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A Proactive Approach For Nonprofit Boards

THE FIRST STEP

Volunteering to serve on the board of a nonprofit corporation can be a rewarding experience, providing those who choose to serve with the opportunity to get involved in their community and effect a bit of social goodwill in the process.  Unfortunately, volunteering to serve on a board can also expose would-be directors to a certain amount of personal liability.  People often overlook or are simply unaware of the fact that when they choose to serve on the board of a nonprofit they are exposing themselves to liability in connection with their service, exposure that arises during their tenure and continues to exist for some time thereafter.  Boards can be proactive in mitigating this risk, however, and one of the first steps they can take is ensuring that  the corporation provides board members with an affirmative right of indemnification to the fullest extent of the law.

The Rhode Island Nonprofit Corporation Act

Most states, including Rhode Island, have enacted indemnification statutes that aim to protect nonprofit directors from liability under certain circumstances.  Rhode Island’s indemnification statutes concerning nonprofit corporations are contained in the Rhode Island Nonprofit Corporation Act, R.I. Gen. Laws §§ 7-6-1, et seq. (the “Act”), specifically, § 7-6-6, which contemplates two types of indemnification: mandatory indemnification and permissive indemnification.  See § 7-6-6.  While mandatory indemnification is available only after a director has successfully defended a proceeding brought against him or her by reason of the fact that he or she is or was a director of the corporation, permissive indemnification is available as long as the director’s conduct satisfied the minimum standards set out in the Act and thus can be addressed in a corporation’s corporate governance documents and available to directors at the onset of proceedings.  See § 7-6-6(d)(1).

For purposes of this discussion it is important to note that a “proceeding” is defined in the Act as “any threatened, pending, or completed action, suit or proceeding, whether civil, criminal, administrative, or investigative in nature.”  Sec. 7-6-6(a)(6).  Thus if a board chooses to provide this type of indemnification it will be providing its members with a breadth of coverage that goes well beyond traditional civil litigation.

At a basic level, the Act provides that a corporation may choose to indemnify “any person made a party to any proceeding by reason of the fact that the person is or was a director” as long as that person’s conduct satisfies the following criteria:

(i) He or she conducted himself or herself in good faith; and

(ii) He or she reasonably believed:

(A) In the case of conduct in his or her official capacity with the corporation, that his or her conduct was in its best interests; and

(B) In all other cases, that his or her conduct was at least not opposed to its best interests; and

(iii) In the case of any criminal proceeding, he or she had no reasonable cause to believe his or her conduct was unlawful.  Sec. 7-6-6(b)(1).

There are certain caveats and fact-specific issues that may impact the analysis in a particular situation, including allegations of improper personal benefit by the director or proceedings brought by or in the name of the corporation; but, generally speaking, § 7-6-6(b)(1) delineates the basic standards by which a director must abide to qualify for permissive indemnification.

An Affirmative Right to Indemnification

On its own the permissive indemnification statute does not give directors an affirmative right to indemnification under the Act.  In other words, a director cannot simply claim that pursuant to the Act he or she is entitled to indemnification—except if the director has successfully defended a proceeding, in which case he or she can assert an affirmative right to indemnification at the conclusion of the proceedings and petition a court of appropriate jurisdiction to enforce his or her rights.  See § 7-6-6(d).  For a director to obtain such a right at the onset of proceedings, the corporation must grant the right to the director in its corporate governance documents—either in its articles of incorporation or, if not there, then in its bylaws.

It is critically important that corporations work with counsel to ensure that they correctly draft the concept of indemnification into the pertinent document.  Depending on the corporation’s objectives and resources, it may be appropriate to limit the extent of the indemnification or to carve-out instances where, under the circumstances, indemnification would not be appropriate.  As mentioned previously, the indemnification statute merely sets the outer bounds of conduct with which a director must comply.  Corporations are free to condition indemnification upon a more stringent conduct requirement or otherwise to grant greater rights and resources to directors than are contemplated by statute, as long as the minimum standard of conduct does not fall below the statutory threshold.

Other Considerations

Indemnification is only as valuable as the financial resources that underpin the grant.  While a corporation may grant its directors a right to indemnification, if the corporation has no resources—or, is otherwise illiquid—the grant will merely be an empty promise that ultimately is of no value to the director.  Corporations may consider purchasing directors and officers liability insurance, commonly referred to as a “D&O Policy,” as part of the corporation’s comprehensive risk management strategy.  D&O Policies are intended to provide coverage in the event a director or officer is sued for alleged wrongful acts in managing the affairs of the corporation.  Depending on the terms of the specific D&O Policy, coverage can range in amount and scope.  When considering whether to purchase a D&O Policy, the corporation should consult with legal counsel and their insurance professionals to ensure they receive the adequate and appropriate coverage.

Final Thoughts

The possibility of litigation should not deter potential volunteers from choosing to serve on the board of a nonprofit organization.  Ultimately, it is up to the nonprofits themselves to be proactive in ensuring that past, present, and future board members are adequately shielded from liability.  Granting a right to indemnification to the board of directors is a good first step in ensuring that board members can confidently serve on behalf of the corporation.

 

About The Author

Jonathan L. Cabot

Jonathan is a member of the firm’s Public Finance and Business & Corporate Law Groups.  His practice involves mergers and acquisitions,… Read More

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