By Zac Kester, JD, LLM, CFRM, at Charitable Allies
Nonprofits do such great things. They provide end of life care, fight homelessness, provide free legal services to indigent individuals, honor fallen soldiers, conserve land and water, combat disease, rescue animals, and much, much more. It takes a team to get all this work done. That team is typically comprised of boards and officers.
Nonprofit board members often join the board for good reasons: they are passionate about the organization and its mission, want to develop skills they may not have the opportunity to develop while on the job, seek to build a professional network, or desire to develop a deeper understanding of what it takes to run a successful organization. But all too often, board members fail to ask the hard questions, fail to oversee the organization and fail to meet their duty of care.
One nonprofit struggled financially and, despite warning signs, the board was inattentive and made slow decisions.
The result? Earlier this year, the individual board members were each found personally liable for $2.25M in damages for providing inadequate oversight, relying on incompetent officers and in failing to take adequate action once they knew there were problems. No director personally or individually engaged in bad behavior other than being inattentive but they were each still held liable.
The Lemington Home for the Aged in Pittsburgh, Pennsylvania was a nonprofit that provided residential elder care services but struggled financially for a number of years. The problem only got worse. The Home’s financial and billing records were in extremely poor condition and the CFO would not even provide records to a consultant hired to assist. Employee insurance premiums were not paid even though payroll deductions had been taken. Nearly $500,000 of Medicare receivables went unbilled and grant funds were misappropriated. The case is In re Lemington Home for the Aged, No. 13-2707 (3rd Cir., 2015).
Despite having received multiple warnings in the form of reports from the state, consultants, and having been warned that the CEO’s performance necessitated her removal, the board stayed the course. It did not take action related to the CEO or CFO, voted to close, but failed to timely notify creditors and file for bankruptcy, and failed to report a $1.4M tax assessment in its favor, among many other things.
But what about directors’ and officers’ insurance? Likely, D&O coverage was involved here somehow, but this case was not about the coverage. And, the damages exceeded most typical D&O policies’ limits, which is probably why there has been so much litigation over the personal liability of directors.
The important lesson: each board member should pay attention and take action when things seem amiss. They can be personally liable for debts of the nonprofit if that board member is inattentive enough so as to be reckless. Such inattentive board members will not be considered to have functioned in good faith in the best interests of the organization, nor will their business decisions be deferred to by a court, and liability will occur.
Charitable Allies is a 501(c)(3) charity that serves the legal and administrative needs of nonprofits in Indiana and beyond.