Understanding and Mitigating Nonprofit D&O Risks

Nonprofit organizations can benefit their communities in many ways. Often, they provide a range of valuable services and other charity to people in need. As the leaders of these organizations, board members are responsible for maintaining successful operations. While this can be fulfilling work, it also carries some risks.

Specifically, nonprofit board members could be held liable for acting in a way that negatively impacts stakeholders. (E.g., employees, volunteers, donors, and beneficiaries.) In some cases, these leaders may be required to meet the same standards as corporate executives. This could pose substantial directors and officers (D&O) liability and litigation exposures.

As such, nonprofit organizations should review the risks board members could face and implement necessary mitigation measures. This article provides more information on common D&O exposures for nonprofit leadership, the potential ramifications, key risk management strategies to consider, and the value of D&O insurance.

Common D&O Exposures

Nonprofit board members could encounter D&O claims from various avenues. Primary sources of these claims include:

• Mismanaged funds—Board members are typically required to follow predetermined budget plans when allocating and spending nonprofit funds. For instance, a donor may state that their financial contributions are to be spent on a particular cause or service. If nonprofit leaders mismanage this donation or otherwise use the money for unapproved reasons, they could be sued and held responsible for reimbursing the affected funds.
• Breach of fiduciary duty—In addition to properly managing their funds, nonprofit board members have a fiduciary duty to always act in the best interest of their organizations and conduct their due diligence. This duty mainly centers around maintaining detailed and accurate financial records. Such documentation can help prove that the nonprofit is using all donations responsibly. It can also limit the risk of employee theft and embezzlement. Without sufficient financial records, nonprofit leaders could be accused of breaching their fiduciary duty and face serious legal penalties.
• Employment practices—Nonprofit board members may face allegations related to employment-related issues involving staff or volunteers. If anyone accuses these leaders of perpetuating or neglecting to address poor employment practices, they could be subject to regulatory fines and related litigation.
• Noncompliance—Board members must comply with their bylaws and all applicable federal, state, and local legislation. These regulations lay the groundwork for appropriate governance practices, fair fundraising measures, open meeting standards, financial reporting protocols, data privacy requirements, and tax-exempt qualifications. Failure to follow these laws could prompt costly lawsuits or disqualify individuals from continuing to serve on the board.
• Alleged wrongful acts—Nonprofit leaders should prioritize the organization’s mission above their own desires or financial opportunities in the boardroom. By doing so, board members can avoid potential conflicts of interest and other unfair situations. If leaders leverage their positions for personal benefits or other wrongful behaviors, they could be sued and face legal penalties.

Ramifications of D&O Claims

Nonprofit organizations could experience several consequences from D&O claims, such as:

• Financial fallout—Because D&O claims often result in litigation, they can lead to significant legal defense costs, settlements, and judgments. These expenses can have lasting financial ramifications, impacting a nonprofit organization’s operations and threatening its board members.
• Reputational damage—D&O claims usually result in considerable reputational damage for the affected nonprofit organization and its leaders, ultimately fueling distrust among stakeholders and the public. This can harm employee morale, disaffect volunteers, and disrupt donations.
• Unfulfilled missions—Due to the financial and reputational fallout stemming from D&O claims, these incidents can also limit a nonprofit organization’s community service efforts.

Risk Mitigation Strategies

Considering the possible ramifications of D&O claims, nonprofit organizations must take the following steps to limit their exposure:

• Utilize strong governance practices. Nonprofit organizations should establish effective governance policies and procedures by utilizing proper vetting protocols for leadership positions, assigning clear roles and responsibilities for each board member, and promoting ongoing stakeholder engagement. Above all, nonprofits should ensure board member actions consistently align with organizational values.
• Provide regular training. To set their board members up for success, it’s essential for nonprofit organizations to offer routine leadership training. This training should highlight the importance of upholding board expectations and nonprofit bylaws, acting ethically, meeting legal obligations, and fostering a culture of accountability and transparency.
• Maintain financial oversight. Nonprofit organizations must have mechanisms in place to ensure they can manage donations and other funds. This may entail having open communication with donors and performing periodic budget reviews. Nonprofits should also keep all financial records up to date. They should routinely check this documentation for errors or discrepancies, correcting as needed.
• Ensure compliance. By maintaining compliance with all applicable employment laws, financial regulations, and industry standards, nonprofit organizations can avoid costly regulatory fines and other legal penalties. It may be beneficial for nonprofits to consult legal professionals for specific compliance guidance.

The Importance of D&O Insurance

Besides implementing effective risk management strategies, nonprofit organizations should secure ample D&O insurance. This type of coverage, which can be purchased as a standalone policy or bundled with other commercial insurance offerings, can help reimburse nonprofit organizations and their leaders for losses stemming from these individuals being held liable for their alleged wrongdoings in the boardroom (e.g., misuse of funds, fiduciary breaches or employment discrimination).

Because D&O insurance can provide board members with much-needed protection against potential liabilities in various scenarios, particularly lawsuits, this coverage can help nonprofits encourage qualified individuals to lead without fear. This, in turn, can help enhance overall organizational success and stability. Nonprofit organizations should work with insurance professionals to secure a policy that meets their unique needs.

Conclusion

Board members play a vital role in helping nonprofit organizations fulfill their missions; however, these leaders may face many D&O risks in their roles. By understanding these exposures, taking steps to limit the likelihood of related claims, and purchasing ample D&O coverage, nonprofit organizations can better protect their board members, allowing these leaders to focus on their communities and serve others.