FIDUCIARY DUTY 101:
DUTY CALLS
IMA NorthEast Regional
Council Conference
September 21, 2015
Leah Cohen Chatinover
Stanger & Associates, LLC
433 S. Main St.
West Hartford, CT 06010
(860) 561-0651
lchatinover@stangerlaw.com
Non Profit Boards
of Directors
• Fiduciary
Duties
• Legal
Obligations
• Protections
© 2015 Leah Cohen Chatinover
Three Questions
• How must a director act and how careful must a
director be when exercising his/her judgment and
making decisions as a member of a board of a
nonprofit organization?
• What are the standards by which a director’s
decisions will be judged after the fact by a court or a
state Attorney General?
• What statutory and contractual protections are
available to a director?
© 2015 Leah Cohen Chatinover
What is a Fiduciary?
• A fiduciary is someone
in a relationship of trust
vis-à-vis a more
vulnerable person or
entity.
• Director/Organization
• Directors – owe a duty
to act in the interests of
the organizations they
serve.
© 2015 Leah Cohen Chatinover
To Whom are Fiduciaries
Duties Owed?
• The organization
• Community at large/general
public
• Beneficiaries or clients
• Donors
© 2015 Leah Cohen Chatinover
Basics of Legal Liability
• Two Sets of
Rules:
–Procedural
–Substantive
© 2015 Leah Cohen Chatinover
Procedural Rules
• State Law
• Certificate of Incorporation
• By-Laws
© 2015 Leah Cohen Chatinover
2 Systems – State and
Federal Law
• State Law – corporate existence, governance,
protection of charitable endowments – Grew
out of Case law (common law) eventually
codified
• Multiple States
• Federal Law – Tax exempt
status and compliance
©2015 Leah Cohen Chatinover
State Law
•
The Model Nonprofit Corporation Act (MNCA) is model legislation prepared by the Nonprofit Organizations Committee of the Business
Law Section of the American Bar Association. The MNCA is a model set of statutes governing nonprofit corporations proposed for
adoption by state legislatures. The newest published revision of the MCNA is the Third Edition, dated 2008 (although the Committee
has adopted changes since then.) Many states have adopted this, or an earlier edition of the MCNA. Those in this region are indicated
with an * below.
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New York, Massachusetts and New Hampshire each have unique state-specific laws. New York, which is highly regulated, amended its
law for the first time in 30 years, last year. The Massachusetts statute is old, confusingly drafted and difficult to use.
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CT
Conn. Gen. Stat. § 33-1000 Connecticut Revised Nonstock Corporation Act**
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MA
M.G.L. 156B §§ 11-13 (except the corporation does not have capital stock, the articles of organization omit reference to
stock and stockholders) and M.G.L. 180
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ME
Title 13-B M.R.S.A. MAINE NONPROFIT CORPORATION ACT **
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NH
N.H. R.S.A. XXVII, Ch. 292
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NJ
N.J.S.A. T. 15A New Jersey Nonprofit Corporation Act**
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NY
Not-for-Profit Corporation Law or NPCL
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RI
RI ST § 7-6, Rhode Island Nonprofit Corporation Act* (1952 Model Act)
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VT
11B V.S.A. Vermont Nonprofit Corporation Act**
©2015 Leah Cohen Chatinover
MNCA and Most Other State
Nonprofit Corporation Laws
• Outline basic requirements for governing
documents; and
• Provide statutory defaults if governing
documents are silent
©2015 Leah Cohen Chatinover
Certificate of Incorporation
• Formally creates corporation's existence
• Should:
– reflect current mission
– most recent changes in the law
– provisions required by IRS for tax exempt status
• Under MNCA and many other state nonprofit laws - may
contain indemnification provisions to protect officers and
directors
• Filed with the Secretary (Department) of State
(Commonwealth)
• Public Document
©2015 Leah Cohen Chatinover
By-Laws – Procedural Rules
• “Constitution” of organization
– Internal governance;
allocation of control
• Not a public document
• Adhere to the KISS principle
By-laws should be simple enough to follow in
practice
• Not just legalese: when a dispute arises: meeting
notice, quorum and voting requirements matter
©2015 Leah Cohen Chatinover
A Hypothetical to Illustrate the
Procedural/Substantive Difference
Millie Millions dies
and unexpectedly
leaves your
organization a $2
million bequest
© 2015 Leah Cohen Chatinover
Hypothetical
• That night, the numbers 1 14 26 33 51 37 come to
you in a vision.
