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Your Responsibilities as a Director or Trustee of a Nonprofit Organization John P. Beavers Introduction1 The directors or trustees of a nonprofit corporation are responsible for oversight of the business and affairs of the corporation. The purpose of this discussion paper is to provide directors (whether called "directors" or "trustees") with an overview of their general obligations to the corporation. Authority of the Board Generally under Ohio law, all of a nonprofit corporation’s power and authority are vested in its directors.2 Corporate law recognizes that a director does not directly exercise all of that power and authority, but it is exercised "under the direction" of the board.3 In reality, the board exercises that authority under its direction by delegating to others, such as:
Ohio corporate law reflects this reality by entitling the board as well as individual directors to rely upon information, opinions, reports, or statements, including financial statements and other financial data, that are prepared or presented by those committees, officers or senior management, and professionals or other experts.6 Exercise of Its Authority Directors exercise their authority only as a board and not as individuals. Under Ohio law, authority is exercised only by action of a majority of the directors present at a meeting at which a quorum is present, unless the act of a greater number is required by the articles, the regulations, or the bylaws.7 For this purpose, a majority of the whole authorized number of directors is necessary to constitute a quorum for a meeting.8 A board can also exercise authority by unanimous consent in writing of all directors.9 Standard of Conduct for Directors
Under Ohio law, the board as a whole and you as an individual director owe certain fiduciary duties to the corporation as an entity and to the members. This is generally expressed under Ohio law as acting "in the best interests of the corporation,"10 and in so doing Ohio law requires the board and individual directors to "consider the purpose of the corporation" and other interests.11 These fiduciary duties include the duty of care and the duty of loyalty. Duty of Care. In simplest terms, the duty of care requires that a director exercise the care that an ordinarily prudent person in a like position would use under similar circumstances.12 Under Ohio law, a director must perform his duties as a director, including his duties as a member of any committee of the directors upon which he may serve:
The duty of care requires that a director inform himself of all material information reasonably available before making a business decision. This duty also requires directors to inform themselves of alternatives to a proposed business decision. The more important the decision, the greater the need to consider additional information and alternatives. Once a director has become adequately informed, the director must act with the requisite care in performing his duties. A claim of "good faith" alone is no defense if a director fails to exercise the duty of care in order to arrive at an informed business decision. Duty of Loyalty. Under Ohio law, the duty of loyalty requires that a director act in good faith, in a manner he reasonably believes to be in or not opposed to the best interests of the corporation.13 There are three components to the duty of loyalty. This first is that a director should act to the extent possible in a disinterested manner. That means not being influenced by any financial or personal interest in the matter under consideration. The second is full disclosure of possible financial or personal interests in any matter under consideration. In common law before statutory corporate law, courts often treated as void or voidable any contract or transaction approved by a board if a director had a financial or other personal interests in the contract or transaction. Ohio statutory law provides that any contract, action, or transaction considered by the board or one of its committees is not void or voidable because of a financial or personal interest of a director if the material facts regarding that interest are disclosed or otherwise known to the board or the committee before the consideration.14 The third is substantive "fairness." Under Ohio statutory law, no contract, transaction or other action of a board is void or voidable, even if there is a financial or personal interest which is not fully disclosed, if the action is "fair to the corporation" as of the time it is authorized or approved.15 However, because what is "fair to the corporation" is a question of fact upon which reasonable minds may differ, directors should rely on full disclosure.
At common law, proving liability against a director for an alleged violation or breach of fiduciary duty required only a showing of a breach by a preponderance of the evidence (i.e., a showing that, more likely than not, a breach or violation had occurred). However, the Ohio statutory law has established a higher standard for proving director liability in most instances. Under current Ohio law, a plaintiff attempting to show that a director breached his fiduciary duties must prove by clear and convincing evidence that a breach has occurred; that is, that the director has not acted in good faith, in a manner he reasonably believes to be in or not opposed to the best interests of the corporation, or with the care that an ordinarily prudent person in a like position would use under similar circumstances.16 The increased protection provided by this higher evidentiary standard applies in any action brought against a director as a director, including, without limitation, any action involving a change or potential change in control. An additional burden is imposed upon any plaintiff seeking monetary damages from a director for an alleged breach of fiduciary duty. Such a plaintiff must prove by clear and convincing evidence that the director’s action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to the corporation or with reckless disregard for the best interests of the corporation.17 This burden applies only to actions in which the plaintiff is requesting monetary damages – a plaintiff requesting injunctive relief, for example, need not prove that a director acted with deliberate intent to cause injury or with reckless disregard, although the clear and convincing evidence standard discussed above would still apply. These protections only apply to directors acting as directors (or as members of committees of directors). These protections in no way limit potential liability for actions taken by officers or employees of the corporation, a fact which is relevant to any director who also acts in a capacity as an officer or employee of the corporation.
