Nonprofit directors as fiduciaries what you need to know

NONPROFIT DIRECTORS AS FIDUCIARIES

January 19, 2010

Eileen Morgan Johnson, Esq.

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Overview

Standard of Care Business Judgment Rule Liability Indemnification Zone of Insolvency Uniform Prudent Investor Act Uniform Prudent Management of

Institutional Funds Act

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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

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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

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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

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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

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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

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Indemnification

Indemnification options Source

By statute Bylaws Articles of Incorporation

Coverage Officer or director Employees and agents

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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

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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

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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

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Zone of Insolvency

Duties owed by directors of a corporation in the zone of insolvency: Duty of care

Duty of loyalty

Duty of obedience

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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

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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

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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

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Zone of Insolvency

May a director resign when a corporation is in the zone of insolvency?

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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

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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

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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

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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

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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

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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

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Uniform Prudent Managementof 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

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Uniform Prudent Managementof 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

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Uniform Prudent Managementof 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”

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Uniform Prudent Managementof 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

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Uniform Prudent Management

of Institutional Funds ActCriteria 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

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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

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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

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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.

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CONTACT INFORMATION

Eileen Morgan JohnsonWhiteford Taylor & Preston L.L.P.3190 Fairview Park Drive, Suite 300Falls Church, VA 22042Phone: 703-280-9271Fax: 703-280-8947E-Mail: emjohnson@wtplaw.com

Questions?