(Note: not all not-for-profit corporation are tax exempt.)
Nonprofit corporations can be:
- public benefit corporations (operating for public or charitable purposes)
- mutual benefit corporations (operating for the benefit of their members), or
- religious corporations (operating to advance or maintain the members’ or directors’ religion).
Not-for-profit corporations are normally created pursuant to statute in the same manner as a for-profit corporation, and kept in existence by compliance with the regular requirements of the federal and/or state governments.
The entity is typically created by filing articles of incorporation with the Secretary of State. Formerly (and still possible), “pro forma” not-for-profit corporation were created by filing articles with the county circuit court, with a notice to the Secretary of State.
The corporation’s operations are governed by detailed rules usually referred to as by-laws, and controlled by a board of directors (sometimes called a “board of trustees,” “board of overseers,” “governing committee,” etc.). Day-to-day operations of the entity are handled by officers.
An individual director acting alone has almost no power; rather, each director exerts his or her power by participation in the board of directors as a whole. Nevertheless, the individual director is still legally accountable for corporate actions in certain circumstances, and has legally protected rights and duties to participate in the board’s decisions and all information related thereto.
There may also be “honorary,” “life,” “emeritus,” or “ex-officio” members of the board who are not counted for quorum purposes, and may not vote even though allowed to participate in discussions at the meeting. A not-for-profit corporation may have “members,” with or without voting rights, or may have no members at all.
Purpose or mission
Directors must ask what purpose and constituency the corporation serves. The corporate purpose is generally stated in the articles of incorporation and bylaws, and may also be shaped by a mission statement or the corporation’s undertakings and activities. The board should reexamine the corporation’s mission and responsibilities from time to time, as demands and opportunities will continually shape and alter what the corporation actually does. Non-profit directors are responsible to the members in the case of a mutual benefit corporation, or typically the state attorney general in the case of public benefit corporations. Constitutional considerations may limit the public accountability of religious corporations.
Information is generally supplied to a director by the staff. To the extent the information provided is not adequate, the individual director must determine what additional information is needed. In the ordinary course of business, a director may act in reliance upon the information and reports received from regular sources whom the director reasonably regards as trustworthy. While an individual director may not delegate his or her authority as a director, and cannot vote by proxy, the board of directors as a whole may delegate the operation of the day-to-day corporate business to others. Regardless of any such delegation, however, the board must set policies and oversee such corporate agents.
Delegation of authority
The board may also delegate authority and act through executive committees which have general power to bind the corporation, standing committees permanently set up to study specific activities and which may have limited power to bind the corporation, and special committees temporarily set up for a limited purpose. The composition of a committee will depend on the type of committee involved, and executive committees should be composed exclusively of board members. The procedures, records and operations of committees should be as clearly defined as those of the board itself.
Any working board must work out its own standard agenda and the degree of formality required in submitting motions, amendments to resolutions, recording votes, etc. Matters of financial importance, however, should always be acted upon by formal resolution and votes recorded in the minutes.
Duty of care
A director is subject to a duty
- of care to be reasonably informed;
- to participate in decisions in good faith;
- to exercise independent judgment; and
- to act with the care exercised by an ordinary prudent person in similar circumstances.
Because directors act as a group, attendance at board and committee meetings is important. Directors may run the risk of not satisfying the duty of care by continuous or repeated absences. Sporadic board attendance by some directors also reduces the morale of those who do attend.
Duty of loyalty
Directors have a duty of loyalty and must consider conflicts of interest, corporate opportunity, and confidentiality.
Conflict of interest
While not inherently illegal, the manner the directors and board deal with a disclosed conflict determines the propriety of the transaction. A conflict of interest occurs when a director has a direct or indirect material, personal interest in a proposed contract or transaction, even where a director sees no monetary benefits. For example, such a conflict may arise when a director has access to information from which the individual may profit.
A director must be sensitive to any interest he or she may have in a decision by the board, and inform the board prior to discussion and presentation of the matter. In many states, a director may be counted for purposes of determining the presence of a quorum even if interested, but that director’s vote may not be counted for the authorization of the matter. When a board of directors discovers it has acted upon a proposal unaware of an undisclosed interest, it should promptly reexamine the issue with appropriate record. In many cases, a board may legitimately deal with an “insider” supplier of goods and services, e.g. because of greater familiarity with their reliability. But corporate records must show that the best interests of the corporation were the overriding consideration in the decision. Also, where a director engages in a transaction which he or she reasonably knows should be of interest to the corporation (a “corporate opportunity”), the director should disclose the transaction to the board of directors in sufficient detail and sufficiently in advance to enable the board to act or decline to act with regard to the transaction. A director should not in the regular course of business disclose information about the corporation’s legitimate activities unless they are already known to the public or are of public record.
Liability to third parties
In serving on the board, a director may have potential liability to third parties or the corporation itself. The director’s possible liability arises because the director is charged with some breach of duty owed either to the corporation or a specific third party, and not necessarily because the corporation may be liable.
Business judgment rule
According to the “business judgment rule,” where a corporate action proves unwise or unsuccessful, a director acting in good faith and in a manner reasonably believed to be in the corporation’s best interest with independent and informed judgment may still be protected from liability. The business judgment rule will not be applied, however, where basic breaches of duty by a director are present, such as criminal activity, fraud, bad faith, or willful or wanton misconduct.
Limitation of liability
Many states, including Missouri, have statutes which limit the liability of an unpaid nonprofit director. Directors may also receive some protection through indemnification by the corporation or the purchase of director’s and officer’s (“D&O”) insurance. Where a director operates in two or more roles, insurance coverage may be determined by which role the director is engaged in at the time of the action. Most D&O policies are written on a “claims made” basis, with coverage for claims made during the coverage period, as opposed to an “occurrence” policy, which covers all claims arising out of incidences occurring during the policy period, regardless of whether the policy is still in effect at the time the claim is made. Typically, a D&O policy does not provide attorneys to defend a lawsuit and only pays after final determination of liability. Also, virtually all D&O policies have substantial exclusions which must be clearly understood. Finally, while most nonprofit corporations are exempt from federal income taxes applicable to corporations, exemption does not automatically apply. Qualification under IRC § 501(c)(3) requires the corporation to be organized and operated exclusively for a charitable purpose, and brings certain unique advantages, including deductibility of contributions by contributors up to limits imposed by IRC § 170(b). The corporation also must not have earnings inured to individuals, it must not carry on substantial activities to influence legislation, and it must not participate in any way in a political campaign.