This document discusses the legal duties and responsibilities of nonprofit directors. It notes that directors must perform their duties in good faith, in a manner that is in the best interests of the organization, and with the care of a prudent person. The business judgment rule creates a presumption that directors acted appropriately. Directors may rely on experts but remain responsible if they have contrary knowledge. The document also discusses standards of care for organizations in financial distress, investment of funds, and modifying donor restrictions.

1. NONPROFIT DIRECTORS AS FIDUCIARIES
January 19, 2010
Eileen Morgan Johnson, Esq.

2. 2
Overview
 Standard of Care
 Business Judgment Rule
 Liability
 Indemnification
 Zone of Insolvency
 Uniform Prudent Investor Act
 Uniform Prudent Management of Institutional
Funds Act

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Standard of Care
Directors must perform their duties (including
service on Committees):
 In good faith
 In a manner reasonably believed to be in the
best interest of the organization
 With the care that an ordinarily prudent
person in a like position would use under similar
circumstances

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Standard of Care
Directors may rely on information from:
 Officer or employee of the corporation
 Lawyer, CPA, or other person within that person’s
professional or expert competence
 Committee of the board to which a matter has
been referred
 Not acting in good faith if they have any contrary
knowledge
 Immune from liability

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Business Judgment Rule
Presumption by courts
 Directors acted in accordance with
statutorily required standard of care
 Absent a showing that they acted
fraudulently or in bad faith

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Liability for Breach of Standard of Care
 Breach of the standard of care is enforceable
by the corporation
 Not by members or donors
 Articles of incorporation (charter) may expand
or limit the directors’ liability

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Indemnification
What is indemnification?
 Providing reimbursement for expenses of
defending against a claim
 Must meet requisite standard of care
 May also include the advancement of
expenses
 Often covered by D&O insurance

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Indemnification
Indemnification options
 Source
 By statute
 Bylaws
 Articles of Incorporation
 Coverage
 Officer or director
 Employees and agents

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Zone of Insolvency
What is zone of insolvency?
 Organizations operating in financial distress
but not technically insolvent
 Usually determined in retrospect
 If directors and officers wonder if their
organization is in the zone of insolvency, then
it probably is

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Zone of Insolvency
“In the zone of insolvency” when:
 Organization is experiencing cash flow
problems; or
 Liabilities exceed assets; or
 Predict problems in the near future

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Zone of Insolvency
Boards governing corporations in the zone
of insolvency:
 Additional responsibilities and liabilities
 Board’s responsibilities expand to protect
interests of creditors, members, employees
 Challenge for nonprofit directors
 Mission v. duties owed to others

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Zone of Insolvency
Duties owed by directors of a corporation
in the zone of insolvency:
 Duty of care
 Duty of loyalty
 Duty of obedience

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Zone of Insolvency
Standard of care for directors of a
corporation in the zone of insolvency:
 Standard of care does not change
 Directors must perform duties in good faith
 In the best interests of the corporation
 Care that an ordinarily prudent person in a like
position would use

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Zone of Insolvency
Prudent person rule requires directors to:
a. Adequately supervise executive director
b. Read and understand financial reports
c. Understand organization’s business activities
d. Properly invest and manage assets
e. Meet as often as necessary
f. Ask questions

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Zone of Insolvency
Business judgment rule
 Courts will not second guess decisions made by
board absent a showing of:
● fraud
● bad faith
● gross negligence
● waste of corporate assets
● culpable negligence

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Zone of Insolvency
May a director resign when a corporation is in
the zone of insolvency?

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Uniform Prudent Investor Act
 Utilize modern portfolio theory to guide investment
decisions reducing portfolio volatility and losses
 Fiduciary’s performance is measured on the
performance of the whole portfolio
 Diversification is required unless, due to special
circumstances, the trust would be better served
without diversification
 Fiduciaries may delegate investment decisions
 Not adopted in DE, GA, KY, LA, NY

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Uniform Prudent Investor Act
Prudent Investor Rule:
 Trustee shall invest and manage trust assets considering
the purposes, terms, distribution requirements, and
other circumstances of the trust
 Trustee shall exercise reasonable care, skill and caution
 Trustee’s investment and management decisions
 Evaluated in the context of whole trust portfolio
 Risk and return objectives reasonably suited
 Part of an overall investment strategy

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Uniform Prudent Investor Act
Circumstances trustee must consider in
investing and managing trust assets:
 General economic conditions
 Possible effect of inflation or deflation
 Expected tax consequences of investment
decisions or strategies

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Uniform Prudent Investor Act
Overall trust portfolio may include:
 Financial assets
 Interests in closely held in closely held
enterprises
 Tangible and intangible personal property
 Real property

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Uniform Prudent Investor Act
Additional circumstances trustee must consider
in investing and managing trust assets:
 Expected total return from income and appreciation
of capital
 Other resources of the beneficiaries
 Need for liquidity, regularity of income, and
preservation or appreciation of capital
 Assets

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Uniform Prudent Investor Act
More circumstances to consider:
 Trustee shall make a reasonable effort to verify
facts relevant to the investment and management of
trust assets
 Trustee may invest in any kind of property or
type of investment consistent with the standards of
the Act
 Trustee who has special skills or expertise
 Duty to use those special skills or expertise

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Uniform Prudent Management
of Institutional Funds Act
Approved by National Conference of
Commissioners on Uniform State Laws July
2006:
 Enacted in every state (and DC) except:
AK, FL, KY, LA, MS and PA

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Uniform Prudent Management
of Institutional Funds Act
Standard of care:
 Investment “in good faith and with the care an
ordinarily prudent person in a like position would
exercise under similar circumstances”
 Prudence required in incurring investment costs
 Factors considered in investing expanded to include
inflation

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Uniform Prudent Management
of Institutional Funds Act
Investment decisions must be made:
 In relation to the overall resources of the
institution and its charitable purposes
 Considering the fund’s entire portfolio
 Investment strategy - risk and return objectives
“reasonably suited to the fund and to the
institution”

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Uniform Prudent Management
of Institutional Funds Act
Investment decisions:
 Charitable funds must diversify assets
 Institution must review assets within a reasonable
time after receipt
 Investment experts held to standard of care
consistent with their expertise
 More precise standards for investment activities
and court oversight

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Uniform Prudent Management
of Institutional Funds Act
Criteria for annual expenditures decisions:
 Duration and preservation of the endowment fund
 Purposes of the institution and the endowment
fund
 General economic conditions
 Effect of inflation or deflation

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Criteria for annual expenditures decisions:
 Expected total return from income and the
appreciation of investments
 Institution’s other resources
 Institution’s investment policy
Uniform Prudent Management
of Institutional Funds Act

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Restrictions imposed by donors
 Modified with court approval
 Impractical or wasteful
 May impair the management of the fund
 Charity must notify state’s chief charitable
regulator if it seeks court approval of modification
 Modify restriction without court approval
 Funds less than $25,000
 Funds over 20 years old
Uniform Prudent Management
of Institutional Funds Act

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Uniform Prudent Management
of Institutional Funds Act
 Preventing restrictions on donations
 Catholic Relief Services example:
Contributions will be used for the purpose(s),
if any, specified by the donor. However, if in
the judgment of CRS, such purpose(s) become
unnecessary, undesirable, impractical or
impossible to fill, CRS may use such
contributions for its general purposes.

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CONTACT INFORMATION
Eileen Morgan Johnson
Whiteford Taylor & Preston L.L.P.
3190 Fairview Park Drive, Suite 300
Falls Church, VA 22042
Phone: 703-280-9271
Fax: 703-280-8947
E-Mail: emjohnson@wtplaw.com
Questions?