Advising and Serving on Nonprofit Boards

Rhonda Lees, Esq.

Lisa Hix, Esq.Partner, Nonprofit Organizations Practice

Venable LLP

October 19, 2015

2

• So you want to be a board member.

• That is great!• The sector needs you.• Much will be asked of you but you will learn quite

a bit and interact with other smart and passionate people.

• Today’s presentation focuses on the role of the board and of individual directors.

3

• So you want to advise a nonprofit board.

• That is great!• The sector needs you.• Much will be asked of you but you will learn quite

a bit and interact with other smart and passionate people.

• Today’s presentation also focuses on the role of inhouse or outside counsel advising a board.

4

What is the role of a nonprofit Board?

•It’s the same for nonprofits and for-profits. •The Board sets overall policy and strategy, performs oversight, and is ultimately responsible. “The buck stops here”. •It delegates day-to-day management -- such as personnel and operations -- to the Chief Executive Officer.

5

• What laws inform the Board’s legal duties?– State nonprofit corporation statute

• State where entity is incorporated– Internal Revenue Service requirements for tax-exempt

entities• Varies depending on designation• For charities and other 501(c)(3) organizations, approval of

compensation with “insiders” can result in financial penalties– Requirements, such as through a government grant, that

the organization is subject to because of its programs• Compliance oversight

6

What is the Role of Counsel to the Board? • Proper Board education on the nature and

extent of their duties can greatly decrease compliance risk and enhance the quality of decision-making.

• Compliance with state nonprofit requirements.• Compliance with tax-exempt status

requirements, broadly (particularly for Section 501(c)(3) entities).

7

What is the Role of Counsel to the Board? • Advise the Board on the nature of their duties when

they are presented with consideration of a major decision.

• Manage conflicts of interest.• Advise incoming Board members on the nature of their

duties and obligations.• Advise the Board regarding their obligations to oversee

the compliance program of the organization.• Preserving the “Business Judgment Rule”

8

Business Judgment Rule

• A director will normally not be held liable if the director make a decision in good faith, is disinterested, is reasonably informed, and rationally believes the decision is being made in the best interests of the organization. – Ex: DC Code § 29-406.30: “Each member of the board of directors,

when discharging the duties of a director, shall act: (1) In good faith; and (2) In a manner the director reasonably believes to be in the best interests of the nonprofit corporation.”

9

Business Judgment Rule

• A finding of gross negligence or recklessness will overcome the presumption of the business judgment rule.

10

Ex: DC Code § 29-406.31: (A) Action not in good faith;(B) A decision:

(i) Which the director did not reasonably believe to be in the best interests of the corporation; or(ii) As to which the director was not informed to an extent the director reasonably believed appropriate in the circumstances; or

(C) A lack of objectivity …(D) A sustained failure of the director to devote attention ..(E) Receipt of a financial benefit to which the director was not entitled or any other breach of the director's duties to deal fairly with the corporation and its members that is actionable under applicable law.

11

• State Nonprofit Statute:• Will inform a specific organization’s requirements with

respect to:– Acceptable forms of decision-making (proxies, quorum voting,

etc); and – The specific articulation of that state’s “fiduciary duty”

requirements for Board members.

12

How does the Board fulfill its role?• Usually through majority vote of a quorum (of

those in attendance) unless other rule specified• Through committees, task forces and staff• Not by proxy or alternates • Check state laws to see whether/how electronic

attendance and voting are permitted

13

• How should Board decisions be documented?– Minutes of significant resolutions, as well as

surrounding discussion.– Include list of every director in attendance and the

name of any individual dissenting from an action or abstaining from a vote (important in documenting conflict of interest reviews).

• Minutes will be “first line of defense” (or the rope with which to hang oneself).

14

In making decisions, what fiduciary duties do directors owe? • Duty of Obedience• Duty of Loyalty • Duty of Care and they often overlap

15

Duty of Care• Model Act: A director fulfills his duty of care if he or she acts in good faith, with

the care of an ordinary prudent person under similar circumstances, and reasonably believes his or her actions are in the best interest of the organization.

– Ordinary prudent person

– Informed, practical judgment and common sense;

– Does not require excessive caution; and

– Does not require special skills (ordinary).

16

Duty of Care

Generally requires making informed decisions based on a reasonable inquiry.

– Attend meetings, review information, request additional information when warranted.– Further inquiry if circumstances seem suspicious or information seems incomplete.

Good faith with a “reasonable belief”

– Fact-based inquiry into the state of mind of the director when making an important corporate decision.

– Did actions of the director reflect honesty and good faith?– Allegiance to the interests of the organization.– Conflict plays a factor (Sibley Hospital Case).– Was there a subjective belief that the action was in the best interest of the organization?

