As I stated in my prior post, I have decided to do a series on board member duties and liabilities. This post concerns the duty of Loyalty -- the 2nd of 3 duties that exist for all board members simply by virtue of going on a nonprofit board.
Duty of Loyalty
The duty of loyalty requires that a board member not use their position of influence within the organization to promote their own, private interests. The good of the nonprofit corporation should be their highest priority when making decisions for the organization. Thus, the central issue regarding the duty of loyalty for nonprofit board members is proper management of conflicts of interest. Conflicts of interest are not inherently terrible things and are frequently going to arise when you have a board of directors that is active and involved in the organization and their community. Nonprofit boards should all adopt (and follow!) a conflict of interest policy that helps to guide them through any potential conflict.
Understanding what constitutes a conflict of interest is therefore key for all board members. I will try to explain it first by defining the terms – (you can also look to Minn. Stat. 317A.255).
Conflict – A conflict arises when a director or certain related persons has a material financial interest in a proposed transaction with the organization
Related person – (this is per Minnesota Statute) – member of the director’s family (spouse, parent, child, spouse of a child, brother, sister, or spouse of a brother or sister); director of a related organization or a member of their family; an organization in which a director (or his/her family) is a director, officer, legal representative, or has a material financial interest
Material Financial Interest – Exists when there is a financial interest of any kind that is substantial enough that it reasonably could affect an interested person’s or related person’s judgment with respect to the transaction under discussion by the organization
Minnesota Statutes holds that a transaction in which a director is conflicted (as described above) is not void or voidable if certain steps are taken:
- The contract or transaction was fair and reasonable to the organization (person asserting the validity has the burden of proving this);
- The material facts of the transaction and the conflict are fully disclosed, and the contract/transaction is approved in good faith by 2/3 of the members eligible to vote (not including the interested member) or a unanimous vote of all members (irrespective of their voting rights);
- The material facts of the transaction and the conflict are fully disclosed to the board, and a majority of the board approves the transaction (without the vote of the interested director or their presence necessary for a quorum – if less than a quorum is present, those remaining directors are the quorum necessary); or
- The transaction is a merger or consolidation
The IRS is also concerned about management of conflicts of interest within nonprofit organizations. The Form 990 asks questions to elicit information about an organization’s policies and procedures regarding conflict of interest. Additionally, the IRS imposes penalties on excess benefit transactions (see prior post for a discussion on that issue).
So, what should you do?
Have a conflict of interest policy (and follow it) and make sure that policy includes procedures to follow if there is a potential conflict of interest.
Regularly disclose conflicts of interest – and don’t be afraid of them! In addition to disclosing conflicts as they arise in reference to specific transactions, it is good practice to have the board annually disclose any potential conflicts.