Benefit Transactions
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Transaction with “Disqualified Person” (DP), if
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value provided by organization > value received from DP
“Disqualified Person” includes
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Insiders – Directors, Officers, Founders, Substantial
Contributors, others with “substantial influence over
the affairs of the organization”
Family members of insiders
Businesses owned or controlled by insiders and/or
family members
©2011 Snell & Wilmer L.L.P.
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Exposure for Excess Benefit Transactions
and Rebuttable Presumption
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Possible excise taxes on “excess benefit”
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DP liable for 25% – “first-tier” tax
DP liable for 200% – “second-tier” tax
DP must repay excess benefit with interest
Organization managers – 10% excise tax for
“knowing participation”
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Organization cannot indemnify a party subject
to excise taxes, or the indemnity will itself be
an excess benefit transaction
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Rebuttable Presumption of Reasonableness is
available to shift burden of proof to IRS, with
appropriate steps in advance
©2011 Snell & Wilmer L.L.P.
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Conflict of Interest Policy
and Questionnaire
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Conflict of Interest Policy
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Procedures to identify potential conflicts
Procedures to identify disinterested members to
vote
Procedures to establish rebuttable presumption of
reasonableness, if practical/desired
Annual questionnaire for possible conflicts
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Facilitates compliance with conflict policy
Permits positive response to question on Form 990
©2011 Snell & Wilmer L.L.P.
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Director Liability:
Protections and Limitations
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Liability can come in various forms
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Protections
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Exceeding scope of duties
Engaging in excess benefit transactions
Taking part in approval of another’s excess benefit
transaction
D&O Insurance
Arizona law, with appropriate provisions in governing
documents
Limitations on Protections
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Excess benefit transactions – no protection
Acting outside the scope of duties – possible limits
“Reasonable” expenses
©2011 Snell & Wilmer L.L.P.
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Maintaining Exempt Status
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No Private Inurement/Excess Benefit: To protect taxpayer
subsidies of charitable organizations, Congress has imposed
heightened scrutiny of arrangements with “disqualified persons”
No Private Benefit: Assets and profits must be used to further
charitable mission and not private interests
Limited Unrelated Business Activities / Tax (UBIT): Limited
activities not furthering charitable mission – taxed like corporation
and threat to exempt status if considerable unrelated activities
No Political Campaign Activity: No supporting or opposing
candidates for office
Limited Lobbying: Strict limitations on efforts to change the law
or oppose a change in the law
Annual Filings: IRS Form 990, Annual Report, Charitable
Solicitation (if applicable in other states)
©2013 Snell & Wilmer L.L.P.
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Unrelated Business Activities
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For activities to be “charitable”, they must
themselves further a charitable purpose
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Activities that merely raise funds to be used for a
charitable purpose, without more, are not charitable –
they are “unrelated”
“Unrelated” activities are taxable just like a for-profit
business
- Expenses may be deducted
- Exceptions for certain types of income, such as
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Rental of real property
Stocks, bonds
Royalties
Exceptions don’t fully apply if “debt-financed” assets
generate the income
©2011 Snell & Wilmer L.L.P.
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Conclusion
Any Questions?
Thank you!
©2011 Snell & Wilmer L.L.P.
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Endnotes
Guidebook for Directors of Nonprofit Corporations, Second
Ed. (2002), ABA Committee on Nonprofit Corporations, p. 24
2 PwC 2012 Annual Corporate Directors Survey
3 Deloitte 2012 Board Practices Report
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©2013 Snell & Wilmer L.L.P.
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Thank You!