17

Duty of Care•Place interests of the Association above personal,

business, financial, or other professional interests•Act honestly and in good faith•Prepare for and participate in meetings•Make reasonable inquiries•Remain informed about the Association’s affairs

18

Duty of Obedience

• Follow articles, bylaws, policies, procedures and laws• Keep information confidential• Remember that a director serves as an individual,

and does not represent his/her Company.

19

A little more about Confidentiality– What is confidential? • What is designated as confidential• Executive sessions: What happens here, stays

here.– When the attorney discusses a matter with you,

it’s subject to privilege; please don’t waive it.

20

• Issues in Privilege:• Third-party attendees of Board meetings;• Business advice is not subject to the attorney/client

privilege. • Mixed legal and business advice is at risk of possible

recovery by private litigants or government investigators.

21

Duty of Loyalty• Act in best interests of the Association

• Avoid conflicts of interest and appearance of impropriety–Business–Financial–Professional–Direct–Indirect

22

ConflictsWhich issues arise re conflicts?• Affiliation with another Board raises potential conflicts on

specific issues, but can be managed. •Must act in best interests of each organization• Consider your participation in both

• Financial ties to “subject matter industry” or contracts need to be at arms length

• A very few associations want to compensate directors.

23

More about conflictsHave a Conflict of Interest policy. Ensure that staff and volunteers follow the policy:The basics:Identifying conflictsCapture disclosuresAnalyze disclosuresDevelop a process for managing conflicts

24

Conflict Management

• Disclose (minor)• The majority of interests are handled by disclosure.

• Remove (not as minor)• Recuse from discussion or vote (getting serious)• Resign (serious, visible, continuing, pervasive)

Who decides? The Chair of the Board, the General Counsel, the CEO and the Audit Committee make the final call on conflicts

25

Liability and risks in each direction• The organization can be held liable for actions of

volunteers acting with actual or apparent authority even if the Association does not know about, approve of, or benefit from such actions

• A director who fails to use reasonable care or acts outside of scope may face personal liability.

26

How to manage the liability• Act with Care, Obedience and Loyalty • Review bylaws, policies, and procedures• Prepare for and participate in meetings• Request expert advice• Identify the problem and fix it

27

How to manage the liability• Review financial reports and follow up • Appropriately maintain information • Act in the organization’s best interests• Avoid conflicts of interest and appearance of

impropriety

28

Legal Protections for Directors• Business Judgment Rule (by state)• Volunteer Protection Act (by state)• Directors & Officers insurance policies • Indemnification (Bylaws and by policy)

These do not protect against intentional misconduct, fraud, dishonesty and claims against each other

29

Here is a good question•If an organization is tax-exempt, why is the IRS involved?• The 990 asks about governance•Penalties, including loss of tax-exempt status, can arise as a result of Board decisions

30

Now that You are Advising the Board• You represent the corporate entity, not an

individual board member. • Your participation: It’s on a spectrum. For some

associations, you will be asked to see, review and attend everything. For others, they might call you but it will be at the last minute.

• Show you can serve as a trusted advisor.• Take opportunities to educate. • “When you see something, say something”.

31

Common Issues• Failing to Understand Fiduciary Duties• After Delegation, Failing to Provide Oversight• Deference to Executive Committee, Chair• Micro-managing Staff• Avoid the Hard Questions

32

Common Issues

• Insufficient Management of Conflicts• Lack of Awareness of Tax-Exemption

Requirements• Outdated or Unclear Governing Documents• Acting Outside the Boardroom

Ethical Considerations for Lawyers Serving as Board Members and Counsel

Mark Stall Jon Woltmann, Sr.General Counsel Associate General CounselEscort Inc. / The Christian Broadcasting Network, Inc.Cobra Electronics Corporation (CBN-The 700 Club)

34

• Purpose – Address ethical issues faced by lawyers serving on a non-profit board

• Reminder – Ethical Rules vary by state; We’ll use the ABA Model Rules today

• Key Issue - Lawyers serving as directors on non-profit boards are often asked or expected to provide “free” legal advice

• When lawyers serve on non-profit boards, “dual role” issues commonly arise

• Note- There is no prohibition on serving in a dual capacity, but there are important ethical issues

35

How Dual Roles Arise

• Lawyer –client relationship can be found when would be client has reasonable expectation under all of the circumstances that the relationship exists. ABA Model Rule 1.13;OSB Formal Op No. 2005-85

• A lawyer/director giving professional opinions in that dual role may also create lawyer-client relationship

• Non-lawyer board members may misinterpret business and practical advice by a lawyer/director as legal advice

• Once lawyer–client relationship is established, lawyer has ethical responsibilities and possible malpractice exposure

36

The Organization as the Client • ABA Model Rule 1.13(a) provides that an attorney “retained by an organization

represents the organization acting through its duly authorized constituents”