• The next day you trot on down to the gas station and
buy 50 power ball tickets with those number
combinations.
• AND YOU HIT!!! And win $15 Million
• So, your $2 million bequest is now $16,999,950
© 2015 Leah Cohen Chatinover
Hypothetical
• You form a Board Committee to
interview three well respected
investment managers. Based on
interviews and
recommendations you hire one
of these managers to manage
your portfolio.
• You rely on research provided by
the investment manager, and
invest the $2 million in a
balanced portfolio targeted for
both income and growth.
• And the stock
market tanks!
• Your organization’s $2 million is
now worth about $1,400,000.
© 2015 Leah Cohen Chatinover
Hypothetical
• Exercise of duty of
care is not a
guarantee of results.
• Only that the correct
procedure and
substantive
standards were
followed.
© 2015 Leah Cohen Chatinover
Traditional Duties
Owed by Fiduciaries
• The duty of care.
• The duty of loyalty.
• The duty of
obedience.
© 2015 Leah Cohen Chatinover
The Duty of Care
• Pay Attention!
• Stay Awake!
• Ask Questions!
© 2015 Leah Cohen Chatinover
The Duty of Care
•
Connecticut General Statutes §33-1104
Sec. 33-1104. General standards for directors. (a) A director shall discharge his duties as a director, including his duties as a
member of a committee: (1) In good faith; (2) with the care an ordinarily prudent person in a like position would exercise
under similar circumstances; and (3) in a manner he reasonably believes to be in the best interests of the corporation.
(b) In discharging his duties a director is entitled to rely on information, opinions, reports or statements, including
financial statements and other financial data, if prepared or presented by: (1) One or more officers or employees of the
corporation whom the director reasonably believes to be reliable and competent in the matters presented; (2) legal counsel,
public accountants or other persons as to matters the director reasonably believes are within the person’s professional or
expert competence; or (3) a committee of the board of directors of which he is not a member if the director reasonably
believes the committee merits confidence.
(c) A director is not acting in good faith if he has knowledge concerning the matter in question that makes reliance
otherwise permitted by subsection (b) of this section unwarranted.
(d) A director is not liable for any action taken as a director, or any failure to take any action, if he performed the duties of
his office in compliance with this section.
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MA
ME
NH
NJ
NY
RI
VT
M.G.L. 180 § 6C
Title 13-B M.R.S.A. § 717
Attorney General Policy and Common Law
N.J.S.A. 15A: 6-14
NPCL § 717
RI ST § 7-6-22
11B V.S.A. § 8.30
© 2015 Leah Cohen Chatinover
The Duty of Care
• A director must use the same care as a
director of a non-profit organization as
s/he would in his/her own business.
• A director is not liable for actions taken
or not taken if s/he complied with this
statute.
• S/he can rely on experts.
© 2015 Leah Cohen Chatinover
The Duty of Care
TIP
To Exercise the Duty of Care Avoid This:
© 2015 Leah Cohen Chatinover
The Duty of Loyalty
• Don’t abuse the
position of power in the
organization!
• Don’t steal from the
organization!
© 2015 Leah Cohen Chatinover
The Duty of Loyalty
• Codified in MNCA and many other state laws
through conflict of interest statute and indirectly
by IRS through requirements on Forms 990 and
1023, and excess benefit transaction regulations.
• Avoid: conflicts of interest; potential for conflicts;
appearance of a conflict; insider transactions.
• Disclose: actual or potential conflicts.
