Because nonprofit organizations benefit from tax-exempt status and other privileges, they owe special obligations to the public. 501(c)(3) tax-exempt organizations should maintain high ethical standards and avoid conflicts of interest. Also, as discussed in the previous section, a nonprofit organization must not engage in political activity or devote a substantial amount of its activities to lobbying. Organizations that fail to comply with these standards may face sanctions, civil liability, or loss of tax-exempt status.
The board of directors is obligated to govern the corporation with integrity and remain accountable to the public. Directors’ legal obligations are referred to as “fiduciary duties.” The three fiduciary duties of directors are the duties of obedience, care, and loyalty.
Duty of Obedience: Directors must conduct business in a manner that is faithful to the incorporating document’s (normally the articles of incorporation’s) purpose. Examples of violating the duty of obedience include engaging in activities that are outside the corporate purpose, excessive lobbying, substantial commercial activity, or activities for the benefit of insiders.
Duty of Care: Directors must carry out their responsibilities with diligence and make informed decisions on matters of importance to the nonprofit. To avoid breaching the duty of care, directors must:
- prepare for, attend, and participate in meetings of the board of directors;
- have a reasonable, good faith belief that their decision is in the best interests of the organization; and
- diligently supervise officers and employees of the organization.
Duty of Loyalty: The duty of loyalty requires directors to act in a manner that does not hurt the corporation; avoid using their position to obtain improper personal benefit; place the interests of the corporation ahead of personal gain.
To avoid violating the duty of loyalty, nonprofit corporations should adopt a written conflict of interest policy. To view a sample policy, click here.
A potential conflict of interest occurs whenever organizational resources are directed to the private interests of a person or persons with influence over corporate decisions. This would include situations where a director votes in favor of a benefit for another person and expects something in return. Typical conflicts of interest would include a director voting in favor of the corporation leasing property owned by a relative, directors granting themselves salaries, the organization hiring one of its own directors to provide legal representation, or the executive director hiring a relative or a director’s relative.
A typical conflict of interest policy requires directors to disclose potential conflicts to the board and provides a formal process for the board of directors to lawfully consider and approve (or disapprove) the decision or transaction notwithstanding the potential conflict of interest. In following the formal process, the directors must also evaluate if the interested transaction is substantively fair to the organization.