• Comments to Rule 1.13 note that there are times when the corporation’s interest may be adverse to the interests of one or more constituents (corporate directors, officers or employees), and in such situations, the lawyer must advise such constituents that he/she cannot represent such constituents and they need to seek other counsel. (Note – This advice should be in writing)

• When a lawyer serves as a board member of the organization, the lawyer is one of the “duly authorized constituents” that the lawyer is now representing

• This dual role leads to issues including competence, independent judgment, confidentiality and conflicts of interest

37

The Organization as the Client • A lawyer has a serious ethical responsibility to evaluate whether a conflict exists between the

role as a Board member and as a lawyer

• Considerations include –o Will lawyer be called on to advise board involving actions coming before the boardo Frequency of such conflictso Potential intensity of conflictso The effect of lawyer’s resignation from board o Possibility of corporation engaging other legal representationSee Utah Ethics Advisory Opinion No. 98-10

• Rule 1.4(b) provides that a lawyer must “explain a matter to the reasonably necessary to enable the client to make informed decisions regarding the representation”

38

The Organization as the Client, cont’d • ABA Formal Opinion 98-410 “Lawyer Serving as Director of Client Corporation”

provides that at the commencement of any relationship where a lawyer is serving in dual roles, the lawyer should assure that the non-profit’s management and fellow board members understand the dual roles, including –o Different responsibilities of lawyer and director;o Lawyer represents only the corporate entity and not individual board

members or managemento When lawyer is serving in role of director, discussions will not receive the

protection of the attorney-client privilege o Explain that conflicts of interest may arise requiring recusal as a director or

declining representation of the corporation

39

The Organization as the ClientActions Taken Against Best Interests of the Corporation• ABA Model Rule 1.13(b) - “If a lawyer for an organization knows that an officer, employee or other person associated with the

organization is engaged in action, intends to act or refuses to act in a matter related to the representation that is a legal obligation to the organization, or a violation of law that may be reasonably might be imputed to the organization, and that is likely to result in substantial injury to the organization, then the lawyer shall process as is reasonably necessary in the best interests of the organization.”

• The Lawyer should consider :o Seriousness of violationo Scope and nature of lawyer’s representationo Responsibility in the non-profit and apparent motivation of person involvedo Organization’s policies regarding such matterso Other relevant considerations

• When considering actions, a lawyer needs to act in a manner that minimizes both disruption to the non-profit and the risk of revealing confidential information

• A lawyer/director will have simultaneous fiduciary obligations as counsel and as a board member

40

Competence• ABA Model Rule 1.1 requires a lawyer to provide “competent representation”

• Non-profit management and the Board often look to lawyers on the Board for [free] legal guidance on a wide range of legal issues even when lawyer is only acting as a board member

• A lawyer serving in a dual role must be careful to limit advice to those within the lawyer’s areas of competence (Note – Special consideration should be given prior to offering tax advice, including advice regarding non-profit formation or non-profit governance)

• A lawyer should always recommend that the board should hire outside counsel when issues arise outside a lawyer’s area(s) of competence

41

Independent Judgment • ABA Model Rule 2.1 requires a lawyer to “exercise independent professional judgment and render candid

advice”

• When a lawyer serves in dual role, the lawyer must determine whether his/her ability to give independent professional advice on legal topics is compromised by the lawyer’s role as a board member.

• A lawyer/director should clearly identify his role when speaking to the Board, to avoid any misunderstanding regarding “legal advice” and “business comments”

• ABA Model Rule 1.7 deals with conflicts of interest, and Comment 35 to Rule 1.7 provides as follows-“If there is a material risk that the dual role will compromise the lawyer’s independence of professional judgement , the lawyer should not serve as a director and should cease to act as the corporation’s lawyer when conflict of interest arise. The lawyer should advise the other members of the board that is some circumstances matters discussed at board meetings while the lawyer is present in the capacity of director might not be protected by the attorney client privilege and that conflict of interest considerations might require the lawyer’s refusal as a director might require the lawyer and the lawyer’s firm to decline representation of the corporation in the matter”

42

Conflicts of Interest, cont’d ABA Formal Ethics Opinion 98-410 identifies four possible conflict of interest situations

1. Serving as counsel in a matter the lawyer opposed as a director;

2. Giving a legal opinion on a board action in which the lawyer/director participated;

3. Acting as a director in corporate matters affecting the lawyer or the lawyer’s employer; and

4. Representing the corporation in litigation naming directors as defendants.

43

Confidentiality of Information

• ABA Model Rule 1.6 requires a lawyer to keep client information confidential “unless the client gives informed consent” or “the disclosure is impliedly authorized in order to carry out the representation”

