Protecting Your Organization's Directors and Officers
Liability Insurance for Not For Profits
Many 501(c)(3) not for profit organization directors and officers devote years of hard work and their own funds to promote the growth of their cause. But a costly lawsuit could quickly put an end to that passion. Do people really sue not for profit organizations? The answer is ‘yes.’ As society becomes more litigious, not for profits are increasingly vulnerable to lawsuits that threaten their operations and, in some instances, force the organization to close their doors and put directors and officers personal assets at risk.
Although armed with perpetual energy for their cause, not for profit officers and directors are sometimes ill-equipped with the business acumen to manage the liabilities of their not for profit in the same way as a for-profit corporation.
Areas of Not for Profit Directors and Officers (D&O) Liability
There are a variety of liabilities that can affect not for profit directors and officers. According to a 2012 survey conducted by Towers Watson, a global professional services company, 63 percent of the surveyed not for profit organizations reported claims in the last 10 years, which were more claims than the public and private companies reported. Some major areas of exposure for not for profit directors and officers include:
For not for profits that hire paid employees, employment practices liability is a significant risk. The same employment laws that apply to for-profit corporations are also applicable to not for profits, but a lot of not for profits don’t have a human resources department to handle employment policies and procedures.
To mitigate the risk of an employment practices claim, organizations should invest the time in developing a hiring policy and an employee handbook. Criminal background checks, education checks and past employer references can uncover information about a potential troublesome employee. Maintain accurate personnel files on all employees and record all incidents in which you had to reprimand, discipline or terminate employees, as these records are necessary in the event of a lawsuit.
Fiduciary Duty Breaches
Similar to for-profit corporations, not for profit directors and officers are also responsible for fiduciary duties owed to the not for profit, to the other directors and officers and to third parties such as donors and members. Directors and officers can be liable for grossly neglectful decisions and wasting resources. This is known as the “duty of care.” The three fiduciary responsibilities include:
- Duty of care. Directors and officers must exercise reasonable care, actively participate in decision-making and are held liable for ordinary negligence. Ignorance isn’t an excuse.
- Duty of loyalty. An officer or director must not use his or her position to pursue outside transactions or interests.
- Duty of obedience. Directors and officers must comply with all federal and state reporting requirements, and ensure the not for profit’s dedicated to its stated mission statement and goals.
Lawsuits for a breach of fiduciary duty can be brought by fellow officers and directors, the state attorney general, the not for profit’s members or the IRS. In some fiduciary breach cases, the IRS could revoke a not for profit’s 501(c)(3) tax-exempt status.
Conflict of Interest
A breach of the fiduciary duty of loyalty is usually manifested in the form of a conflict of interest. This occurs when directors and officers use their power for their own interest, or that of another interest or entity. Self-monitoring potential conflicts of interest that exist among board members and directors can deter from officers, board members or staff having personal financial gain from the not for profit.
Government Enforcement Actions
Not for profits must follow applicable laws, including tax, civil rights and employment laws. All organizations must file accurate and timely annual tax return with the IRS. Not for profits with annual gross receipts of less than $50,000 must file the Form 990-N (e-Postcard) and those with annual gross receipts over $50,000 must file the Form 990. A not for profit’s 501(c)(3) tax-exempt status could be in jeopardy if they don’t do so accordingly.
Excessive employee compensation is closely monitored by the IRS and could result in costly fines. Employee compensation must be reasonable and comparable to other not for profits of a similar size. On the new IRS Form 990, a not for profit must report if any employees are compensated more than $100,000 annually.
Additionally, the state attorney general’s office usually monitors not for profits to ensure they’re following their stated mission and goals and applicable state laws. Conducting activities outside of your mission could expose you to scrutiny, resulting in more problems with the IRS.
Misuse of Funds
A not for profit relies on grant funding and donations to operate, but it’s important that funds are used for the stated mission and goals.
To mitigate this risk, directors and officers should always aim to present a transparent financial picture of their organization to avoid lawsuits from donors. Accurate bookkeeping and filing the IRS Form 990 in a timely manner is essential. Be aware of volunteers or employees who handle money as there could be a risk of swindling funds.
For more tips on minimizing risk with D&O liability, check out our webinar recording.
- Directors & Officers (D&O) Liability Webinar Recording
- Employment Practices Liability Webinar Recording
- The Legal Benefits of Directors & Officers Liability
ABOUT THE AUTHOR