• Will Your Charitable Service Go Unpunished?
  • July 20, 2010 | Author: John J. McGregor
  • Law Firm: McCormick, Barstow, Sheppard, Wayte & Carruth LLP - Fresno Office
  • We are a nation of volunteers. Americans have given of their time, talents and resources on a scale unprecedented in world history. Not surprisingly, charities have come to hold and consume significant economic resources. In California, the recent declines in State and local governmental revenues have only underscored the role of nonprofit organizations in addressing social problems.

    The growing monetary clout of charities has not gone unnoticed. Even recently, there wasn’t much law governing not-for-profit organizations. That has changed. Legislators and regulators have now promulgated a hail of laws and regulations. In California, the administration of these new rules falls largely to the Attorney General and to the Internal Revenue Service. The bifurcated state/federal regulatory structure adds complexity to the novelty of the rules. The resulting puzzle is too new to have been tested much in the courts.

    It gets worse. Recent, vigorous prosecutions by the California Attorney General and the IRS indicate that both are quite willing to pursue volunteer directors of charities for fines, penalties, investigative costs and unpaid employment taxes (and interest and penalties on those taxes).

    Do you intend to volunteer for a lawsuit? Of course not. Therefore, ask some basic questions before agreeing to serve as director of a charity.

    Does the charity handle money? The more money that passes through a charity’s hands, the more risk there is to the director. State and federal rules present an array of accounting and accountability requirements, and directors bear the ultimate responsibility to see that the charity complies with them.

    Unfortunately, some of the recordkeeping rules are mushy. For example, California law requires a charity to keep "adequate and correct books and records of account." But it doesn't say what is "adequate" or "correct." Therefore, a prospective director would do well to ask who handles the books and records and who prepares and files any annual reports to the Attorney General and the IRS. Have a look at those reports. Do they appear skillfully presented by competent professionals? If you don't know the professionals, ask around.

    California law also requires a charity to keep minutes of the proceedings of its board and committees. Ask to see these, if for no other reason than to better understand the work you would undertake as a director. Are the minutes clear? Do they seem adequate to the charity's operations? Does the board seem to be acting reasonably?

    How much time is involved if I say "yes"? It can be an honor to be asked to serve as a volunteer director, but service as a director entails unavoidable responsibility. That's true even of "honorary" directors. In the past, charities made it a practice to elect large charitable donors to their boards. Donors today should be careful to avoid being elected unless they intend to engage actively in the charity's affairs. All directors, whether "honorary" or not, have two fiduciary obligations: the duty of loyalty and the duty of care. These duties are owed to the charity, not to the charity's donors or to its constituency.

    The duty of loyalty obligates the director to avoid engaging in financial transactions with the charity that aren’t approved by a “disinterested majority” of the charity's board. According to the AG, this means that more than half the board's membership must consist of directors who have no direct or indirect interest in the transaction, and the majority of those board members must approve.

    Thus, if a director is to be reimbursed for expenses, she should be certain that her expenses are reasonable and documented in writing. The charity's reimbursement should preferably be strictly in accordance with written guidelines approved by the board and consistently applied among the directors.

    Similarly, a director who wants to be paid for services to the charity must get the approval of a disinterested majority of the Board. But beware! In instances where the AG has disagreed with the disinterested directors, it has sued them for wasting charitable assets. The AG also maintains that board approval must be given in advance and that the compensation arrangement must be in writing.

    The duty of care is, in short, the duty to stay awake. It obliges a director to be involved actively in oversight of the charity's operations. The ideal charitable board consists of "worker bees" who do their homework and who do not hesitate to ask tough questions of paid staff members. Board members who show up for the occasional meeting and who disappear in the interim are asking for legal trouble.

    What is the charity’s financial condition? Is the charity living within its financial means? In a time of declining donations and revenues, some nonprofits are fighting for their financial lives. The recent demise of some hospitals in the San Joaquin Valley have been well documented. Start-up charities are especially at risk of exhausting their financial resources. Be mindful that a director can in some circumstances be personally responsible for a charity's tax debts. For example, a director of a tax-exempt hospital was recently held to be personally liable for its unpaid employment tax liabilities. To avoid those liabilities, a director may need to summon the courage to make wrenching, unpopular financial choices on the charity's behalf.

    How prominent is the charity? Remember that the more important the charity's function and the larger its profile, the more likely it is that its directors' actions - and inactions -- will be spotlighted by the media. In Fresno County, directors of Genesis and the Fresno Metropolitan Museum found themselves vilified by news reports alleging their failures to question large expenditures authorized or incurred by the charity's executives.

    Is the charity well-managed? How competent, committed and honest does the paid staff appear to be? The paperwork and regulatory burdens on charities have risen dramatically. Regulators carefully review "paper trails" of financial transactions. Verbal explanations of expenditures, even if highly plausible, are unlikely to find a sympathetic regulatory ear. The IRS requires annual reporting by many charities on Form 990. This form has been greatly revised by the IRS to require far more detail than in the past. Not only must a charity now report more about its financial condition and operations, it also must summarize certain of its governance practices and highlight any deviation from its announced charitable mission. A prospective director would do well to review the charity's most recent Form 990 to see if it seems to address those areas in a satisfactory manner. Forms 990 are public record. They, and evaluations of charities that file them, can be found online at www.charitynavigator.org and www.guidestar.org.

    Does the charity carry D&O insurance? The myriad of new laws and regulations and their vigorous enforcement by regulators effectively mandates that charities maintain directors and officers ("D&O") insurance coverage appropriate to the risks that their directors undertake. Insurance has two functions: it funds the cost of a legal defense and provides indemnity in the case of loss. The ideal D&O policy will have coverage amounts adequate to the risks entailed by the financial operations of the charity. It will preferably provide for something called "defense outside the limits of coverage." This means that the insurance carrier's cost of providing you a lawyer doesn't reduce its obligation to indemnify you against loss. By contrast, under a "burning limits" policy, legal costs reduce the carrier's indemnity obligation dollar for dollar.

    When accepting the call to serve as director of a charity, realize that you become a steward of resources for the public. Your obligation is to husband those resources carefully for the common good. With the honor of serving as a director comes responsibility of sometimes uncertain dimensions. So a director must serve in an active, aware and independent manner. It's not enough just to be well-meaning. Don't let the honor of serving as a director become a horror.