Fiduciary Duty

 

We often hear from our leaders “I am not a paid employee of the USCF - I am a volunteer.” Some people believe we must realize the USCF board is indeed a volunteer group. They feel that giving volunteers that serve on a board a break for not doing a good job would be nice. We are told we ought to recognize their volunteer status and be more lenient. This largess is extended to local club, state chapter, as well as delegates -- both officers and board members. Executive Board members seem to extend this largess to themselves. When a poor job is done we usually hear a litany of rationalizations as well as all the effort, hard work, and money the individual provides for chess as if this mitigates the breach of fiduciary duty. We are always reminded since they receive no money for their service any behavior is acceptable. Certainly a few perks for their friends or supporters should be OK. What is usually forgotten is these individuals are acting as stewards of other people's money and public benefits. The board acts as a group in this regard and fiduciary duty does not excuse unilateral action by an individual board member on behalf of the corporation. If people don't want accountability they should not volunteer to be a board member of a tax exempt organization. In my view, fiduciary duty is the one area least understood by our voluntary leaders.

 

Note it is expected that directors and officers will do a good job for the corporation but in case they do not and to protect the membership it is critical that the corporation obtain general D & O liability insurance as well as a specific fidelity bond in an amount determined by the board for board members and each executive officer responsible for accounts and finances.

 

The reality is, like for-profit directors and officers, directors and officers of nonprofit corporations can be held personally and individually liable for their actions, or lack of action, in managing the organization. In asserting liability, a director or officer is typically charged with breaching a duty or standard of care owed either to the corporation or to a specific party. Potential liabilities for nonprofit directors and officers generally fall into three categories: (1) liability for breach of duty to the organization, (2) third-party liability in which persons who suffer some injury from the corporation seek to hold directors and officers personally responsible, and (3) government enforcement actions. 

 

Breaches of Fiduciary Duty

 

The classic lawsuit against a for-profit director or officer is the shareholder derivative suit wherein a stockholder, or a class of stockholders, brings an action for breach of a fiduciary duty to the corporation. Although most nonprofit corporations do not have shareholders, nonprofit directors and officers are still susceptible to actions for breaches of fiduciary duty and may be held accountable to their nonprofit organizations.

 

Fiduciary duties are duties to the organization alone and may be enforced only by those who have a special interest in the organization or who otherwise are entitled to act on its behalf. In this regard, directors or officers within an organization may be entitled to sue a fellow director or officer who is thought to have breached his fiduciary duties. If the nonprofit organization has voting members, a member may bring a breach of fiduciary duty action against the director. In addition, in some states the Attorney General may have the power to enforce the director's or officers fiduciary obligations to the organization.

 

Directors and officers are held to three primary legal duties: (1) the duty of loyalty, (2) the duty of care, and (3) the duty of obedience.

 

1. Duty of Loyalty

 

The duty of loyalty requires a director to maintain undivided allegiance to the interests of the organization and bars a director from using his/her position, the organization's information which he/she possesses, or the organization's property in a manner which allows him/her to garner a personal profit or a personal advantage. The duty of loyalty, therefore, implicates questions of conflict of interest, corporate opportunity and confidentiality.

 

A conflict of interest exists in any transaction by or with the corporation in which a director has a direct or indirect personal interest, or any transaction in which a director may be seen as unable to exercise impartial judgment or otherwise act in the best interests of the corporation. Such conflicts, in and of themselves, are not unethical and do not constitute or imply any wrongdoing, but they can be improper through misconduct or even negligence when considerations of personal interest, appear to influence or compromise an individual’s impartial judgment or actions in the performance of his or her responsibilities on behalf of the corporation. When a director has such an interest in a transaction which is being considered by the board of directors, the director may be obligated to disclose the conflict before the board takes action on the matter and disqualify himself from participating in the deliberation and vote on the matter as warranted. Further while it is not unknown for a Board member to sue the organization, the differentiator regarding a conflict of interest often is if the Board member is suing to make the corporation whole/to obey the law versus pursuing a personal/financial interest as part of the action. An easy way to tell if personal/financial interests are involved is if there is a request/demand to pay the Board member monetary damages.

A corporate opportunity arises when a director is aware that he can individually participate in a transaction which could possibly fall within the organization's present or future activities. Before a director engages in such a transaction, he may be required to disclose the opportunity to the board of directors in sufficient detail and with adequate time to permit the board to act or decline to act on the opportunity. Confidentiality refers to a director's obligation to protect from disclosure the organization's legitimate internal activities. A director should regard all matters as confidential involving the corporation unless there is to be public disclosure per organization policy or the information is a matter of public record or public knowledge. The individual director is not a spokesperson for the corporation and thus disclosure to the public of corporate activities should be made only through the corporation's designated spokesperson.

 

2. Duty of Care

 

The standard of care imposed upon a nonprofit director or officer is established by statute or by common law. With respect to the common law standard, few courts have addressed duty of care issues. The modern trend is to hold nonprofit directors and officers to a standard of conduct comparable to their counterparts in for-profit corporations. Notwithstanding this trend, nonprofit directors and officers may be held to a higher standard of care whereby liability is imposed for mere negligence or inattention, comparable to the standard of care imposed upon a trustee managing funds entrusted to his care.

 

The duty of care requires a director to exercise independent judgment. Generally, the duty of care also asks a director to: (1) participate indecisions in good faith, (2) with the care of an ordinarily prudent person in similar circumstances, and (3). in a manner the director reasonably believes to be in the best interests of the corporation.