© 2015 Leah Cohen Chatinover
The Duty of Loyalty
•
Connecticut General Statutes §33-1127 - 1130 Concerning “Directors’ Conflicting Interest Transactions”
Sec. 33-1128. Judicial action. (a) A transaction effected or proposed to be effected by the corporation, or by an entity controlled by the
corporation, may not be the subject of equitable relief, or give rise to an award of damages or other sanctions against a director of the
corporation, in a proceeding by a member or director or by or in the right of the corporation, on the ground that the director has an
interest respecting the transaction, if it is not a director's conflicting interest transaction.
(b) A director's conflicting interest transaction may not be the subject of equitable relief, or give rise to an award of damages or
other sanctions against a director of the corporation, in a proceeding by a member or director or by or in the right of the corporation,
on the ground that the director has an interest respecting the transaction, if: (1) Directors' action respecting the transaction was taken
in compliance with section 33-1129 at any time; (2) members' action respecting the transaction was taken in compliance with section
33-1130 at any time; or (3) the transaction, judged according to the circumstances at the relevant time, is established to have been fair
to the corporation.
Sec. 33-1129. Directors’ action. (a) Directors' action respecting a director's conflicting interest transaction is effective for purposes of
subdivision (1) of subsection (b) of section 33-1128 if the transaction has been authorized by the affirmative vote of a majority, but no
fewer than two, of the qualified directors who voted on the transaction, after required disclosure by the conflicted director of
information not already known by such qualified directors, or after modified disclosure in compliance with subsection (b) of this section,
provided that where the action has been taken by a committee, all members of the committee were qualified directors, and either (1)
the committee was composed of all the qualified directors on the board of directors, or (2) the members of the committee were
appointed by the affirmative vote of a majority of the qualified directors on the board.
(c) A majority, but no fewer than two, of all the qualified directors on the board of directors, or on the committee, constitutes a
quorum for purposes of action that complies with this section. Directors' action that otherwise complies with this section is not affected
by the presence or vote of a director who is not a qualified director.
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MA
ME
NH
NJ
NY
RI
VT
Attorney General Policy and Common Law
Title 13-B M.R.S.A. § 718
RSA 7:19-a and RSA 292:6-a (not comprehensive), Attorney General Policy and Common Law
N.J.S.A. 15A: 6-8
NPCL § 715-a
RI ST § 7-6-26.1
11B V.S.A. § 8.31
© 2015 Leah Cohen Chatinover
The Duty of Loyalty
• An insider transaction may not
be a conflict of interest if:
– Proper procedural safeguards
were followed – transaction
approved by disinterested
directors.
– Proper substantive safeguards
were followed – transaction was
fair to the corporation.
© 2015 Leah Cohen Chatinover
The Duty of Loyalty
• Conflict of Interest Annual Disclosure
Form
• Conflict of Interest Policy
• Don’t just adopt it, follow it. Don’t
confuse written policy with
governance.
© 2015 Leah Cohen Chatinover
Excess benefit transaction 26 U.S.C.A. § 4958
• transaction in which an economic benefit
provided by a tax-exempt organization
• to or for the use of a disqualified person (such
as an officer, director or key employee)
• value of the economic benefit provided by the
organization exceeds the value of the
consideration received by the organization.
• Excess benefit can occur in exchange of
compensation for services or property
© 2015 Leah Cohen Chatinover
Executive Compensation
Compensation
Fair market value of
compensation for services
= value that would
ordinarily be paid for like
services by a similar
organization in similar
circumstances.
© 2015 Leah Cohen Chatinover
Correcting the Excess
Benefit
• Disqualified person must undo the excess benefit to the
extent possible, and take any additional measures necessary
to place the organization in a financial position not worse than
that in which it would be if the disqualified person were
dealing under the highest fiduciary standards (and the
transaction had not occurred at the problematic level of
compensation.)
• Payment in cash or cash equivalents equal to the excess
benefit plus the interest on the excess benefit at a rate no
lower than the lower than the applicable Federal rate.
© 2015 Leah Cohen Chatinover
Initial Contract Exception
• binding written contract between with a person
who was not a disqualified person immediately
before entering into the contract.
