Nonprofit board members should be aware of liability pitfalls

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By Beau Ruff

Charities and nonprofits need good people who are willing to donate time and energy to make sure the enterprise is running efficiently and doing good deeds. So, they seek out volunteers who are willing to devote time and energy to serve on the board and help to oversee the group’s operations and mission.

But, no good deed goes without liability exposure. Knowing some of the rules can help.

Beau Ruff, Cornerstone Wealth Strategies
Beau Ruff,
Cornerstone Wealth Strategies

It’s my goal that this column not stifle volunteerism among our local nonprofits, but rather to create awareness of possible pitfalls so every willing board member can make a positive difference in our community and beyond.

When serving on a board, you take on legal liability for its operations. Board members are charged with the duty to oversee the organization and act as its legal governing body. Board members have at least three sources of authority which guide their duties: state law, the organization’s bylaws and federal law, especially as it relates to nonprofit tax-exempt status.

Legally Recognized Entity Status is necessary to limit liability. Make sure the nonprofit is an entity recognized by state law. Without entity protection, it is possible that all persons acting as a corporation, but without corporate authority, may be held liable for debts and liabilities incurred (RCW 24.03.470). This means the organization should be incorporated as a state-recognized nonprofit entity under the auspices of the state Secretary of State. Tax-exempt status is important and separately obtained by filing with the Internal Revenue Service.

Board members must act in good faith and as a prudent person. Under Washington law, a board member is charged with serving “in good faith, in a manner such director believes to be in the best interests of the corporation, and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” (RCW 24.03.127).  The statute states a board member must act like a prudent person and not be negligent in his or her duties.

Negligence, by the way, is often defined (not so helpfully) as the failure to exercise the care of a reasonably prudent person. This means that in the event the board member fails to act with reasonable prudence, he or she may be held liable for the negligence. Negligence can be both by commission (acting without prudence) and by omission (failure to act when an ordinary prudent person should have acted).

Be involved. Be informed. Be critical. It is important to always attend and be involved in the decision-making of the governing body, at least to the extent possible. It is not a defense to a claim of liability that the board member didn’t know about the action or event giving rise to liability (see above regarding failure to act when a prudent person should have acted).

It is also important to gain the facts necessary to make a good decision. If the facts are not sufficient, ask for more. So, if the board president wants to hire his friend to act as the president and the board member is unsure that the proposed salary is reasonable, request industry salary information or contact a human resources specialist. If a board member gains insight into a product or organization through work on the board that could assist personally or professionally, don’t use it. Keep nonprofit business private.

Don’t allow the nonprofit to make loans to board members or officers. No further explanation is necessary here.

Nonprofits have statutory duties for the investment of funds. Washington has implemented the Prudent Management of Institutional Funds Act under RCW 24.55. Generally, this law provides statutory standards of conduct upon an institution’s investment fund. Often, a charity will have a fund or reserve that is maintained to either fund current operations or it is used as a rainy-day fund.

Simply choosing to invest the funds, without attention to these other matters, is insufficient. The statute specifically lays out the criteria the institution should employ to set up the fund, choose investments and investment advisors, and the factors to consider in the ongoing management and investment of the institution’s funds. Those considerations should be included in both the Investment Policy Statement and the minutes of the regularly scheduled meetings of the board or investment committee.

Director and officer insurance can help. Talk to your insurance agent to see if you are currently covered for director and officer insurance. It can provide an additional layer of protection and potentially entice otherwise hesitant volunteers to serve on the board.

Now that you are aware of the responsibilities, opportunities and challenges of serving as a board member, volunteer and make this world a better place.

About Beau Ruff:

Attorney Beau Ruff works for Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick, where he focuses on assisting clients with comprehensive planning.