• Rule 1.6 does not apply to communications between the lawyer and other board members, if the lawyer is acting as a board member

• If the lawyer is acting in a dual role, then Rule 1.6 requires the lawyer to keep communications related to the representation confidential

44

Attorney Client Privilege• When serving is a dual role, a lawyer faces the risk that communications

between the lawyer/director and may not be protected by the attorney client privilege

• The potential loss of the attorney client privilege primarily arises from evidentiary challenges-o Proving the communications related to legal vs. business advice;o Proving the communication was made as a legal advisor and not as a director;

and o Proving that other directors intended their communication to and from the

lawyer/director to be a confidential communication with counsel and not merely a discussion among directors

45

Attorney Client Privilege, cont’d

• To minimize the waiver of the attorney client privilege , the lawyer director should announce to the Board when providing legal advice in his/her capacity as a lawyer and not in the capacity as a director

• In addition, the lawyer and other Board members must take precautions to maintain the privilege, including excluding the advice from the minutes to the Board meeting

• The lawyer should take efforts to advise other Board members that the presence of a lawyer/director does not automatically create an attorney client privilege

46

Conflicts of Interest• ABA Model Rule 1.7(a)(1) prohibits a lawyer from representing a client if the representation “will be directly adverse to

another client”

• Comments to ABA Model Rule 1.7(a)(2) prohibits a lawyer from representing a client if there is a “significant risk” the representation ” will be materially limited by the lawyer’s responsibilities to another client, a former client or a third person or by the personal interest of the lawyer”

• An in house lawyer should exercise extreme care when they serve as a director or a lawyer/director for a non-profit, which is engaging in transactions with the lawyer’s employer

• Comments to Rule 1.7 further note –

“Even when there is not a direct adverseness, a conflict of interest exists if a lawyer’s ability to consider, recommend or carry out an appropriate course of action for the client may be materially limited as a result of the lawyers other responsibilities or interests“

“In addition to the conflicts with other current clients, a lawyer’s duties of loyalty and independence may be materially limited by responsibilities to former clients under Rule 1.9 or by the lawyer’s responsibilities to other persons, such as fiduciary duties arising from a lawyer’s service as a trustee, executor or corporate director”

47

Additional Resources• CNA Professional Counsel “Serving on Client Boards: Dual Capacity and Dual Dilemma” April 2006,by Emily J. Eichenhorn

http://www.paragonbrokers.com/wp-content/uploads/2011/01/Serving-on-Client-Boards-Dual-Capacity-and-Dual-Dilemma.pdf• “Ethics considerations for attorneys serving on non-profit boards” by Dan Ebner

http://apps.americanbar.org/litigation/committees/ethics/articles/spring2015-0315-ethics-considerations-attorneys-serving-nonprofit-boards.html

• Oregon State Bar Bulletin “Managing the Dual Roles The Ethics of Serving on Corporate Boards” August/September 2008, by Helen Hierschbiel https://www.osbar.org/publications/bulletin/08augsep/barcounsel.html

• “Ethical Issues for Attorneys Who Represent and/or Serve on the Board of a Tax Exempt Organization” 2013 by Courtney Darts, Jennifer Grudnowski, ProBonoPartnership, Inc. http://www.acc.com/chapters/gny/upload/ACCGNY-Ethics-CLE-Presentation-Slides.pdf

• “Ethics Advisory Opinion Utah [Ethics] Committee No. 98-10 December 28,1998 https://www.utahbar.org/ethics-advisory-opinions/1-7-conflict-of-interest-current-clients/eaoc-98-10/

• ABA Business Law Section’s Business Law Today “Lawyers’ Service on Nonprofit Boards- Managing the Risks of an Important Community Activity” Vol 18, No 2 November/December 2008 by Willard L. Boyd III https://apps.americanbar.org/buslaw/blt/2008-11-12/boyd.shtml

• ABA Standing Committee on Ethics and Professional Responsibility Formal Opinion 98-410 “Lawyers as Serving as Director of Client Corporation” February 27,1998 http://shop.americanbar.org/eBus/Store/ProductDetails.aspx?productId=219973

• Lawyers as Directors of Non-Profit Corporations” November 30, 2006 by Walter R. Rogers, Jr. http://www.smithlaw.com/media/alert/125_lawyersasdirectorsnonprofits.pdf

• Corporate Pro Bono Institute “Multijurisdictional Practice in the U.S.: In House Counsel Pro-Bono”2015 http://www.cpbo.org/wp-content/uploads/2015/04/MJP-Guide-2015-April.pdf

• Association of Corporate Counsel “Ethical Issues for U.S. In-House Counsel to Consider 2015” February 19, 2015 by Kristen Chittenden and Jack Tanner http://webcasts.acc.com/handouts/2.19.15_SLD_Slides.pdf