• fixed payment
• contract in which there is a material change,
extension or renewal of the contract, more than
incidental change to the amount payable under
the contract is treated as a new contract and not
within the exception.
© 2015 Leah Cohen Chatinover
Rebuttable Presumption – Procedural
Rules - Found in Many Conflicts of
Interest Policies
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If an organization meets the following three requirements, payments it makes to a
disqualified person under a compensation arrangement are presumed to be reasonable, and
a transfer of property or the right to use property is presumed to be at fair market value.
The compensation arrangement must be approved in advance by an authorized body (such
as Board of Directors) but only those individuals who do not have a conflict of interest
concerning the transaction,
Prior to making its determination, the authorized body must obtain comparability data
The authorized body must timely document the basis for its determination concurrently with
making that determination (in minutes within 60 days or before next meeting).
– terms of the transaction
– date of its approval
– the members who were present and who voted
– comparability data relied upon
– actions of any members of the authorized body having a conflict of interest, and
documentation of the basis for the determination.
© 2015 Leah Cohen Chatinover
Substantive Alternative
• If Rebuttable Presumption is:
• Met, IRS must show that the
compensation is NOT reasonable by
attacking the comparability data.
• Not Met, a facts and circumstances
approach will be followed – that is, the
organization must show that the
compensation IS reasonable.
© 2015 Leah Cohen Chatinover
The Duty of Obedience
• Advance the mission of the
organization.
• Remain faithful to and pursue the
goals of the organization, as expressed
in governing documents.
• Ensure that the corporation’s
purposes are adhered to and that
charitable assets are not diverted to
non-charitable uses.
• Subsumed within the other two
duties.
© 2015 Leah Cohen Chatinover
Management of
Endowments
• Subset of
Fiduciary Duty of Care
• Steward the financial resources of
the organization.
© 2015 Leah Cohen Chatinover
General Concepts
• Restrictions as to Use
• Restrictions as to Maintenance of
Corpus (a true endowment)
• Board Designated Funds
© 2015 Leah Cohen Chatinover
Wishes of the Donor
Must be Respected
• Expressed in a Gift
Instrument
• Letter
• Agreement
• Will
• Trust
• Solicitation and
Acknowledgment
© 2015 Leah Cohen Chatinover
UPMIFA
• Uniform Prudent
Management of
Institutional Funds Act
• Governs Endowments
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CT Conn. Gen. Stat § 45a-535
MA M.G.L. 180A
ME Title 13 M.R.S.A. §5101
NH RSA 292:B
NJ
N.J.S.A. 15A-25
NY NPCL Article 5-a, §550 eq. seq.
(NY has several unique provisions)
RI
RI ST § 18-12
VT 14B V.S.A. § 3411
• Predecessor statute –
UMIFA. For the most
part these trends began
with UMIFA - UPMIFA
clarified and added
detail.
• Biggest Departure from
UMIFA – Elimination of
Historic Dollar Value
(HDV)
© 2015 Leah Cohen Chatinover
Definitions
• Institutional Fund: a fund held by an institution (entity
organized and operated exclusively for charitable purposes)
exclusively for charitable purposes or a fund held by a trustee
for a charitable community trust.
• Endowment Fund: institutional fund not wholly expendable
by the institution on a current basis under the terms of a gift
instrument. The term does not include assets of an institution
designated by the institution as an endowment fund for its
own use – (Board Designated Funds)
© 2015 Leah Cohen Chatinover
Modern Portfolio
Management Theory
• Fund Management –
prudency standard for
managing and investing
funds: in good faith and
with the care an
ordinarily prudent
person in a like position
would exercise under
similar circumstances.
© 2015 Leah Cohen Chatinover
Modern Portfolio
Management Theory
• Institution may pool two or more institutional funds for purposes of
management and investment. (Fund accounting no longer required.)
• Management and investment decisions made in the context of the
organization’s portfolio of investments as a whole and as a part of an
overall investment strategy having risk and return objectives reasonably
suited to the fund and to the institution.
• Diversification
• Rebalancing
© 2015 Leah Cohen Chatinover
Professional Management
• Management and investment may be
delegated to an external agent.
