Nonprofit Board Governance Legal Issues

Building BRIDGES to More
Effective Board Governance

Project BRIDGES Board Retreat
September 19, 2011
Ken Liu
Gammon & Grange, P.C.

Project Bridges Board Presentation • © Gammon & Grange, P.C. 2011 www.gg-law.com 703-761-5000 • Sept. 19, 2011 • Slide 1

7 BRIDGES to a Better Board
Topics
1. Board Basics
2. Risk management
3. Informed Boardsmanship
4. Duties of care and loyalty
5. Governing interested party transactions
6. Evaluation of legal compliance
7. Staff-Board roles and relationships


1.1 Board Basics: What is A Director?

 The individual director:
 Acting alone has no powers, unless expressly authorized
by the Board
 Exerts his or her power by voice & vote when the entire
Board is duly convened
 Shares in all the powers and responsibilities of the
Board
 The Board has a collegial governance power


1.2 Board Basics: Who are the Directors’
Constituencies?

 A director is accountable to:
 Constituents/Members: Those whom the organization
serves
 Donors: Those who support the organization
 The general public (essence of being public charity)
 The law: State and federal governments
 The entity’s Articles, Bylaws, Policies, Budget, etc.
 The Board of Directors -- each other
 The Lord (Matthew 12:36 (ESV) I tell you, on the day of
judgment people will give account for every careless word
they speak . . .)


1.3 Board Basics: What are the Directors’
Purposes?

 A director serves the purposes of the organization
and ensures organization’s activities are serving
those purposes
 Where are these purposes found?
 Articles of Incorporation
 Bylaws
 Mission Statement
 The Bible
 All activities should be consistent with purposes


1.4 Board Basics: BRIDGES’ Purposes
Statement (in Articles & Bylaws)
Articles and Bylaws purpose statement:
The Corporation seeks:
 to develop a network of churches and faith-based
organizations to combat social and spiritual problems in local
communities,
 facilitate programs and support services that strengthen the
capacity of churches and faith-based organizations to combat
these problems, and
 provide resources, education, and training to churches and
faith-based organizations to help them strengthen and expand
their capacity to relieve poverty, serve the needy in their
communities, and provide Biblical solutions to the heart issues
underlying the social and spiritual problems the Corporation
seeks to combat.


1.5 Board Basics: Primary Sources of a
Director’s Legal Duties

 Articles of Incorporation
 Bylaws
 D.C. Nonprofit Corporation Law
 Federal tax exempt law / IRS regulations
 “Common Law” duties
 Duty of care
 Duty of loyalty


2. Risk Management Quiz


Risk Management Quiz
1. Is it permissible for a nonprofit corporation (like
Project BRIDGES) to make a loan to an officer or
director on terms that favor the nonprofit (e.g.,
agreement provides that nonprofit is to receive greater
than fair market value interest)?

 YES, under federal law and IRS regulations; but
 BUT NO, under D.C. law. Any and all loans to a
nonprofit’s directors and officers are prohibited


2. Are nonprofit boards required to adopt a budget
process?

 No, but it is strong recommended! No law requires a
budget, but the budget is one of the most important
tools of financial accountability whereby Board fulfills
fiduciary responsibility. Best practices would require a
complete budget process.


3. Is it advisable for a large nonprofit Board to carry
on most of its work through a small executive
committee that determines compensation issues
and approves related-party transactions?

 NO: Executive committee can handle routine matters
between Board meetings; but should not take over
Board’s authority for big ticket decisions: e.g.,
approving large contracts, new program areas,
affiliations, sale of significant assets, related-party
transactions, etc.


4. May a nonprofit Board choose not to have term
limits in its bylaws?

 YES: But it is generally advisable to limit director terms
to help keep directors accountable, and Board vibrant
and responsive to constituencies. Best practice NGOs
have term limits.


6. Should a Board member personally review
employee performance appraisals and instruct
employees on job performance?

 NO, unless the director also has a hat as an officer, or is
specifically authorized to do so, say in a smaller entity.
This is not only micromanaging, it could be usurpation
of the CEO’s authority. Directors are not operating
officers of the nonprofit, and generally have no
authority to act for the entity between Board meetings.


7. Does D.C. law grant immunity from liability to
directors of nonprofit organizations?

 YES, BUT LIMITED: D.C. law grants civil (not criminal)
immunity, unless the director’s act leading to the
injury:
 is willful misconduct,
 results in improper personal benefit,
 exceeds the scope of his authority, or
 if the nonprofit doesn’t meet certain expense and
insurance tests


8. If a director or officer of a nonprofit organization
publicly endorses a political candidate because of
the candidate's stand on moral issues (e.g., faith
based initiatives, human rights, etc.), could the
organization lose its tax-exempt status for
impermissible political activities?

 YES: Political campaign activity is absolutely prohibited.


