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Lawyers Journal

Counseling the board of directors of a Massachusetts nonprofit corporation

David A. Parke is a partner with Bulkley, Richardson and Gelinas LLP, of Springfield, and a member of the MBA Business Law Section Council. He co-authored The Massachusetts Corporation: Legal Aspects of Organization and Operation and authored Forming a Business Corporation Under Chapter 156D, and contributed to other publications and CLE programs.

An attorney who counsels the board of directors of a Massachusetts nonprofit corporation must be mindful of some special considerations that apply to a nonprofit board. This article will review the responsibilities of directors of a Massachusetts nonprofit corporation.

The directors of a nonprofit corporation perform functions that are similar to those performed by the directors of a business corporation. These include setting strategic goals, hiring and evaluating the chief executive officer, approving budgets and considering significant transactions involving the corporation.

However, unlike a business corporation, the board of a nonprofit corporation must act to achieve a specific charitable or other nonprofit mission. If the corporation is a public charity, the directors are essentially trustees of the corporation's assets, charged with properly applying those assets for the corporation's specific charitable purpose. If the corporation has been recognized by the IRS as tax exempt, the board must not allow any activities to occur that would expose the organization to tax penalties or loss of its exempt status.

Because nonprofit boards are often structured to satisfy a development role, or to represent the community in which the corporation operates, nonprofit boards tend to be larger and more diverse than business corporation boards. Unlike boards of business corporations, nonprofit boards typically consist of volunteer directors. Because of these differences, counsel has an especially important role in helping the board carry out its responsibilities in accordance with law.

Duties of the directors

The duties of directors of a Massachusetts nonprofit corporation are well established. A director must act in good faith, and exercise fiduciary duties of care and loyalty. The relevant part of the Massachusetts nonprofit corporation statute, M.G.L. Ch. 180, Sec. 6C, states that a "director… shall perform his duties as such… in good faith and 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 with respect to a similar corporation… would use under similar circumstances."

There are other statutory and common law provisions that are applicable to management of a charity under Massachusetts law. M.G.L. Ch. 180A addresses the management of funds of a charitable corporation. The Massachusetts nonprofit corporation statute, M.G.L. Ch. 180, requires involvement of the Massachusetts Attorney General before a public charity makes certain dispositions of assets or dissolves.1 The board of a charity is limited in its power to change the charitable purposes of the corporation.2 As discussed below, the board is also limited in its power to delegate control over the charity's assets.

The requirement that a director act in good faith means that a director must act in an honest manner. A director is not acting in good faith if the director relies on third party information in approving any action, where the director has knowledge that would cause such reliance to be unwarranted. Failure of a director to make a reasonable inquiry into facts that support the director's decision on a matter may also constitute lack of good faith. Failure to act in good faith can have significant consequences including jeopardizing the director's right to indemnity by the corporation or coverage under any directors and officers liability insurance maintained by the corporation.

In exercising the director's duty of care, the director must perform adequate due diligence as to any matter under consideration by the board. The Massachusetts nonprofit corporation statute permits a director to rely, under appropriate circumstances, on reports and recommendations from others. A director may rely on information from an officer or employee whom the director reasonably believes to be reliable as to the matter presented; from attorneys, accountants or other professionals as to matters that the director believes are within such person's professional competence; and from committees of the board as to matters delegated to the committee which the director reasonably believes merits confidence.3

The "business judgment rule" may be available to protect a director from honest mistakes or errors in judgment. While the business judgment rule is applied with respect to business corporations in Massachusetts,4 it is not clear to what extent the business judgment rule would apply to directors of a Massachusetts nonprofit corporation. Under the business judgment rule, courts defer to decisions of the directors, who are presumed to have acted in the best interests of the corporation. Where the business judgment rule applies, a plaintiff must challenge the good faith or the investigative process of the board.

To comply with the duty of loyalty, a director must act in a manner reasonably believed to be in the best interests of the corporation. This means that a director may not improperly benefit from transactions with the corporation, may not divert opportunities that belong to the corporation, and must keep confidential private information learned as a board member.

