Can Board Members Be Sued When a Nonprofit Fails or Is Sued?
Some people may be afraid to serve on a nonprofit's board of directors because they have heard that their personal assets could be at risk in case the organization closes, suffers a lawsuit, or somehow breaks the law.
However, that fear is, thankfully, unfounded in most cases. A fully incorporated nonprofit enjoys the same limited liability that any corporation does. So creditors cannot go after the personal assets of board members.
There are other personal liability issues though that might keep a board member up at night. For instance, a disgruntled employee might bring suit over wrongful termination, a supplier could claim breach of contract, or a volunteer or visitor could be injured and sue the organization.
Fortunately, it is rare for nonprofit board members to be found liable for a nonprofit’s legal problems. That’s because nonprofits usually are incorporated.
Incorporation offers the protection of limited liability to corporate directors and officers. This is important, especially if the organization takes in and expends significant sums of money, buys property, hires employees, or enters into leases and contracts.
What limited liability means is that the organization's directors and officers have limited personal liability for business debts or other legal actions brought against the nonprofit. For example, creditors can only go after corporate assets and insurance to satisfy liabilities incurred by the corporation.
This principle applies, however, only when the board has fulfilled its essential duties, such as the duty of care. Board members are legally bound to "exercise reasonable care when he or she makes a decision for the organization.
Reasonable care is "what an 'ordinarily prudent' person in a similar situation would do." In the business world, some boards have been liable when they did not fulfill this requirement.
Other ways a nonprofit board member might be held liable include:
- When a board member directly injures someone on purpose
- When a board member guarantees a loan or other business debt for the nonprofit which then defaults on that loan or debt
- When a board fails to make sure that the organization deposits payroll and property taxes or files mandated tax returns.
- When a board member engages in fraudulent activities or does something illegal or just plain reckless that causes harm, or mixes up charitable and personal funds.
As long as the nonprofit is incorporated and board members understand their responsibilities, avoid conflicts of interest, and “do the right thing,” they should be fine
Beware, however, of serving on the board of an unincorporated nonprofit. Although some states protect the people who affiliate with unincorporated nonprofits, many others do not. Let’s say an unincorporated musical group owns its small performance facility. An audience member trips on a broken step and sues the organization. Should the injured party win the suit, judgments could amount to more than the organization’s insurance. In that case, the people involved with the organization (board members, staff, officers) could be required to pay the excess damages.
Board members, in such a case, are not protected the way they are in an incorporated nonprofit. These types of nonprofits are more common than you might think, so check the organization’s incorporation papers before agreeing to serve on a board. If you are already involved in an unincorporated nonprofit, consider the pros and cons of incorporating. You and your fellow board members might sleep better if you took steps to become incorporated.
To make sure that no legal actions slip through the cracks of incorporation law, most experts do recommend that nonprofits purchase Directors and Officer (D & O) liability insurance to protect against certain kinds of lawsuits and other types of litigation.
There are several types of specialized insurance that nonprofits should consider besides D&O. They include general liability, workers’ compensation or accident insurance, property, and auto insurance.
Although some people are deterred from serving on the board of a nonprofit because they fear a threat to their personal finances, do not let that fear keep you from taking part in a rewarding experience with a charitable nonprofit. Do your research beforehand so that you can be reassured the nonprofit has all of its protections in place.
This article is just for informational purposes. It is not intended to be legal advice. Check other sources, such as the IRS, and consult with legal counsel or an accountant.