9. Can a 501(c)(3) nonprofit lose its tax-exempt status
for lobbying activities?

 NO: IF the lobbying is “non-substantial.”
Definitely less than 5%; maybe less than 20% or higher IF
done with volunteers.


10. If BRIDGES does not fund any Muslim projects or
groups, must it worry about compliance with the
Anti-Terrorist Funding Provisions of the USA Patriot
Act?

 YES: Patriot Act: criminal liability for providing material
support or funds, for use in terrorist act
 USAID grant recipient must certify it has taken all reasonable
steps to ensure it does not and will not knowingly provide
material support or resources to any entity that commits or
supports terrorist acts
 Combined Federal Campaign participants must certify that
they do not knowingly support any persons or organizations
on the terrorism lists of the U.S., U.N., or European Union


3. Informed Boardsmanship


Informed Boardsmanship
1. Are Board members familiar with the organization's
mission, purposes, objectives, policies, statement of
faith, programs, and activities?

 Clearly Articulate Your Mission & Values and
 Communicate your organization’s activities to the broader
community


2. Are Board members committed to the organization's
mission, purposes, objectives, policies, statement of
faith, programs, and activities?
Are they qualified to implement its goals?

 Take steps to encourage full participation by all Board members
 Recruit Board members who:
 Embrace and are passionate about, the mission and purposes
 Are qualified to implement goals
 Reflect the diversity of your organizational culture: race, gender,
professions, experience/background, skills


3. Are Board members adequately informed about the
Board's responsibilities and liabilities?

 Before new people join board, need to adequately
prepare them for expectations, legal responsibilities and
liabilities.


4. Does the Board regularly evaluate the use of its
resources to ensure they are effectively used to
further the organization's goals?

 One of the Board’s biggest responsibilities is ensuring the
organization’s money, staff and volunteers, intellectual
property, and other resources are properly used.


5. In recognition of its public trust, is the Board
accountable to the community for the organization's
success in carrying out its mission and meeting its
ethical and legal obligations?

 Community = donors, beneficiaries, constituents, and government
authorities
 Annual audit; publicly available?
 Board should be familiar with Form 990
 Consider ECFA Membership (www.ecfa.org)
 Watch the watchdog groups, such as:
 www.charitynavigator.org
 www.bbb.org/us/charity


6. Does the Board conduct periodic opportunities for
training, education, and upgrading of needed skills
for its members?

 A properly trained and managed Board is one of the most
effective safeguards against legal liability.
 Nonprofit Board members need to be instructed as to their
fiduciary duties to the corporation, the unique
requirements of a nonprofit organization, and restrictions
on transactions due to the limitations on private benefit
and inurement, unrelated business activity, legislative and
political activity, etc.



 Keep abreast of latest legal developments affecting
nonprofit organizations
 Sample resources for Board training
 ECFA: www.ecfa.org
 Christian Leadership Alliance
www.christianleadershipalliance.org
 BoardSource: www.boardsource.org
 Independent Sector: www.independentsector.org
 Gammon & Grange: www.gg-law.com
 Sign-up for G&G Law Alerts™


7. Does the Board run effective and efficient meetings
that address the needs of the organization?

 Provide timely and effective reports in advance of
Board meetings
 Board meetings must be used for furthering the goals
of the organization, not specific interests of individual
Directors
 Divide Board's work between individual Directors,
committees, and entire Board



 Require absent Directors to review minutes of any
Board meeting missed, and to register their dissent
when in disagreement with any Board action
 Annually assess Board's effectiveness, providing for
procedural changes, training, and education


8. Has the Board developed purposeful policies &
procedures?
 Develop efficient procedures, but don’t let them
supersede strategic thought and action
 Develop risk management policies and strategies in
consultation with legal counsel
 Implement accounting and fiduciary guidelines
 Implement conflicts of interest policy


9. Does the Board have an effective budget process?

 Coordination of budget with organization's purposes,
mission, and strategic plan
 Line-item breakout of all significant categories of
expenses and income
 Review monthly financial statements, including
budget projections, comparisons, and line-item
variances



 Review detailed breakout of new activities or projects
 Follow policy of red flagging any line item that is
more than 5 percent (5%) above budget, and prohibit
such expenditures without special Board approval
 Insist on annual audit


4. Duties of Care & Loyalty


4. Duties of Care & Loyalty

Two fundamental duties of a Nonprofit
Director:

 Duty of Care
 Duty of Loyalty


 Director is a fiduciary – Director must at all times
act for the benefit of the organization, in its best
interests and to further its exempt purposes

 "A director shall perform his duties as a director,
including his duties as a member of any committee of
the board upon which he may serve, in good faith, in a
manner he reasonably believes to be in the best
interest of the corporation, and with such care as an
ordinarily prudent person in a like position would use
under similar circumstances.”
 Model Business Corporation Act (MBCA), 35.


