Protecting Yourself as a Director of A Nonprofit Corporation
You have been asked to serve on the Board of Directors of your child's daycare or a local art organization. Should you accept, or is service as a director of a nonprofit corporation too risky?
Limitation of personal liability is one of the primary advantages of operating in corporate form. Directors of Oregon nonprofit corporations enjoy some substantial protections from liability. Still, individual directors might be liable under certain circumstances if they fail to fulfill their duties to the corporation or follow tax laws.
Statutory Limitations on Liability
The Oregon Nonprofit Corporation Act generally protects uncompensated directors against liability for all but gross negligence or intentional misconduct. Moreover, liability for gross negligence can be, and often is, eliminated through provisions in the Articles of Incorporation.
Federal statutes also provide protection for uncompensated directors. The Volunteer Protection Act of 1997 limits the liability of volunteers except for "willful or criminal misconduct, gross negligence, reckless misconduct, or a conscience, flagrant indifference to the rights or safety of the individual harmed by the volunteer . . . ."
Each director is still responsible for his or her own acts. Being on a board of directors will not shield you from the consequences of your personal actions. If you drop the banana peel that causes a slip-and-fall injury at your nonprofit, you will have personal liability because of your actions without regard to your status as a director. Another example: a director who votes for an unlawful distribution is personally liable to the corporation in some circumstances. Conflict of interest transactions, such as loans by the corporation to a director, are a special source of risk.
Employment Tax Withholdings
Taxes are common sources of personal risk. Nonprofit corporations with employees must withhold state and federal payroll taxes just as taxable employers must. Taxes withheld from employees' wages do not belong to the employer even though the cash is in the corporation's bank account. The employer acts as an agent for the employees, holding their money for deposit with the Internal Revenue Service and the Oregon Department of Revenue. When cash runs short, a common (and expensive) error is to spend the withheld taxes on operations. Any responsible person (usually a corporate officer or employee, but perhaps a director) who willfully fails to withhold, account for, or pay over withholding taxes to the government is subject to a penalty equal to 100% of the tax. This results in a personal liability not dischargeable by bankruptcy.
Excess Benefit Transactions
Special rules apply to "excess benefit transactions" by tax-exempt entities. Since 1996, the IRS has authority to impose a special tax on officers, directors, and others who are in a position to "exercise substantial influence over the affairs of the organization" for any benefit they receive in excess of the value given back to the organization. The statute is intended to be used primarily for preventing excess compensation and other perks. The IRS has emphasized that it intends to use this power only in egregious situations.
An "excess benefit transaction" is one in which the charity provides an economic benefit to a director or other "disqualified person," which exceeds the value of the consideration (including performance of services) received in return by the organization. This effectively puts the Internal Revenue Service in the position of making a subjective judgment of the value of services or other consideration transferred to the charity. The IRS will be looking over your shoulder asking "Did the charity get a fair deal?"
The tax on an excess benefit transaction is significant. The initial tax on the disqualified person is 25% of the excess benefit, which may be supplemented by an additional fine of 200% of the excess. A separate tax is imposed on organization managers (which might include directors) who knowingly participate in approving the transaction. A director may be jointly and severally liable for a tax of 10% of the excess benefit, not to exceed $10,000 for each transaction. "Participation" specifically includes "silence or inaction" where the director has a duty to speak or act.
How can you protect yourself? The regulations contain two safe harbor mechanisms to protect the organization and those involved from tax liability. The first comes from disinterested board disclosure, review, and documentation. Three steps are required:
- Full advance disclosure of the facts of the transaction to a disinterested board or committee;
- Consideration of fair market value and comparability; and
- Documentation of the decision and the underlying facts.
The second safe harbor is to obtain a "reasoned opinion of counsel," which means a formal evaluation of the facts and law from a qualified tax-exempt organization lawyer.
Workers' Compensation Insurance Premiums
As with a for-profit entity, directors may have personal liability if the nonprofit corporation fails to pay required workers' compensation premiums. These obligations are not dischargeable in bankruptcy.
In many circumstances, the director can look to the corporation for indemnification against liability. Indemnification, however, is only as good as the financial capacity of the corporation.
The indemnification provisions under the Oregon Nonprofit Corporation Act generally require the corporation to indemnify a director for expenses incurred in a successful defense. In most other instances, the corporation may, but is not required to, indemnify the director. A corporation is prohibited from indemnifying a director for liability to the corporation itself.
Limitation of liability provisions are no substitute for a general liability insurance policy. The likelihood of a claim arising from personal injury or property damage from common negligence is much higher than an action based on vicarious liability of directors. Errors and omissions (E&O) insurance for the directors and officers is often cost-prohibitive for smaller nonprofits, but is sometimes available through a nonprofit's national organization. Employment practices liability (EPL) insurance is often more cost effective and covers many potential employment-related risks. Many homeowners insurance policies offer low-cost (but low limits) riders covering volunteer service.
Adequate insurance should be your first line of protection. Still, these statutory provisions should give great comfort to anyone considering service to a nonprofit as a director.
 Oregon Revised Statutes Chapter 65. Oregon's Nonprofit Corporation Act, modeled on the American Bar Association Revised Model Nonprofit Corporation Act. The author of this article was a member of the drafting committee that revised the Oregon statute in 1989.
 ORS 65.369.
 ORS 65.047(2).
 42 USC §§ 14501-14505.
 42 USC § 14503.
 ORS 65.367.
 ORS 65.364.
 IRC § 6672.
 IRC § 4958.
 Regs. § 53.4958-6.
 Prop. Reg. § 53.4958-1(d)(7).
 ORS 656.735(4).
 ORS 65.394.
 ORS 65.391.
 ORS 65.391(4).
Related Practice Areas
Return to Articles