The director's compliance with his or her duty of loyalty will be vigorously scrutinized by the courts when a director acts as to a matter in which he or she has a conflict of interest.5It is important that a nonprofit corporation, especially one that is a public charity, adopt and implement a conflict of interest policy. Where a director has an interest in a transaction under consideration by the board, that interest must be disclosed to the board. The interested director may not participate in the consideration by the board of the proposed transaction.

Who may assert claims

There are some immunities and other protections available to volunteer directors of a Massachusetts nonprofit charitable corporation. However, failure of a director to properly comply with his or her duties can still lead to individual exposure, and to costly and embarrassing consequences to the nonprofit corporation. Claims may be asserted by the Attorney General, the corporation, or those acting in place of the corporation, and governmental agencies such as the Internal Revenue Service.

The Massachusetts Attorney General is charged with enforcing the due application of funds given or appropriated to a public charity.6 The Attorney General has broad power to challenge and seek appropriate remedies when the board fails in its governance responsibilities. The Attorney General has, in recent years, taken action to address executive severance arrangements, compensation to outside directors, related party transactions and conflict of interest matters, and fundraising practices, of Massachusetts public charities.

A nonprofit corporation may also take action against a director or former director who has breached his or her fiduciary duties.7 In some cases, a director may have a duty to cause the corporation to take action to address a breach of fiduciary duty by another present or former director that adversely affects the corporation.

The Internal Revenue Service has power to assess penalties against directors and others who are involved in the approval of excessive compensation arrangements, or other excess benefit transactions, under the intermediate sanctions provisions of the Internal Revenue Code.8 In an extreme case, a corporation can lose its tax exempt recognition from the IRS.

Developments over the past several years, including the Federal Sarbanes-Oxley Act of 2002, changes made by IRS to the Form 990 filed by tax exempt corporations, and certain reported abuses at nonprofit corporations, have focused attention on good governance practices. While many of the Sarbanes-Oxley requirements do not apply to nonprofit corporations, some of its governance-related requirements that are applicable to public companies, such as establishment of an audit committee, providing for financial expertise on the board, and adoption of internal controls, are employed by nonprofit corporations.

The IRS Form 990 now asks a tax exempt corporation to disclose various information regarding its governance, including information regarding its independent directors, its establishment of a conflict of interest policy, whistleblower policy and document retention policy, and its process for determining executive director compensation. There is an increased expectation by the public of transparency in the management of nonprofit charitable corporations. The Forms 990, and its disclosures regarding a charity's governance, are publicly available on the Massachusetts Attorney General's website.

Recommendations

Because of limitations on resources and volunteer time, it can be challenging for smaller nonprofit corporations to be aware of, adopt and follow all the best governance practices that are being reported. The following are some basic things that counsel can do to ensure that the nonprofit corporation is moving in the right direction:

  1. Be sure the board has a sufficient number of independent directors
    Having independent directors becomes critically important when the corporation must address related party transactions, and other conflict of interest situations.
  2. Be sure that the board includes directors with the appropriate expertise
    In this regard, the board should include directors who have financial management experience, who understand financial statements and budgets, and who can interact effectively with the corporation's auditors. Depending on the mission of the nonprofit corporation, board expertise in other areas will be necessary.
  3. Observe corporate formalities
    For any proposed matter that must be acted upon by the board, counsel must consider what notice is required for a meeting of the directors, how the meeting should be called and notice properly given, how directors may participate in the meeting, and what are the quorum and approval requirements for board action.

    For certain extraordinary actions, approval of the members of the corporation may be needed. In some cases, the board should meet in executive session or in the absence of a specific director with a conflicting interest. Minutes should be drawn that carefully and accurately reflect the matters considered and actions taken. When there is a potential conflict of interest by a board member, the minutes should reflect how the conflict was handled.

  4. Carefully consider the limits on what may be delegated or approved by the board
    There are limits under Massachusetts law on the power of the directors of a charity to delegate their authority to others. The Massachusetts Supreme Judicial Court has held that the power of an officer of a charitable corporation to bind the corporation, without approval by the directors, must be more strictly construed than in the case of a business corporation.9 The board of a nonprofit corporation may not freely delegate authority to encumber a substantial part of the corporation's assets, or to transfer management of the charity's assets to another authority.10

    What this means is that the board, rather than the officers, should consider and approve significant transactions involving the corporation; the board should approve the relevant terms rather than delegating authority to an officer to do so; and the board should be aware of its limited authority when confronted with any proposed transaction involving a transfer of management of a significant part of the charity's assets.