4.1 Duty of Care
Duty of care
A Director should:
(1) be reasonably informed; and
(2) exercise independent judgment;
(3) to participate in corporate decisions;
(4) in good faith;
(5) with the care of an ordinarily prudent person in
similar circumstances.


4.1 Duty of Care
Regularly attend all meetings of the Board

 Directors can only act as a group (the Board)
 Board benefits from individual and collegial insights
and group discussion
 D.C. law and BRIDGES’ Bylaws (8.5) permit
participation by electronic means, so long as everyone
can hear and participate
 D.C. law and BRIDGES’ Bylaws (8.6) also permit Board
action by unanimous written consent, without a live
Board meeting


4.1 Duty of Care
Each Director is obligated to:
 Obtain all information needed to participate in informed
way with regard to every matter requiring Board action
 May rely upon information received from the following
sources if the director reasonably believes the source to
be reliable and competent
 Officers and employees of the corporation
 Professionals and experts – lawyers, accountants, etc.
 Committees of the Board
 BRIDGES’ members and their pastors
 Review and understand all documents submitted to Board
 Request additional information whenever necessary


4.1 Duty of Care
Each Director is obligated to:
 Exercise independent judgment on all corporate
decisions – no rubber stamps
 Director can be liable even if he remains silent in the
face of improper Board action
 To avoid liability, Director must actively dissent on
the record
 Responsibly exercise delegation
 Board manages the corporation, but does NOT manage
day-to-day operations
 Board sets policies
 Day-to-day operation is function of management
(officers, employees, agents)


4.1 Duty of Care
 Responsibly exercise DELEGATION.
 Board can delegate its duties to committees of the
Board
 Can delegate actual Board authority IF committee
composed only of current Board members.
 “The designation and appointment of any such
committee and the delegation thereto of authority shall
not operate to relieve the board of directors, or any
individual director, of any responsibility imposed upon
it or him by law.”
 DC Code §29-301.22


4.2 Duty of Loyalty
 Duty of Loyalty requires that BRIDGES’ directors at
all times act in BRIDGES’ best interests and not for
their own personal interests

 Three aspects to the Duty of Loyalty:
 Corporate Opportunity
 Confidentiality
 Conflicts of Interest


4.2 Duty of Loyalty
“Corporate Opportunity” - when a director knows
that he or she can participate in a transaction that
would plausibly fall within BRIDGES’ present or
future activities
 What should the director do?
 Affirmatively present the opportunity to Board,
 BEFORE participating in the transaction,
 and let the Board determine that it wishes to abstain from
the opportunity (i.e., ROFR)
 Always document this fully (e.g., in the minutes of the
Board meeting)
 showing the conflicted Director was recused from final
discussion and voting.


4.2 Duty of Loyalty
 Director should treat as confidential all BRIDGES-
related matters unless
 There has been general public disclosure; or
 The information is a matter of public record or
common knowledge
 Directors are not ex officio spokesmen for BRIDGES
 Disclosure of matters risks waiving applicable
privileges (e.g. attorney-client privilege)


5. Governing Interested Party
Transactions


Transactions
 Conflicts of interest arise whenever a Director (or
senior manager with decision-making influence)
has a real or apparent personal interest in a
proposed organizational transaction

 Conflicts of interest transactions must be properly
handled to avoid self-dealing
 Self-dealing arises whenever the personal interest or
the interest of a family member, friend, or other
organization in which a Director is involved takes
precedence over BRIDGES’ best interests


Transactions
 To avoid prohibited conflicts of interest, the Board
should adopt and consistently follow a conflicts of
interest policy

 A good conflicts of interest policy takes into account
restrictions on private benefit / private inurement,
and IRS regulations on “Intermediate Sanctions” for
excess benefit transactions


Transactions
 Private benefit:
 benefit to private person or entity,
 unrelated to exempt purposes, and
 not resulting in substantially equivalent benefit to
organization
 Private inurement:
 private benefit
 to an insider (an individual who has significant
influence over the organization) or to a person or
entity closely related to an insider
 receives benefits greater than she or he provides in
return


Transactions
 “Intermediate Sanctions”
 the IRS can impose a penalty “excise tax”
 on an “excess benefit transaction”
 Involving a “disqualified person”

 Sanctions can apply to both:
 The disqualified person, and
 The managers (including directors) who approve the
“excess benefit transaction”


Transactions
Questions to ask to avoid conflict of interest:

 Was there full disclosure to the rest of the Board?
 Was there unbiased decision-making by the Board?
 Was the transaction fair to the organization overall?
 Even though the transaction involves an apparent conflict
of interest, when all the facts are known, is there a
demonstrable absence of self-dealing?
 Was personal appropriation of all corporate opportunities
avoided?
 Was any interested director properly insulated from final
discussion and voting?


