Piper Academy

November 13, 2013

The Legal, Ethical, and Fiduciary

“Ins & Outs” of Nonprofit Board Service

Dennis Mitchem Ron Stearns Craig McPike

• 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

• An informed, engaged board facilitates

effective governance
• Being “informed” includes understanding
how the organization works
• Board member welcome package
◦ Articles, bylaws, tax-exempt documents
◦ Various policies
◦ Committee charters
◦ Director and officer information

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Overview of Fiduciary Duties of Directors

• Statutory Duties of Directors

◦ Under Arizona law, directors are required
to discharge their duties
- 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")

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 Practical Suggestions in
Discharging the Duty of Care

• Generally, act in a reasonable and informed

manner when participating in the board’s
decisions and its oversight of management
• Guidelines for a specific transaction or other
decision
◦ 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

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 Practical Suggestions in
Discharging the Duty of Care (cont.)

◦ Consider the advice of outside advisors, when

appropriate
-Internaladvisors 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
-Actively probe and test all information presented
-Actively judge its reliability and accuracy, and
-Request additional information, if necessary

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 Duty of Loyalty

• Requires directors to exercise their

powers
◦ 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

◦ Conflicts of Interests
◦ Corporate Opportunity
◦ Confidentiality

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 Business Judgment Rule

• Business Judgment Rule

◦Common law doctrine expressly adopted by
Arizona
◦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
◦“Clear and convincing evidence” required to
successfully challenge a director's action or
failure to act before the presumption is rebutted

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 Third-Party Reliance

• A director is entitled to rely on information, opinions,

reports, or statements (including financial statements
and other financial data) prepared or presented by
◦ Management: Officers and other Associates whom the
director reasonably believes are reliable and competent
in the matters presented
◦ Experts: Legal counsel, public accountants or other
persons as to matters the director reasonably believes
are within the person's professional or expert
competence
◦ 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

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 Role of Directors in Management of the
Corporation – Oversight Function vs. Strategy

• Under Arizona law

◦ 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
◦ Do oversee management1
- Directors not personally responsible for acts/omissions of
management/third parties if prudently selected and reliance is
reasonable
◦ Do not directly engage in day-to-day operations
- Actual operations are a function of management
- Directors’ responsibility is limited to monitoring and overseeing
management
• Increasing board focus on strategy
◦ Strategic planning tops “wish list” of public-company directors2
◦ 54% of public-company boards discuss strategy at every meeting3
◦ Good benchmark for nonprofit boards
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 Risks of Action Outside Typical
Responsibilities and Duties

Action by directors that

◦ 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
◦ Could violate the reasonable-care standard
◦ Could violate the duty of care
- 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

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 Risks of Action Outside Typical
Responsibilities and Duties (cont.)

◦ Could result in loss of attorney-client privilege or

other important privileges otherwise available
◦ Could result in loss of control of written material
(dissemination to outsiders)
◦ Could result in statements, writings or actions
harmful in future governmental proceedings or
litigation
◦ Could result in confusion of responsibilities and
blurring lines of authority
◦ Could cause the board to lose sight of the larger-
scale monitoring that it is intended to provide

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 Heightened Scrutiny –
“Disqualified Person” Transactions

• Excess Benefit Transactions

◦ Transaction with “Disqualified Person” (DP), if
 value provided by organization > value received from DP
◦ “Disqualified Person” includes
- 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

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Exposure for Excess Benefit Transactions
and Rebuttable Presumption

• Possible excise taxes on “excess benefit”

◦ 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”
• Organization cannot indemnify a party subject
to excise taxes, or the indemnity will itself be
an excess benefit transaction
• Rebuttable Presumption of Reasonableness is
available to shift burden of proof to IRS, with
appropriate steps in advance
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 Conflict of Interest Policy
and Questionnaire

• Conflict of Interest Policy

◦ 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
◦ Facilitates compliance with conflict policy
◦ Permits positive response to question on Form 990

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 Director Liability:
Protections and Limitations
• Liability can come in various forms
◦ Exceeding scope of duties
◦ Engaging in excess benefit transactions
◦ Taking part in approval of another’s excess benefit
transaction
• Protections
◦ D&O Insurance
◦ Arizona law, with appropriate provisions in governing
documents
• Limitations on Protections
◦ Excess benefit transactions – no protection
◦ Acting outside the scope of duties – possible limits
◦ “Reasonable” expenses

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 Maintaining Exempt Status

• 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)

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 Unrelated Business Activities

• For activities to be “charitable”, they must

themselves further a charitable purpose
◦ 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

• Rental of real property
• Stocks, bonds
• Royalties
- Exceptions don’t fully apply if “debt-financed” assets
generate the income

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 Conclusion

Any Questions?

Thank you!

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 Endnotes

1
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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Thank You!