  5. Make sure the board is adequately prepared to make its decisions
    Decisions about executive compensation, deployment of significant corporate assets, investment of corporate funds, and entry into ventures with other organizations may require a more developed record for the board. The board should not be asked to make any decisions without having adequate information, and in appropriate cases, advice regarding standards that govern its decision making.

    For example, decisions about a chief executive officer's compensation are often made under a compensation policy pursuant to which data regarding comparable compensation of similarly situated executives is made available. It may be appropriate to have a report and recommendation from a committee that has been charged to review issues on a particular matter on which the board is asked to act.

  6. Diligently follow the conflict of interest policy
    This is an area where directors and the corporation have special exposure. It is not uncommon for volunteer board members to have relationships that from time to time may create a conflict with the corporation. A nonprofit corporation must adopt a conflict of interest policy, and once adopted, follow it carefully. This includes obtaining regular disclosures from board members and officers regarding potentially conflicting relationships.

    With respect to any specific transaction under consideration, a director must disclose any conflicting interest and permit the board to determine, without participation by the affected director, whether there is a conflict and whether the transaction is fair and appropriate. Minutes should be kept that reflect the procedures followed and actions taken by the board.

  7. Be prepared to guide the board when controversies arise
    There will inevitably be controversies where the board must make difficult decisions. Counsel should be available to guide the board with respect to its crisis management, and assist where internal investigations must be conducted. Counsel can be particularly helpful in advising where special litigation or other investigative committees should be formed, and how board and committee activities should be conducted, especially where preservation of confidentiality and attorney-client privilege is important. Counsel can help balance the often competing concerns regarding transparency and public disclosure, and not taking any action that would jeopardize the corporation's position in litigation.

  8. Make sure there is a process to assure succession in the board
    The Massachusetts nonprofit corporation statute contemplates that a nonprofit corporation will have members who elect the directors. In many nonprofit corporations, the board of directors is the same body that has the power of the members. In a nonprofit setting, where most or all of the members or directors can be volunteers, it is not uncommon for a corporation to lose contact with members or directors, or not maintain a good record regarding who are its current members. In a small nonprofit corporation, there may be no one who is charged with assuring that there is a continuation of active directors.

    Therefore, it is important for counsel, at the planning stage, to consider how the corporation should be structured to ensure succession in its board of directors. Counsel should also work with the corporation to see that annual meetings and elections are held. Nonprofit corporations can also deal with issues of succession by establishment of a governance committee or nominating committee that is charged with assuring that the corporate structure is the most effective structure, that new board members are selected, and that there is succession in management.

    As discussed above, there are several areas where counsel can assist in the good management of a Massachusetts nonprofit corporation.

1MASS. GEN. LAWS ch.  180, §§8A and 11A (2012).

2See Attorney Gen. v. Hahnemann Hosp., 397 Mass. 820, 836 (1986).

3MASS. GEN. LAWS ch. 180, §6C (2012).

4See Harhen v. Brown, 431 Mass. 838, 845 (2000).

5See Am. Disc. Corp. v. Kaitz, 348 Mass. 706, 711 (1965).

6MASS. GEN. LAWS ch. 12, § 8 (2012).

7See In re Bos. Reg'l Med.l Ctr. Inc., 328 F. Supp. 2d 130, 145 (D. Mass. 2004).

8I.R.C § 4958 (2006).

9See Bos. Athletic Ass'n v. Int'l Marathons, Inc., 392 Mass. 356, 366 (1984) (holding that the board may not delegate to the president of the Boston Athletic Association authority to enter into an exclusive promotion agreement with an outside firm for promotion of the Boston Marathon, on terms deemed acceptable by the president).

10See Mass. Charitable Mech. Ass'n v. Beede, 320 Mass., 609-10 (1947).

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