 

The first requirement, "good faith," essentially means honesty of intention, openness and fair dealing. The second requirement means that a director is not expected to possess any special skills, but he is expected to exercise sound practical judgment and common sense. In addition, "care" refers to the diligence and attentiveness of the director. The director is expected to be diligent and knowledgeable in fulfilling his tasks and duties, which includes good knowledge of the bylaws and rules as well as attending and preparing for meetings. All directors must remember that they act as a group, and therefore regular board meeting attendance is essential. Also, the director must be attentive and alert to potential problems and must request additional information if the director feels the information is inadequate to make a decision.

Ignorance is not reflective of diligence. The third requirement, "best interests," reflects the duty of loyalty, i.e., that the director must put the organization's mission before any personal interest he may have.

 

3. Duty of Obedience

 

 

Nonprofit corporations are organized to achieve specific objectives or purposes, which are generally set forth in the organization's bylaws and charters. Adherence to the purposes or "missions" of the organization is critical as they form the basis for the corporation's tax exemption and, thus, its status as a nonprofit entity. Moreover, the stated "mission" guides the distribution of the organization's assets at dissolution. All directors must know the corporation's purpose and the persons or interests it serves, and be prepared to serve accordingly.

 

Pursuant to the duty of obedience, directors of nonprofit organizations may not deviate from their duty to fulfill the particular purposes for which the organization was created. If they do substantially deviate from the organization's stated purposes, courts or attorneys general may institute legal action on behalf of the organization to unwind transactions which are contrary to the organization's stated purposes. Nonprofit directors may be liable to the corporation for any harm it suffers as a consequence, or for any amounts expended if the transaction cannot be unwound.

 

A related element of the duty of obedience is "law-compliance," which imposes on directors an obligation to act in conformity with all laws (including bylaws) generally affecting the organization. From your duty of care you should know the rules and to fulfill your duty of obedience is to follow the rules.

 

* LIABILITY EXPOSURES AND PROTECTIONS FOR NONPROFIT ORGANIZATIONS AND THEIR DIRECTORS AND OFFICERS by Elizabeth A. Pitrof, Esq.

 

* Guidebook for Directors of Nonprofit Corporations by George Overton, American Bar Association.

 

 

WPraeder 12887461



Joined: 12 Nov 2005
Posts: 204
Location: PA, USA

Post:53678 Posted: Tue Jun 12, 2007 11:01 pm    Post subject: Loyalty to an Institution


hmb wrote:


I would like to see some civil and process-oriented discussion of what the "duty of loyalty" means in the case of Ms. Polgar and in the case of her husband, Mr. Truong. My limited understanding of this duty suggests that it might cause her to have to remain neutral in such areas as raising money for either organization (USCF or SPF) compared with the other, and in otherwise advancing any interest of one of organization compared with the other (and now, this could also include the matter of attempting to advance the interests of her new employer, Texas Tech, too).

Perhaps Mr. Praeder, or some of the attorneys or other knowledgeable folks here, could discuss this.



Hal,

It is my understanding the duty of loyalty requires a director to act solely in the best interests of the Corporation rather than in his or her own interests, the interest of another corporation, or those of his or her associates.

One important aspect of the duty of loyalty is to retain the confidentiality of information that is explicitly deemed confidential by the Corporation, as well as information that appears to be confidential from its nature or matter. This means they can’t share what they know with others and act on what they learned in one role when they are performing in another.

The duty of loyalty also encompasses a director’s obligation to avoid conflicts of interest. In general, a conflict of interest exists when the Corporation does business with: a director of the Corporation; another entity in which a director of the Corporation is also a trustee, director, officer, employee, consultant, or agent; or another entity in which a director has a interest such as an ownership, compensation, or investment interest. To avoid even the appearance of a conflict of interest, a director may want to treat as a conflict any transaction between the Corporation and (i) the director’s spouse or close personal friends, their descendants and ascendants, (ii) any entity in which such a relative or close friend is a trustee, director, officer, employee, consultant, or agent, or (iii) any entity in which such a relative or close friend has a financial interest.

In my view a much more subtle application of the duty of loyalty does not lie in choosing to forward another’s interest over the interest of the Corporation but in properly dealing with overlapping interests be they personal or between corporations in which you are involved. The duty of loyalty requires one to pursue the interest of each organization you are involved with unswerving fidelity. Because of this, addressing issues with overlapping constituencies can be problematic. An example is approaching the same individuals or institutions for fund raising purposes from both organizations in which you are involved.

Along these lines problems of overlapping purpose are the most troubling. If the purpose of one organization is educational and instructional to broaden and develop chess as art and recreation and the purpose of the other organization is to hold chess tournaments, the former organization trying to enhance the ability of tournament organizers to hold chess tournaments creates a loyalty issue for someone who is involved with the decision making for both organizations. Another example is if the purpose of one organization is educational and instructional and the purpose of the other organization is to support collegiate-level competitive chess, the former organization trying to further collegiate-level competitive chess creates a loyalty issue for someone who is involved with the decision making for both organizations. If loyalty issues are left unchecked, over time, one organization may become undifferentiated from the other. Additional and similar examples can be proposed.

In my opinion, these more subtle situations are where the rubber meets the road regarding executing in the spirit of ones duty of loyalty. See the link below for a further process oriented discussion.

Regards,
Wayne Praeder
http://www.betteruscf.org/manage.htm