Many individuals are honored when asked to serve on a philanthropic non-profit board of directors.  Serving as a board member can be a rewarding experience, but it also comes with significant responsibilities. This article guides you through the essential steps and considerations before committing to this important role.

What Does Membership Mean?

Members of a non-profit organization’s board of directors are fiduciaries who steer the organization by adopting sound, ethical, and legally compliant decisions and policies. They also ensure that the non-profit organization has adequate resources to advance its mission. In cases where a non-profit organization has paid staff, directors typically provide foresight, oversight, and insight rather than managing day-to-day operations.

Regardless of whether a non-profit organization is large or small, prospective directors should perform their due diligence prior to undertaking this commitment. Understanding the full scope of responsibilities and duties is crucial for effective participation.

The following is an overview of the duties and responsibilities of directors of non-profit organizations, as well as a breakdown of general due diligence to perform prior to joining a board of directors.

Understand the Duties of Directors

The board of directors has three primary legal duties known as the “duty of care,” “duty of loyalty,” and “duty of obedience.”

1. Duty of Care: Requires a director to be familiar with the organization’s finances and activities and to participate regularly in its governance. In carrying out this duty, the directors must act in “good faith” using the “degree of diligence, care and skill” which prudent people would use in similar positions and under similar circumstances.
2. Duty of Loyalty: Requires a director to act in the interest of the organization. Any conflict of interest, real or possible, must be disclosed in advance of joining the board of a non-profit organization, and they must also be disclosed whenever new conflicts arise. Many states (including New York) require non-profit organizations to maintain a written “Conflicts of Interest Policy” that define the circumstances constituting a conflict of interest and setting forth the procedures for disclosing and dealing with the conflict.
3. Duty of Obedience: Requires a director to ensure the organization complies with applicable laws and regulations, its mission and its internal governance documents and policies. Directors should ensure:
   • The organization dedicates its resources to its mission.
   • The organization carries out its purposes and does not engage in prohibited or unauthorized activities (which are outlined below).
   • The organization complies with all applicable laws, including filing annual financial reports with the federal government and any state in which the organization is registered that requires such a filing (e.g., New York and California).

Review Organization Structure and Governance Documents

Understanding the organization’s purposes and its programs are crucial for an effective member of the organization’s board of directors. Unless you fully understand why the organization was formed and what it plans to accomplish, directors will not be able to perform their tasks effectively. To understand why the organization was formed, review the following:

• Review the organization’s organizational and governance documents, including the Certificate of Incorporation, its Application for Federal Income Tax Exemption, its By-Laws and the Board and Committee Minutes for the last year to learn about the organization’s purposes, activities and concerns.
• Read the organization’s mission statement. If the organization has no mission statement, ask why and explore whether one can be adopted.
• Review the organization’s governance policies, including the Conflicts of Interest Policy to familiarize yourself with your obligations under these policies.
• Review the organization’s financial report and other related financial information to understand the type of financial situation and challenges the organization is facing.
• Obtain an understanding of the internal control structure of the organization and the processes in place to monitor it.
• Speak with current and former directors to learn about the board of director’s procedures and internal dynamics.
• Review the organizational chart and understand the accountability structure for those within the organization.
• Understand the employee evaluation and compensation processes and due diligence procedures for entering into material contracts.
• Ask about whether the organization provides insurance for directors to avoid potential personal liability for actions taken on behalf of the organization. This is often called directors and officers insurance or D and O insurance.

Familiarize Yourself with Prohibited Actions

Non-profit organizations are subject to a range of federal, state and local laws.  While directors are not required to have specialized legal knowledge, they should be familiar with the following basic rules and requirements with which their organization must comply:

1. No Political Campaign Activity – Federal law expressly prohibits organizations that receive tax exemption pursuant to Section 501(c)(3) of the Internal Revenue Code from participating in or intervening in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office. Many states have an analogous state law version of the same prohibition (e.g., New York).
2. Lobbying May Not Comprise a “Substantial” Part of Activities – In general, no organization may qualify for 501(c)(3) status if a “substantial part of its activities” consists of attempting to influence legislation (i.e., lobbying). A non-profit organization will be regarded as attempting to influence legislation if it contacts, or urges the public to contact, members or employees of a legislative body for purposes of proposing, supporting or opposing legislation. Non-profit organizations may, however, involve themselves in issues of public policy without the activity being considered as lobbying. For example, non-profit organizations may conduct educational meetings, prepare and distribute educational materials or otherwise consider public policy issues in an educational manner without jeopardizing their tax-exempt status.