• Directors subject to prudence standard
– in good faith, with the care that an
ordinarily prudent person in a like
position would exercise under similar
circumstances, in:
• Selecting an agent;
• Establishing scope and terms of the
delegation;
• Periodically reviewing agent’s actions in
order to monitor performance and
compliance.
© 2015 Leah Cohen Chatinover
Release or Modification
of Restrictions
• With a (living) donor’s written
consent. Not a deceased donor’s
family.
• By a court, if a restriction
becomes unlawful,
impracticable, impossible to
achieve or wasteful.
Attorney General notice and
opportunity to be heard.
Modification in accordance
with the donor’s probable
intention. (Depending on
the state, failure of the
institution may not qualify.)
© 2015 Leah Cohen Chatinover
Expenditure – Elimination of
Historic Dollar Value
• Furthest departure from UMIFA
and most controversial.
• UMIFA – Historic Dollar Value
must be maintained. That is, the
aggregate value of the donor’s
original contributions to the fund.
Designed to preserve original
monetary value of the
endowment in perpetuity.
• No adjustment for inflation; no
requirement to preserve original
purchasing power.
• Example of HDV: Original Gift:
$100,000. Interest and
Appreciation: $5,000 annually.
• May spend $5,000; must preserve
$100,000 in perpetuity.
© 2015 Leah Cohen Chatinover
UPMIFA –
Eliminated HDV
• Institution (Board of Directors) may
appropriate for expenditure or
accumulate so much of an endowment
fund as the institution determines is
prudent for the uses, benefits, purposes
and duration for which the endowment
fund is established.
• Subject to intent of the donor expressed
in a gift instrument
• Board must act in accordance with the
prudence standard (act in good faith,
with the care that an ordinarily prudent
person in a like position would exercise
under similar circumstances.)
© 2015 Leah Cohen Chatinover
Board must consider 7
factors:
• duration and preservation of the endowment fund;
• purposes of the institution and the endowment
fund;
• general economic conditions;
• possible effect of inflation or deflation;
• expected total return from income and the
appreciation of investments;
• other resources of the institution; and
• investment policy of the institution.
• NY – presumption spending
over 7% is imprudent
© 2015 Leah Cohen Chatinover
IN THEORY
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Elimination of bright line HDV would provide stricter
guidelines on spending from endowment funds.
Language designed to encourage maintenance of original
purchasing power.
Under UMIFA, once an endowment fund went
“underwater,” appreciation could no longer be spent,
creating an incentive for institutions to invest for current
income.
Conversely, where fair market value was far greater than
HDV, the old rule did not provide much of a limit on
expenditure.
UPMIFA drafting committee concluded that prudence
standard + more detailed guidance was best; elimination of
historic dollar value should not lead to overspending of
endowment funds.
© 2015 Leah Cohen Chatinover
IN PRACTICE
•Plenty of
Questions.
•No
Answers.
© 2015 Leah Cohen Chatinover
“Underwater” Funds
When the National Conference
of Commissioners on Uniform
State Laws (NCCUSL) approved
UPMIFA in July 2006, it did not
anticipate the collapse of
financial markets so soon
thereafter. Drafting
committee did not address
sharp decline in value.
“Underwater Funds”
became the focus of the
discussion.
© 2015 Leah Cohen Chatinover
“Underwater” Funds
• Does UPMIFA permit a Board to spend •
below HDV to maintain spending at its
historic rate?
•
• Factors that might be relevant:
– programmatic disruptions caused
by dramatic changes in funding.
– inefficiencies created by stop-andgo funding.
– need is greater during down cycle.
© 2015 Leah Cohen Chatinover
There are no
answers.
Document
thorough analysis
of the human and
programmatic
costs of reducing
spending; growth
investment
orientation
Attorney General
Interpretations
• Informal position of CT AG’s
office is that this portion of the
statute is unconstitutional.
• Only Court can modify a donor
restriction in this way.