Transactions
 IRS recognizes rebuttable presumption that
transaction is reasonable if:
 approved by governing body composed entirely of persons
without conflict of interest (recuse interested directors
from final discussion and voting);
 Board relies on appropriate comparability data for
determining reasonable compensation or other FMV of
benefit received or provided
 basis for approval, and comparability data, were
contemporaneously documented by Board


6. Evaluation of Compliance
and Risk Management


Sarbanes Oxley (SOX)

1. Have a written document retention and periodic
destruction policy
2. Develop and adopt whistle-blower policy.
3.Establish a conflict of interest policy
4.Independent and competent audit committee (or at least
an annual audit)
5.CEO and CFO should sign off on all financial statements
including Form 990
6.Disclose financial statements (Form 990)


6. Evaluation of Compliance and Risk
Management
Charitable Solicitation

 In most states, nonprofits must register to solicit charitable
contributions
 Religious organizations are exempt from D.C. registration
requirements, but such exemption must be claimed and
affirmatively granted through the Dep’t of Consumer and
Regulatory Affairs
 Religious organizations are also exempt from Maryland
registration requirements, but must submit evidence of
entitlement to the exemption to the Maryland Secretary of
State


Management

No substantial lobbying is allowed

 “Lobbying”: advocacy of passage or defeat of
particular legislation
 Insubstantial lobbying is acceptable


Management
No political campaign activity allowed

 “Political campaign activity”: advocacy of election
or defeat of a candidate for public office
 This is an ABSOLUTE prohibition
 Can lose exempt status for violation


Management
Intellectual Property
 Conduct searches of names before adopting
 Consider federal trademark registration of key names,
logos
 Do not allow 3rd parties to use names, logos, w/o license
 Have contracts to own IP in works created by
independent contractors
 Include clause protecting proprietary information in all
contracts


Management
Financial audits
 Establish audit committee to engage outside auditor
 Use RFP process every 3 to 5 years
 After audit is completed, conduct comprehensive
exit interview with auditor(s)


Management
Legal Audits

The Gammon & Grange Legal Audit Questionnaire™ ("LAQ")
enables a nonprofit organization to take a significant, self-
directed step in assessing its legal health. Diagnoses the
organization’s legal strengths and weaknesses and developing
a plan for improving legal compliance and risk management

 An ounce of legal checkup is worth a pound of litigation
“cure”.


7. Staff/Board Roles and
Relationships


Staff/Board Roles and Relationships
 Project BRIDGES’ structure:
 Governed by Board of Directors
 Managed by officers
 Founder & Co-Founder: vision-casting, representing
BRIDGES to its constituencies and communities
 Board Chair: presides over meetings of Board
 President: manages BRIDGES’ day-to-day activities
 Secretary: keeps Board meeting minutes, corporate
books & records
 Treasurer: oversees all financial activity
 Supported by members (mostly churches; members
have no governing voice or vote)



Boundaries:
 Board: decides the ENDS (i.e., goals and objectives)
 Exec. Dir. and Staff: decide the MEANS
Board should provide clear parameters on the means


the E.D. and staff may use to achieve the Board's ends
 Within those policy parameters, give the E.D. the

discretion to use his creativity and professional skills to
achieve the Board’s ends
 Board chair and Executive Director share leadership of the
organization – Chair in setting longer term goals, E.D. in
running operations


Know When to Delegate
 Create an Executive Committee & determine in
advance (bylaws, etc.) what the EC can decide
between board meetings.
 Develop effective committees
 Which committees are necessary or helpful?
 Who can serve?
 Who should chair?
 Who appoints or elects members?
 What is the committee’s role?
 Who staffs the committee?
 Create an advisory group with ensured term limits for
volunteers


Evaluation of Board Member Performance
 Engage in annual self-evaluation through key questions
submitted by Board anonymously
 Engage in periodic peer evaluation: Board members
evaluating Board members, or Board development
committee
 Engage in accountability by inviting staff members to
assess whether Board members are in touch with the
reality of nonprofit’s challenges
 Submit to professional evaluation and advice of board
development committee


Evaluation of Board Member Performance
 Board members performance issues to evaluate:
 Attendance
 Preparation
 Constructiveness of contributions
 Loyalty
 Record as donor
 Fundraising assistance
 Representation before public


Leadership
 “Leadership is not about titles, positions or
flowcharts. It is about one life influencing another.”
― John C. Maxwell

 “the Son of Man did not come to be served, but to
serve . . .”
- Matthew 20:28


Kenneth Liu
Gammon & Grange, P.C.
8280 Greensboro Dr., 7th F
McLean, VA 22102
703-761-5000
kel@gg-law.com
www.gg-law.com

© 2011 Gammon & Grange, P.C. The content in this presentation is
provided for general informational purposes only and does not
constitute legal advice. This presentation may be freely distributed
in full without modification.


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