Understand Special Rules for Private Foundations

The distinction between public charities and private foundations is a matter of federal tax law. Public charities are heavily supported by the public and are subject to more public scrutiny to help ensure adherence to appropriate standards of conduct. Private foundations, on the other hand, are generally supported by a small group of supporters, such as one family or corporation, and therefore are subject to stricter and more extensive federal rules than public charities, including strict prohibitions on self-dealing and limits on the amount of stock they may hold in one company.

1. Strict Prohibition Against Self-Dealing – Federal tax law prohibits all non-profit organizations from using charitable assets towards private benefit, and failure to comply with this general rule can jeopardize a non-profit organization’s tax-exempt status. For private foundations, layered on top of this general rule are special rules to prohibit a variety of transactions between the private foundation and those considered as its insiders, including its directors (referred to as “disqualified persons”).  Federal tax law prohibits these insider transactions, referred to as acts of “self-dealing” by imposing punitive taxes on those engaging in such transactions. Prohibited acts of self-dealing, if engaged in directly or indirectly by a private foundation and a disqualified person, whether or not the transaction benefits the private foundation, include:
   • A sale or exchange between the private foundation and a disqualified person, even on terms that are favorable to the private foundation
   • A lease of property between the private foundation and a disqualified person, unless the lease is without charge and furthers exempt purposes.
   • A loan or other extension of credit between the private foundation and a disqualified person, unless the loan is interest-free and the proceeds of the loan are used exclusively for exempt purposes.
   • The private foundation’s payment of compensation or expense reimbursement to a disqualified person, unless not excessive and for personal services necessary to carry out exempt purposes. This means that any compensation for services as a director must not be considered excessive.
   • A disqualified person’s use of a private foundation’s income or assets by or for the benefit of the disqualified person, as well as the provision of goods, services or facilities between the private foundation and a disqualified person, except for the goods or services that are furnished to the disqualified person on the same terms as are furnished to other members of the public or are provided without charge and used exclusively for exempt purposes.
2. 5% Distribution Rule – A private foundation (one that does not qualify as a private operating foundation) is required to distribute annually – through grants and grant-related expenses (i.e., eligible administrative expenses) – at least 5% of the total fair market value of its noncharitable-use assets from the preceding year. Foundations that are newly formed have until the end of their second year of existence to meet this distribution requirement. The purpose of this rule is to force private foundations to distribute their assets instead of accumulating significant endowments through passive investment income. A private foundation that fails to meet this distribution requirement is subject to a 30% excise tax on the undistributed income.

Understand your Commitment to the Role of Director

Serving as a director of a non-profit organization is a substantial and important commitment, and you must be willing to dedicate your time and energy to your role, which may include:

1. Attendance during Board Meetings –As a director, you will have a duty to attend board and committee meetings and to actively participate in discussions and decision-making.
2. Role as Supervisor – As a director, you may not be involved in the day-to-day activities of the non-profit organization, but you will be responsible for managing the organization and supervising those day-to-day activities to ensure compliance with the law and the furtherance of the purposes of the organization.
3. Role as Advocate and Fundraiser – As a director, you will have a duty to act as an advocate for the organization in the furtherance of its purposes. Many organizations contract with outside professional fundraisers to raise funds on their behalf, and the selection and monitoring of a fundraising professional is an extremely important function of the board of directors.
4. Commitment as a Donor – Ask if directors are expected to contribute more than their time to their organization, and if so, what are those expectations.

Conclusion

If you are interested in philanthropy, becoming a director of a non-profit organization may be a rewarding experience. However, as discussed in this article, understanding the responsibilities and obligations of serving as a director is crucial for the success and compliance of the organization. Please reach out to your Wiggin and Dana attorney to discuss any questions or concerns you may have regarding your role, legal requirements, or any specific situations that may arise. We can provide you with tailored advice and guidance to help you navigate all aspects of structure and governance of a non-profit organization and ensure that the organization complies with relevant law.

Resources

• Best Practices Before Joining the Board of a Non-Profit Organization: Do Your Due Diligence
• Charitable Giving Options: Donor-Advised Funds vs. Private Foundations
• 5 Key Annual Requirements for Private Foundations
• Private Foundations 101: Annual Administrative Requirements