In evaluating a director’s compliance with his fiduciary duties, courts generally follow the so-called "business judgment rule." Under the business judgment rule, courts do not inquire into the wisdom of actions taken by directors in the absence of fraud, bad faith, or abuse of discretion. The business judgment rule specifically applies to any situation in which directors make a decision which, in retrospect, was or is argued to be a bad one. If the directors are thereafter sued because of that decision, a court applying the business judgment rule will not second guess the merits of the decision as long as the court finds all of the following to be true:
If one or more of these factors is not satisfied, the court will interpose its own judgment to determine whether the transaction in question is in the best interests of the corporation. Reliance on Experts, Special Committees, and Officers At times directors are faced with decisions that require special knowledge or expertise which the directors themselves do not possess. Additionally, directors may not have the time or resources to investigate personally every matter that comes before the board. Because of these limitations, Ohio law expressly permits directors to rely reasonably upon information presented by officers, employees, outside professional advisors and board committees in making their decisions.18 The following standards apply when determining whether a director’s reliance on information, opinions, reports, or statements (including financial statements and other financial data) prepared or presented by others is appropriate:
Consideration of Other Interests In determining what he reasonably believes to be the best interests of the corporation, Ohio law requires that a director consider the purposes of the corporation.19 However, a director may in his discretion also consider other interests, including the following:
Indemnification and D&O Insurance Corporations may indemnify, or agree to indemnify, directors against liabilities, and directors may in certain circumstances be entitled to indemnification as a matter of right. However, there are limits on indemnification. For example, indemnification is precluded if a court finds a director did not act in good faith or in a manner reasonably believed to be in the best interests of the corporation.21 Although under Ohio law a director is not necessarily culpable or liable for mere negligence as discussed above, Ohio precludes indemnification in a derivative action if the liability involves misconduct by the director in the performance of a duty to the corporation.22 Accordingly, errors and omissions insurance is important for directors. Most states’ laws do not prohibit insurance giving broader coverage of director liability than permitted by indemnification. By reviewing and comparing coverages of the insurance products of different insurers, directors can usually find this broader coverage at reasonable rates. Practical Application of Fiduciary Duty Principles The practical "tips" listed below will help to ensure that you satisfy your fiduciary duties as director of the corporation:
Footnotes: 2. See Ohio Revised Code §1702.30(A) which provides that “Except where the law, the articles, or the regulations require that action be otherwise authorized or taken, all of the authority of a corporation shall be exercised by or under the direction of its trustees.” 3. See Ohio Revised Code §1702.30(A) which provides that “the authority of a corporation shall be exercised by or under the direction of its directors.” 4. See Ohio Revised Code §1702.33(A) which provides that a board may create “an executive committee or any other committee of the trustees, to consist of not less than three trustees, and may authorize the delegation to any such committee of any of the authority of the trustees . . . .” 5. See Ohio Revised Code §1702.34 which requires each Ohio corporation to have “officers” consisting of at least a president, secretary, and treasurer having, respectively, “such authority and perform such duties as are determined by the persons authorized to elect or appoint them . . . .” 6. See Ohio Revised Code §1702.30(B) which provides “In performing his duties, a trustee is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, that are prepared or presented by the following: (1) One or more trustees, officers, or employees of the corporation who the trustee reasonably believes are reliable and competent in the matters prepared or presented; (2) Counsel, public accountants, or other persons as to matters that the trustee reasonably believes are within the person's professional or expert competence; (3) A committee of the trustees upon which he does not serve, duly established in accordance with a provision of the articles or the regulations, as to matters within its designated authority, which committee the trustee reasonably believes to merit confidence.” 7. See Ohio Revised Code §1702.32 which provides that “The act of a majority of the directors present at a meeting at which a quorum is present is the act of the board, unless the act of a greater number is required by the articles, the regulations, or the bylaws.” 9. See Ohio Revised Code §1702.25. (1) One or more trustees, officers, or employees of the corporation who the trustee reasonably believes are reliable and competent in the matters prepared or presented; (2) Counsel, public accountants, or other persons as to matters that the trustee reasonably believes are within the person's professional or expert competence; (3) A committee of the trustees upon which he does not serve, duly established in accordance with a provision of the articles or the regulations, as to matters within its designated authority, which committee the trustee reasonably believes to merit confidence.” 19. See Ohio Revised Code §1702.30(E). |