• MA AG formal opinion
that institution must
maintain original
purchasing power
© 2015 Leah Cohen Chatinover
LAWYERS
VS ACCOUNTANTS
• FASB 117
• Over strenuous objection of the NCCUSL, FASB
issued guidelines requiring that:
– endowment funds be classified as
permanently restricted net assets.
– Essentially reinstated the HDV floor for
financial statement purposes.
– FASB proposal still in comment stage to
eliminate temporarily restricted
classification, but this proposal won’t
change requirement to classify endowment
funds as permanently restricted
© 2015 Leah Cohen Chatinover
Expenditure to Support a
Financially Weak Institution
• In principle, the law favors
perpetuity of the fund (in the
hands of another institution) over
perpetuity of the institution.
• But, UPMIFA gives Boards almost
total discretion (with a reminder
to keep perpetuity in mind).
• How long is perpetuity? What
are the needs of the charity?
What was the donor’s intent?
• Boards of Directors can easily
justify/rationalize spending
decisions.
• Example: Does the statute allow a
Board to spend down an
endowment to bolster a failing
school, based on an expectation
of increased enrollment (which
then doesn’t happen?) Law may
be different in different states.
• Is this prudent?
© 2015 Leah Cohen Chatinover
Limitations on Personal Liability –
Volunteer Protection
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Federal Volunteer Protection Act - 42 U.S.C.A. § 14501 et seq. – “VPA”
The VPA establishes a minimum level of protection that pre-empts state law except to the
extent that state laws provide greater protection
VPA provides immunity for volunteers serving nonprofit organizations for harm caused by
their acts or omissions
if:
– the volunteer acting within the scope of his or her responsibilities at the time of the
alleged act or omission.
– the harm not caused by willful, criminal or reckless misconduct, gross negligence or a
conscious, flagrant indifference to the rights or safety of the individual harm.
– the harm was not caused by the volunteer operating a motor vehicle, vessel, or aircraft
•
Nevertheless, despite the VPA, many volunteers remain liable for harm they cause, and all
volunteers remain liable for some actions.
•
Every state in the United States also has a law that pertains specifically to the legal liability of
some volunteers. These laws differ to a great extent. NY is very limited. Others are less
limited.
© 2015 Leah Cohen Chatinover
Indemnification
• Statutory – Some States
• What is
more flexible than others
Indemnification?
• Reflected in Certificate of
Incorporation and/or By- • Corporation covers
laws.
the expenses a
• Permissive or Mandatory
director incurs in
defending an action
• Corporation may select
and paying
from various levels of
settlements or
protection for its Directors
judgments related to
and Officers
service on the board.
© 2015 Leah Cohen Chatinover
Indemnification
•
Connecticut General Statutes §33-1117
•
Middle Ground - a corporation may
indemnify an individual who is a party to a
proceeding because he is a director
against liability incurred in the proceeding
if: (1) (A) He conducted himself in good
faith; (B) he reasonably believed (i) in the
case of conduct in his official capacity, that
his conduct was in the best interests of
the corporation; and (ii) in all other cases,
that his conduct was at least not opposed
to the best interests of the corporation;
and (C) in the case of any criminal
proceeding, he had no reasonable cause
to believe his conduct was unlawful.
• MA M.G.L. 180 § 6
• ME Title 13-B M.R.S.A.
§ 714
• NH ??
• NJ N.J.S.A. 15A: 3-4
• NY NPCL § 722
• RI RI ST § 7-6-6
• VT 11B V.S.A. § 8.51
© 2015 Leah Cohen Chatinover
Indemnification
• Circumstances when indemnification
is not available:
• Insufficient funds.
• Board unsympathetic to director
who has been sued and refuses to
authorize the indemnification (if
permissive).
• Organization decides it is
inappropriate to use resources in
this way.
© 2015 Leah Cohen Chatinover
Director and
Officer Liability Insurance
• Fills the Gap: Defense
Costs
• Covers Employees/Paid
Officers
• Covers actions other than
those in the exercise of
policy or decision-making
responsibilities
• Critically Important
© 2015 Leah Cohen Chatinover
Conclusion
© 2015 Leah Cohen Chatinover