The Deontological Significance of Nonprofit Corporate Governance Standards: A Fiduciary Duty of Care Without a Remedy
77 Pages Posted: 23 Jan 2008 Last revised: 4 Dec 2008
Date Written: January 23, 2008
Given the diverse charitable mission and high rate of unpaid donor and volunteer service to the charitable nonprofit board of directors, few would seriously suggest that a nonprofit corporate director's fiduciary "duty" of care to oversee management should exceed that of a for-profit corporate director counterpart. Most for-profit corporate directors duty of care breaches are protected by the business judgment rule and statutory exculpation clauses. However, systemic abdication of directorial duties can result in ruinous unprotected "liability" to for-profit directors through shareholder derivative suits. Unfortunately, abdication and dereliction are far more common on volunteer nonprofit charitable boards. Except in the largest charitable nonprofit corporations, directors often view their role as advisory rather than supervisory. Consequently, one might expect parallel duties of care to have even more ruinous effects in the charitable nonprofit corporate sector. In fact, this is not true because most charitable nonprofit corporations do not have shareholders, donors lack standing to bring fiduciary duty suits, and while state attorney general offices have standing, they lack resources and interest to enforce the duty of care. So, while for-profit director abdication is far more common, it is far less likely to result in director liability.
So, what is the significance of a charitable nonprofit director fiduciary "duty" of care if it does not result in any liability consequences? First and foremost, the duty properly explained, is eventually internalized tending to create aspirational care behavior in spite of a lack of breach liability. Secondly, every charitable nonprofit corporation is classified either as a private foundation or a public charity for federal tax purposes. These classifications attach monetary liability significance to management engaged self-dealing and excess benefit transactions that become monstrous if uncorrected after detection. Moreover, these self-dealing and excess benefit transactions create potential monetary liability to charitable nonprofit directors who "knowingly participate" in such transactions. Specifically, even though charitable nonprofit directors are not directly involved in the culpable manager's behavior, the charitable directors will incur monetary penalties if they had a "duty" to act. The failure must be due to deliberate inattention but the intent may be inferred from the fact that knowledge of the improper behavior would have likely developed had the director not been systematically absent from regular directors meetings.
The 2008 revision draft of the Model Nonprofit Corporation Act creates fiduciary duties of care for charitable nonprofit corporate directors comparable to those in for-profit corporations. The 2008 draft of the American Law Institute Principles of the Law of Nonprofit Organizations adopts a similar approach. While neither drafting project offers compelling reasons for creating and imposing largely symbolic fiduciary "duties" of care, this Article suggests that philosophical, moral and legal liability bases do exist and indeed depend upon the existence of such a duty. Absent the duty, not only would charitable nonprofit corporate director management oversight behavior likely deteriorate, scandalous management behavior would also likely expand unchecked. The unique combination of state law duty with federal liability detection and liability appears the most efficient and best model as it seldom embroils the finances of the nonprofit corporation for enforcement such as shareholder derivative suits.
An assorted array of other solutions to charitable directorial abdication are in process as well but all have critical defects examined in the context of the charitable nonprofit corporation. Following the Enron-era scandals, the federal Sarbanes-Oxley Act was enacted in 2002 to increase publicly traded for-profit corporate director independence from management, management accountability to the board, and information transparency regarding director management oversight. These measures add superficial luster to the state law fiduciary duties by making objectionable management activity and lax board oversight more apparent to shareholders and the public. But those provisions do not apply to charitable nonprofit corporations without members or shareholders, the primary target of this Article and the largest group of nonprofit organizations. While a few states have adopted similar provisions and a few large national charitable nonprofit corporations have voluntarily elected to comply with Sarbanes-Oxley, the enforcement paradox continues to plague directorial accountability for lax charitable management oversight.
Notwithstanding federal charitable director liability, the system could be vastly improved, particularly at the management level. While the same federal tax law creates even more monstrous liability against participating managers for uncorrected self-dealing and excess benefit transactions, the initial penalty is low and lacks deterrence effect because of low detection rates. Higher initial penalties would discourage transactional misbehavior even if not detected. Finally, managers are flatly prohibited from self-dealing transactions in the context of private foundations but only prohibited from "excess benefit" transactions in the context of public charities. Given the scandalous behavior in several notorious charitable management abuse cases, the absolute prohibition applicable to private foundations ought to be extended to public charities. Finally, greater public information transparency would mobilize the press to examine readily accessible documents for violations. News stories can alert the IRS to otherwise undetected violations. So both private foundations and public charities of an identified minimum size should be required to post charitable exemption applications and annual IRS filings on their own websites.
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